In Part I of our Themes from Q1 Earnings, there was cautious optimism in the E&P space as most of the operators we tracked reported relatively stable performance. In the Q2 E&P operator earnings calls, there was continued discussion of positive free cash flow, as well as deleveraging and a return of capital to shareholders. Notably, commentary regarding any tax implications arising from Washington was absent this time around, and previously outlined ESG initiatives, perhaps not surprisingly, were also all well on track, if not better, this quarter than in Q1. In this latest round of earnings calls, however, the primary themes were nuanced with indications of tempered growth plans, and continued growth in free cash flow stemming from increased operational efficiency in spite of projected inflation.

Maturing Industry

Chief among the near-term concerns addressed in the Q1 E&P operator earnings calls was the general consensus that significant production growth was not desirable, as the industry was maturing and consolidating, with steady operations being the forward-looking game plan. This sentiment proved out in the Q2 earnings calls.

• “As we look at supply and demand fundamentals, oil supply is still purposely being withheld from the market, and we continue to believe there’s not a call on U.S. shale production growth. We will continue, therefore, to target flat oil production for the foreseeable future and plan to do that by completing less wells than originally planned this year.” – Travis Stice, CEO, Diamondback Energy
• “I think like we’ve said kind of through the year, we’d rather sacrifice capital or cut capital in lieu of growing production. So if you keep beating production estimates and raising your baseline for staying flat, that’s really growth. And so we really don’t want that.” – Kaes Van’t Hof, CFO, Diamondback Energy

The one possible exception was from Pioneer Natural Resources, which did set a positive production growth rate target, albeit in the mid-single digits.

• “It’s a little too early for us to comment on the details, specifically for 2022 capex and production. But I’d tell you that we’re committed to our investment framework that yields that maximum of 5% oil growth for 2022.” –
  Richard Dealy, President and COO, Pioneer Natural Resources

Operational Efficiency vs. Cost Inflation

Another undertone of the Q1 earnings calls was the anticipation of increased cost inflation from field service providers (and labor, generally). This theme also came to the forefront in the Q2 earnings call, with the added elements of commodity price increases. However, tying with the concession by E&P operators that this is a maturing industry, operational efficiencies were also on the rise.

• “We lowered our wells a million per well, a million per well, with hundreds and hundreds of wells to go. And today, we’re trying to get off the cost per foot and talk about the pumping time during the day and the time that we complete wells and how much our rate of penetration because if the time has improved and you’re a million dollars less per well, it’s going to be hard for service companies to take that away from us, very hard.” –
  Roger Jenkins, President and CEO, Murphy Oil
• “We’re seeing kind of lower single-digit inflation this year and it has been driven primarily by OCTG, so still the raw material availability and even capacity constraints are kicking in. … We have seen a little bit of pressure in other areas like fuels, chemicals, transportation-related services tied to WTI. We’re seeing some labor challenges rear its head from time to time. What I would say is we are managing to manage all of those and we’re doing that through probably a couple of areas. Just increased competitiveness and tendering, so kind of leveraging more competitive tendering and just manage competition. I’d also say we’re delivering offsetting efficiency improvements in other areas of the business that’s helping us and I think ultimately it’s showing up in our metrics.” – Mike Henderson, Executive VP, Murphy Oil

Return of Capital to Shareholders

Tying into the themes of stable operations and growth in free cash flow, return of capital to shareholders was a prominent selling point in among Q2 E&P operator earnings calls.

• “We’ve signaled very clearly an evolution in our guidance by talking about 50% going back to the shareholders. And that evolution and guidance is also reflective of a maturation of our business.” – Travis Stice, CEO, Diamondback Energy
• “Day-to-day, we will continue to look at opportunities that we can find similar situations where we can add great assets, overlay our expertise and knowledge base, deliver synergies, make them better, and deliver those types of operational results plus financial outcomes that are going to further our deleveraging plans. Get us in a position to be thinking about how we potentially return capital to shareholders.” – Joe Gatto, President and CEO, Callon Petroleum
• “Our budget is our budget, and we won’t raise our spending levels with stronger commodity prices, but we’ll simply generate more free cash flow. Supported by such strong performance, we have just raised our quarterly base dividend by 25%. This is the second quarter in a row that we have increased our base dividend.” – Lee Tillman, Chair, President and CEO, Marathon Oil

On the Horizon

While tempered growth was projected among the publicly traded E&P operators, at least one executive noted that, “…the private companies out here in the Permian are really leaning into this higher commodity price, notwithstanding the fact that the forward curve is $20 disconnected from today’s price. …It’s a little bit too early to see what the effect is going to be. But I think the more quarters that pass where public companies are exercising the discipline of flat production, I think is what our industry needs. And the privates will have an impact on the overall equation. But I think the macro element won’t really change.” (Travis Stice, CEO, Diamondback Energy). Several notions come to mind with this prospect. Will the cream rise to the top and be taken up through consolidation by way of M&A activity, or will these independent try to stay low, just within the scope of private equity? Or, and this is a big “or”, will some seek to go public via IPOs or SPACs? Is it too early to ask for Q3 earnings calls to see how it shakes out?

Conclusion

Mercer Capital has its finger on the pulse of the E&P operator space. As the oil and gas industry evolves through these pivotal times, we take a holistic perspective to bring you thoughtful analysis and commentary regarding the full hydrocarbon stream. For more targeted energy sector analysis to meet your valuation needs, please contact the Mercer Capital Oil & Gas Team for further assistance.