Themes from Q3 2020 Earnings Calls
Part 1: E&P Operators
As discussed in our quarterly overview, the oil & gas sector experienced a relatively stable price environment as compared to the volatile energy prices seen in the first half of the year. The third quarter saw the WTI range narrow and hover around $40 per barrel, in line with industry participant expectations of nominally higher prices than in the second quarter.
However, the concurrent overlapping impact of (i) discord created by the OPEC/Russian rift and resulting supply surge; and (ii) the drop in demand due to COVID-19 related issues was historic and continued to play a role in the third quarter. As if COVID-19 and the Russian-Saudi price rift wasn’t eventful enough, the regulatory shakeup expected to come from the Biden administration following the November election will add to the mix for what seems to be an already pressing and critical time for the industry. The unfortunate, overlapping timing of these events has made the bankruptcy courts busy with no indication of that trend coming to a halt.
In this post, we capture the key takeaways from E&P operator third quarter 2020 earnings calls.
Theme 1: Continued Cost Reductions Lower Break-Even Prices
One recurring theme among E&P operators in our prior E&P operator earnings calls was the continued focus on reducing operating costs and capital expenditures in the pursuit of increased efficiencies. All six E&P operators we tracked in our current quarterly overview saw gains along these lines, evident by positive free cash flow in Q3 due to a decline in break-even prices.
- “Yes, we do see the break-even is roughly $32 next year. I don’t think that’s too dissimilar from where we were before we were indicating kind of in the mid-30s. But it depends on the capital program at any given time and where you’re putting those assets and the productivity.” – William Berry, CEO, Continental Resources, Inc.
- “Our pro forma maintenance capital corporate breakeven is at a very, very attractive low — in the low 30s WTI, including the base dividend.” – Scott Sheffield, CEO, Pioneer Natural Resources Company
- “Impressive downside resilience as evidenced by our low-cost structure and enterprise free cash flow breakeven, approximately $35 per barrel WTI breakeven in 2021, including our dividend…” – Lee Tillman, President & CEO, Marathon Oil Company
- “Due to sustainable cost reductions achieved this year, maintenance capital and the current dividend can now be funded with oil in the mid-30s.” – Lloyd Helms, COO, EOG Resources, Inc.
Theme 2: Continued Emphasis on Debt Reduction and Shareholder Dividends
Another recurring theme in our prior quarterly analysis was the focus by E&P operators on reducing debt and reinforcing dividends. The panel of operators we tracked in this quarterly earnings call review was split almost evenly among those who were still focused on debt reduction and those who put the return of capital to shareholders as their top priority.
- “The cornerstone of our 2021 plan is maximizing free cash flow to pay down debt… While our dividend has been suspended, but not terminated, both our shareholders and our board are very supportive of bringing the dividend back at the appropriate time after our debt is reduced.” – William Berry, CEO, Continental Resources, Inc.
- “We are well aware that some of our larger peers are planning to return cash to shareholders. But as we have repeatedly stated, our plan is to apply our free cash flow, alongside our monetization proceeds, towards meaningful debt reduction, until we have significantly lowered our total debt balance.” – Jim Ulm, Chief Financial Officer, Callon Petroleum Company
- “[With respect to the prioritization of allocating free cash flow] the base dividend will be first. And then second, will be a combination of balance sheet and variable dividend.” – Scott Sheffield, CEO, Pioneer Natural Resources Company
- “Put very simply, our forward capital allocation philosophy has not changed. We will protect our dividend, spend maintenance capital at most and use excess free cash flow to pay down debt. If our expected free cash flow will not cover our dividend, then we will cut capital to ensure our dividend is protected.” – Travis Stice, CEO, Diamondback Energy, Inc.
- “[W]e are putting this free cash flow to good use. Advancing our dual objectives of returning capital to our shareholders through our base dividend reinstatement and improving our balance sheet through … gross debt reduction while cutting our 2022 maturity tower in half. Importantly, both the fourth quarter dividend reinstatement and gross debt reduction were fully funded by actual third quarter free cash flow.” – Lee Tillman, President & CEO, Marathon Oil Company
- “We remain committed to pursuing our objective to strengthen our balance sheet further during upturns. Beyond the regular dividend and debt reduction we regularly review performance scenarios that may present options for additional cash return to shareholders. We haven’t ruled out buybacks or a variable or special dividend and we’ll consider all options for additional return of cash to shareholders when the opportunity presents itself.” – Tim Driggers, CFO, EOG Resources, Inc.
Theme 3: Uncertainty Lies Ahead
Despite the relative stability of oil and gas prices in the third quarter, E&P operators continue to project significant uncertainty for their industry. The critical near-term factors affecting their forward outlook include regulatory changes for the oil and gas industry as put forth by the Biden administration, an upcoming meeting of OPEC+ producers in December, and the potential timeline of effective and available vaccines to curb the energy demand shock brought on by the COVID-19 pandemic.
- “There’s certainly some significant headwinds on the commodity space right now. I mean we’ve got the election uncertainty and looming policy changes… We’ve got COVID that we’re still struggling how to contain that. And is there going to be a vaccine anytime soon, and what does that mean to the supply demand recovery? We’ve got OPEC+ meeting in December to talk about whether they maintain cuts or start easing those cuts, and then we’ve got a global inventory overhang that’s still there. All of those are macro issues that I can’t control, and we can’t influence.” – Travis Stice, CEO, Diamondback Energy, Inc.
- “There are still several unknowns that we will continue to evaluate during our budgeting process. The impact of the election, the timing of COVID-19 vaccine and in turn, the return and stabilization of oil demand, especially what OPEC decides to do in during the mid-November to December 1 OPEC meetings.” – Scott Sheffield, CEO, Pioneer Natural Resources Company
On the Horizon
Broadly speaking, the E&P operator earnings calls suggest an uneasy calm. The question is, has the oil and gas industry emerged from the first major quake and should it expect relatively minor aftershocks, or is it in the eye of the storm, experiencing a brief respite before the tempest picks up again? Overall, it is clear that oil and gas operators can not only weather the storm, but still produce free cash flow that is significant enough to shore up the balance sheet and return capital to shareholders while concurrently maintaining lean operational and capital programs. This modus operandi, however, comes at the cost of highly subdued expectations for growth (with one noted exception among the six E&P operators we monitor).
Throughout the earnings calls, we noted that management outlooks that included flat or even slight production declines over the near-term horizon were not considered to be “downside” scenarios, but evidence of, if nothing else, at least sustainable ongoing operations. Additionally, we noted that at least half the E&P operators discussed continued efforts to support and advance various ESG initiatives, including proactively reducing emissions, and imparting stronger positive impacts on the local communities in which the companies operate.
Regarding M&A activity, there was not much commentary regarding overall industry trends, but the overriding thesis was brought up in a number of calls that the focus of any such activity should be on “not necessarily bigger, but better.”