In Part 1: Themes from Q2 2022 Earnings Calls, the common themes among E&P operators and mineral aggregators calls included the strengthening of balance sheets to offset price volatility, the increasing role of share buybacks, and the persistence of supply and demand imbalances.  This week we focus on the key takeaways from the Upstream Q3 2022 earnings calls. 

Continued Focus on Share Buybacks

As we noted in our analysis of last quarter’s earnings calls, E&P operators and mineral aggregators have seen exceptional profitability since the start of the upcycle in late 2021; companies accentuated paying down their debt and distributing to shareholders.  With the continuance of stable cash flows, the role of share buybacks has increased as a source of returns in lieu of bolt-on acquisitions or other investment opportunities.

• “Look, we’ve seen the volatility in the market that every quarter, we’ve had the opportunity to buy shares back, and when that opportunity presents itself, we’ll do so aggressively.  I think the key to any of those questions is the ability to generate free cash flow.  And that’s certainly what our focus is… [as well as] maintaining the flexibility on how the return of that free cash flow gets prosecuted. I will say that in conversations with our long-only shareholders,  a lot of those guys prefer to get the cash back.  But again, we believe that we’ll have opportunities to repurchase shares back.”
  – Travis Stice, CEO & Chairman, Diamondback Energy Inc.
• “While we had guided third quarter return of capital to at least 50% of our CFO due to strong operating and financial performance, our financial strength, including our replenished cash balance and favorable market conditions, [and] including clear value in our stock price, we saw an opportunity to materially step-up the pace of repurchases.  We bought back $1.1 billion of stock during the third quarter.”
  – Dane Whitehead, Executive Vice President and CFO, Marathon Oil Corp.
• “On the capital allocation side… we continue to take advantage of current equity market conditions by repurchasing 8.4 million shares in the quarter and another 3.2 million shares after the close of the quarter through October 21.  Said differently, we bought back another 4% of our total shares outstanding.  And over the last eight quarters, we have repurchased approximately 20% of the outstanding shares of the company.  We continue to see this as a remarkable low-risk capital allocation opportunity moving forward.  And although we have not given an explicit capital allocation framework, if you extrapolate these levels of buybacks moving forward, you can see that we will continue to dramatically reduce our denominator and thereby meaningfully grow our free cash flow per share.”
  – Alan Shepard, CFO, CNX Resources Corp. 

Moderate Production Growth

As a consequence of a favorable pricing environment and continued tightness on the supply side, industry operators are increasing production in order to capitalize on strong market conditions. Ultimately, firms may not be able to fully capitalize on high prices due to increased labor and equipment costs as well as other miscellaneous supply-side challenges.

• “We generated total production volumes for the quarter of 40,000 Boe per day, an increase of 19% over our second quarter volumes.  All that increase was from royalty volumes, which were up 23% to 37,300 Boe per day.  Our base production is trending up as development activity remains robust across our acreage and as our target development programs with operators in the Shelby Trough, Haynesville and East Texas, Austin Chalk continue taking shape, while growing and moving forward.  Production from the quarter exceeded expectations due to certain operators, particularly in Louisiana Haynesville, bringing new wells on line at more aggressive initial flow rates to take advantage of higher natural gas prices.”
  – Tom Carter, Chairman and CEO, Black Stone Minerals, L.P.
• “We posted strong results this quarter that were underpinned by sequential production growth of 7% on a BOE basis and 8% on an oil-only basis, exceeding both our guidance and consensus estimates.  These gains were driven by well performance that was above expectations and consistent execution in the field, particularly on the completions front with reduced cycle times in the Permian and Eagle Ford.  At a bigger picture level, our commitment to a life of field development philosophy of our multi-zone resource base, paired with continuous improvements in drilling and completion designs, has resulted in year-over-year improvements in Callon’s well performance at a time when concerns around inventory degradation are increasingly becoming a focal point of the industry.”
  – Joe Gatto, President & CEO, Callon Petroleum
• “I think there is asset maturation.  I think certainly, supply chain constraints are also limiting growth… I think all of those factors weigh into more of a muted production growth from US shale going forward. That said, out here in the Permian, I think we’re still continuing to hit production records every month, somewhere close to 5.3 million to 5.5 million barrels a day. But that’s going to be challenged to continue to grow that into the future. Do we have the assets out here?  Yes, we do.  But some of those other topical constraints that I mentioned are going to be impediments to efficient growth.”
  – Travis Stice, CEO & Chairman, Diamondback Energy Inc.
• “I think, just generally we see some large pads coming on [in] Q2 and beyond… The Diamondback piece, which we have 100% visibility on, will grow 10%.  It’s just going to start growing in Q2 and Q3… the way we see it right now is basically flat oil from Q3, which was an all-time high into Q4 and Q1 and then the ramp starts to begin again in… Q2 of next year.”
  – Kaes Van’t Hof, President, Viper Energy Partners, L.P.

Inflation Continues To Limit Growth

The current high-price environment incentivizes operators to grow rapidly.  While most industry participants certainly would like to increase the scale of their output, multiple executives discussed how high inflation has constrained their efforts.  The impact from inflation is evident in multiple areas, but especially in the cost of raw materials and labor.

• “One of the major topics of the year continues to be the inflation story.  The price pressure we are seeing on steel, fuel and labor continues to be persistent.  Our employees are maintaining their focus on finding ways to mitigate inflation through innovation and efficiencies in our operations.  Through their efforts, we now expect our average well cost to increase a modest 7% as compared to last year.”
  – Billy Helms, President, and COO, EOG Resources Inc.
• “The biggest concern we’ve got is not so much labor inflation or service inflation outside the company as much as it is… the quality of the available labor set or the quality of the available service skill set.  And that’s where we spent most of our time.  So it’s not just the easy question of will the individuals and the service provider be available.  It’s more a question of can we get the best of the individuals and the best of the service providers available.”
  – Nicholas Deluliis, President, CEO & Director, CNX Resources Corp.
• “Casing has been a massive headwind for us and for the industry.  Midland Basin casing is now $110 a foot, that is a huge number of… fixed cost that we can’t really control here.”
  – Kaes Van’t Hof, President & CFO, Diamondback Energy Inc.
• “I think on the labor inflation side, that’s subject to kind of more of the macro environment.  I mean you could potentially paint a scenario where if the company slips — or the country slips into recession, some of those pressures ease.  And conversely, if we avoid that, you can continue to see pressure on those fronts.  So again, this just goes back to kind of the wider guidance we provided on this call, and then we’ll have some more color as we move forward.  I think we’ll know a lot more a quarter from now about where things are headed.”
  – Alan Shepard, CFO, CNX Resources Corp.

Mercer Capital has its finger on the pulse of the minerals market.  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, including the E&P operators and mineral aggregators comprising the upstream space.  For more targeted energy sector analysis to meet your valuation needs, please contact the Mercer Capital Oil & Gas Team for further assistance.