US producers’ debt reduction drive loses urgency

US oil and natural gas producers continue to work toward debt reduction goals, but for many the urgency has faded amid continued cost cuts and a rise in crude prices to above where most had pegged their 2019 spending budgets.

Occidental Petroleum cannot escape growing attention on its debt after the company last month leap-frogged Chevron in a bid to acquire Anadarko. Investors worry that the deal may have overstretched the company's balance sheet. But chief financial officer Cedric Burgher seeks to allay those fears, partly thanks to the firm's $10bn backing from investment group Berkshire Hathaway. With divestments of $10bn-$15bn planned after the merger, Oxy predicts its debt will be less than two times its earnings before tax at a crude price of $60/bl by 2021. This rises to just over two times at $50/bl, which is still "manageable", Burgher says.

Share prices of many US onshore producers have lagged gains across the broader stock market partly because investors remain wary of the companies' ability to service debt in a volatile oil market. Companies borrowed heavily earlier this decade at near-zero interest rates to fund output growth plans. While operators have been able to steadily lower costs and cap spending to generate free cash flow, they may still struggle to juggle funding capital expenditure (capex), growing dividends and repaying debt.

Balance sheet strain may get more acute as 52pc of debt is due within the next seven years, peaking at just under $30bn by 2022, consultancy Rystad Energy says. To pay the debt at a crude price of $50/bl, many producers may have to significantly lower their dividends. Companies like ConocoPhillips have been able to significantly cut debt, but that has been funded largely through multi-billion dollar asset divestments.

ConocoPhillips' net debt fell by nearly a third on the year to $8.7bn in the first quarter. The firm was sitting on $6.2bn of cash at the end of March compared with just under $5bn a year earlier. Further debt reduction remains an option, but "I do not think we will be comfortable taking net debt down to zero", chief financial officer Don Wallette says. A sizable cash position will allow ConocoPhillips to consider opportunistic acquisitions. "We view the balance sheet in general and cash balances in particular as strategic assets and the source of competitive advantage," Wallette says.

Devon Energy is the latest to take the divestment route to pare debt, shedding its Canadian assets for $2.8bn. But for other US independents, debt reduction no longer appears to be front and center of investors' minds.

Maintaining discipline

Capital discipline and rising cash flows as a result of higher oil prices in the first quarter are helping companies to continue shoring up balance sheets. Many producers' net debt fell at the end of the first quarter compared with a year earlier. Exceptions were Concho Resources, whose debt spiked on the back of its $9.5bn acquisition of RSP Permian last year, and Hess, which is investing in the Stabroek deepwater project offshore Guyana.

Key Bakken producer Continental Resources' net debt fell by nearly 10pc year on year to $5.5bn in the first quarter, and while it rose slightly against the $5.48bn in October-December 2018, the firm is confident of cutting debt to $5bn this year. The firm's incremental cash flow, if crude prices hold, may allow it to bring net debt far lower, to about $4.2bn, chief financial officer John Hart says. Fellow Bakken producer Whiting Petroleum is betting that its recently expanded hedge position will allow it "to take every free cash flow dollar we can and to pay down our debt," chief executive Bradley Holly says.