The cash flow question

Author Manash Goswami, Senior Reporter

Will US shale producers stick to their budgets and stay within cash flow, or will higher oil prices reignite the spending?

Investors get to play another round of that quarterly guessing game – “Will they or won’t they?” – when US oil and gas producers begin to unveil their third quarter earnings later this month.

Will they stay disciplined and stay within budgets, and continue to shore up their balance sheets? Or will they announce large upward revisions in spending, as expectations of stable crude prices bring back the old all-bets-are-off bullishness?”

The US shale industry has consistently managed to surprise investors and market-watchers since emerging as a major contributor to global supply. From digging in its heels to withstand a sub-$30/bl oil market, to cost reductions and technology innovations, producers have proven to be resilient in the face of challenge.

But a persistent disappointment across the sector has been a lack of success in generating free cash flow from operations. It wasn’t that big a deal when oil was above $100/bl back in 2014, and near-zero interest rates meant there were enough funds to go around. But investors are getting impatient, as share performance of US independents have largely lagged gains both in crude prices and the broader equities market.

The impatience is understandable. According to a Moody’s Investors Service report, the North American oil and gas industry has $240bn in debt due through 2023. Of that, E&P (exploration and production) companies have the largest share, at about $93bn, and the remaining is with oilfield services and midstream firms. Maturities peak in 2022 at $68bn compared with $32bn due in 2019. 

Companies have bowed to the pressure, so far. Aside from higher oil revenues, they have used proceeds from large asset sales to reduce borrowing. Some big-ticket US mergers and acquisitions (M&A) include Diamondback Energy’s purchase of fellow Permian producer Energen in the third quarter. More recently, Encana sold is San Juan basin assets in New Mexico for $480mn.

But some large independents like Occidental Petroleum, Apache and Anadarko have already revised their 2018 spending plans up in the second quarter. And with oil prices holding stronger this quarter, others could follow. 

Returning to an aggressive expansion spree may, however, weigh on crude prices, exacerbating the unconventional industry’s financial stress.