The energy sector in the third quarter has experienced a general decline as crude prices have exhibited volatility and have remained depressed relative to last year. U.S. producers continue to cut rigs and capital expenditures due to continued excess supply and concerns of declining demand. In this post, we examine some of the most discussed items and trends from the Q3 earnings calls, specifically E&P companies and those in the mineral aggregator space.
E&Ps experienced mixed earnings although many beat expectations and were cash flow positive as the industry has been trending in this direction. The two major topics discussed in E&P earnings calls have been capital discipline and treatment of free cash flow.
Capital Discipline: Doing More with Less
- We also want to highlight our capital discipline. Third quarter non-acquisition CapEx came in slightly lower than the second quarter and almost 10% lower than the first quarter. As we look to the fourth quarter, we continue to expect CapEx to be significantly lower around $550 million. Each quarter it’s been lower throughout the year. This is by design as we expect to be roughly in line with CapEx expectations for the year. -John Hart, CFO, Continental Resources
- I’m happy to report that the third quarter operating cash flow before working capital changes of $706 million exceeded exploration and development capital of $670 million. This marks an important return to free cash generation for the company primarily driven by better capital cost. -Jack Harper, President, Concho Resources
- As we move forward as a combined company, our commitment to capital discipline and returning capital to shareholders remains unchanged. We remain on track to spend within our full year pro forma combined capital budget of $8.6 billion, excluding Africa. Furthermore, we have established a capital budget for 2020 that we expect will fully optimize free cash flow and position us to grow production in a capital-efficient manner while maintaining the safety of our dividend. -Cedric Burgher, SVP & CFO, Occidental Petroleum Corp
The topic of capex budgets and spending has been a major talking point for E&P companies since the oil and gas market took a big hit at the end of 2018. Rising prices for the first three quarters of 2018 begat exuberance, and producers below through their budgets only to see prices fall precipitously. Uncertainties surrounding future commodity prices as well as diminishing capital outlays from the public and private markets forced companies to trim capital budgets and rigidly stick to them to ensure that free cash flow generation was positive.
Uncertainties surrounding future commodity prices as well as diminishing capital outlays has forced companies to trim capital budgets.
Many of these companies for the first six months of the year were near or over budget in capital spending. And while capital expenditures may be frontloaded for various reasons, a consequence of trying to remain in bounds of the budget has been decreasing active rig counts during the year.
However, the reduction in rigs counts for several companies has allowed for more strategic capex dollars to be spent on target infrastructure resulting in improvements in cost per foot. Overall the efficiencies and cost savings have enabled companies to be free cash flow positive for the third quarter.
Where is Free Cash Flow Going?
- As of October 29, we have repurchased 5.5 million shares for $187 million. We plan to continue prioritizing our share buybacks with our excess cash. We see tremendous value in the acquisition of our stock as our share price does not reflect our strong earnings, cash flow and the deep oil-weighted inventory we have for future growth. -John Hart, CFO, Continental Resources, Inc.
- Well, we’re going to look at primarily toward, what is our free cash flow and our free cash flow and I’m debating, I’m still traveling around, we’re going to go out and see all of our long shareholders again early next year. But we’re trying to determine a long-term strategy of what’s best between share buybacks in regard to in addition to increasing the dividend, whether or not to go to variable dividend and balance sheet… we have roughly approximately over the next several years about $5 billion. And so we’re trying to come up with the ideal plan to disperse that in regard to all three of those. Obviously, with two-thirds of that going toward shareholder friendly measures such as buybacks and dividends. -Rich Dealy, EVP & CFO, Pioneer Natural Resources
- …on the how we balance dividend versus stock buybacks. I would say that it would kind of laid out a framework for where we think the free cash flow could be under the different side boards. And I think philosophically you’ll see us kind of increase the dividend more in a systematic way and in a way that we can sustain forever. And then every other dollar that’s available especially at this price, I’m going to be buying stock back. -Tim Leach, CEO, Concho Resources
- Our consistent industry-leading operational results, combined with our ability to fully deliver on value capture, positions us for a full cycle success and enhances our ability to generate increased excess free cash flow to reduce debt and to return cash to shareholders. Returning excess capital to our shareholders is a part of Oxy’s DNA. In the third quarter, we returned approximately $600 million to shareholders. -Vicki Hollub, CEO, Occidental Petroleum Corp.
E&P’s appear to be answering the longtime demands from investors of capital return in the form of dividends and share repurchases. Many companies are continuing large stock repurchase programs through combinations of free cash flow generation and ongoing asset sales. This treatment of free cash flow is a result of the strict capital discipline seen across the industry and may prove to be a worthwhile investment should commodity prices improve going into 2020. External and political changes could help (or mute) this effort.
The trade-off for increased free cash flow is slower production growth.
However, the trade-off for increased free cash flow is slower production growth. Many companies are putting “caps” on growth in order to achieve their desired levels of free cash flow generation. Vicki Hollub of Occidental says in their latest earnings call, “Our intent is to cap our annual production growth at an average of 5% as we balance the vast opportunities in our portfolio with growing free cash flow.”
It’s clear that E&P’s believe that their current stock valuations do not reflect the intrinsic value they think they bring to the table, particularly as commodity prices bounced back from year-end 2018 lows but stock prices received less of a boost. However, excessive share buybacks may put limitations on growth and future production, straining growth of cash flow yield should the commodity environment remain depressed.
Mineral aggregators had mixed earnings in the third quarter of 2019, but were more stable than E&Ps. While Kimbell Royalty Partners realized a record-breaking performance in the quarter, others such as Brigham Minerals seem more concerned with future performance in the face of underwhelming past performance.
Mineral aggregators have had to answer a number of questions regarding potential acquisitions. Although acquisition and divestiture activity is the defining characteristic of the aggregator space, companies among the group seem hesitant to make acquisitions that are perceived as too aggressive at this juncture. The consensus is that it will be worth the wait.
Acquisition Opportunities and Strategies: Playing the Waiting Game
- We are actively searching for those larger transactions and working with those, dialoguing with individuals. And so, I think what’s going to happen is over time and then whether that’s in the next, say, 3-months to 12-months or so, we’ll find that larger transaction, be able to use our equity to acquire with. -Rob Roosa, Founder and CEO, Brigham Minerals
- The macro environment is, frankly, tough right now. And in response to that, we’ve pulled in our horns, some on acquisition–on the acquisition front and are being more selective. We haven’t seen anything that we can’t live without. We’re being a bit more defensive at the moment. And while we’re in that mode, we’ll prioritize paying down the revolver, which will position us for future acquisitions or share repurchases. -Thomas Carter, Chairman and CEO, Black Stone Minerals
- Lastly, the acquisition market remains robust, and we continue to evaluate opportunities across our many basins. We continue to see great value for acreage outside of the Permian Basin, even considering dramatically reduced drilling activity in 2020 and beyond. So while just about everyone else is focused on the Permian and although we continue to evaluate the Permian, we are having more success in other basins with significantly less competition. –Bob Ravnaas, Chairman and CEO, Kimbell Royalty Partners
- That said, in this environment, and with the asset base that we have and the operators we have and the clear growth that’s immediately in front of us, it seems for us inappropriate to dilute that with acquisitions. -Daniel Herz, CEO and President, Falcon Minerals
Although they have an increasingly specific appetite for acquisitions, mineral aggregators have emphasized their preference for larger packaged transactions. Travis Stice, CEO and Director of Viper Energy Partners, demonstrates this strategy as they expanded their footprint in the Permian via large acquisitions during the third quarter. Large swaths of contiguous acreage continue to be more valuable to aggregators, which opens up the market opportunity for larger players to come in and consolidate some of these mineral owners and sell the combined acreage at a premium. It will be interesting to monitor the transactions space to determine whether the waiting game will pay off.