In Shakespeare’s Henry IV Part 2, the newly crowned King Henry V renounces the wildness of his youth. “Presume not that I am the thing I was, for God doth know, so shall the world perceive, that I have turned away my former self,” he says. It could be a motto for the US-independent oil and gas sector.
All the evidence from corporate strategies and capital allocation decisions suggests that in the past three years or so, the North American exploration and production industry has reached maturity. The implications for world oil markets are profound.
In the 2010s, the US was seen as “the new swing producer”, responding quickly to price changes with increased or decreased supply. For North American E&P companies today, stability is the watchword. The aim is to avoid those rapid responses and to stick to robust long-term plans that are resilient to fluctuations in commodity prices. The days of the US acting as a swing producer may be receding into history.
Earlier this month, the OPEC+ countries agreed to extend their existing crude production cuts to the end of 2024, and Saudi Arabia announced an additional one million barrels per day reduction for July. One obvious question following that move is what US producers will do in response. The answer, based on the current strategic positioning of most of the industry, seems to be “not much”.
Back in the 2010s, US E&Ps would respond not just to actual changes in global oil supply and demand, but even to expected changes signaled by OPEC, by ramping drilling and completions activity up or down. Today, Wood Mackenzie analysts do not expect much change to US companies’ plans.
We are forecasting that US Lower 48 oil production will grow by about 700,000 b/d in 2023 compared to 2022, broadly in line with last year’s increase. And we expect that growth in 2024 and 2025 will be similar.
“It’s not stagnation. Companies are still growing,” says Ryan Duman, a principal analyst with our US Lower 48 Upstream research team. “It’s just very different from what we saw in 2018. It’s predictable, financially sustainable growth.”
In 2018, US Lower 48 oil production rose by about 1.5 million b/d, followed by a 1.2 million b/d increase in 2019. But since then, the industry has moved away from the “growth at all costs” mindset that characterized the first phase of the shale revolution.
The independent oil and gas companies, led by the larger producers such as ConocoPhillips, EOG Resources, and Devon Energy, but including many others as well, have been adopting capital frameworks that are intended to be stable through the ups and downs of commodity cycles. The strategic approach is closer to that of the oil and gas Majors than to fast-growing startups in an emerging industry.
The E&P companies’ investment case is based not on growth prospects, which was what mattered in the early years of the shale boom, but on returning cash to shareholders. That can be through dividends, both regular and variable, and share buybacks. Companies are aiming for slow but steady growth in production, with higher cash distributions when commodity prices are high, and limited downside when they are low.
When oil and gas prices soared last year, the US independent oil and gas companies operating cash flow hit a new record at US$157 billion, up about 75% from 2021. Under the old E&P business model, that cash would have been used to fuel an investment boom. But instead, companies used roughly half of that cash for share buybacks, dividends, and paying down debt. The proportion of operating cash flow reinvested in capital spending dropped to just 36%.
“When commodity prices rise, US E&Ps don’t anymore all say ‘let’s add more rigs’,” Duman says. “They say ‘Let’s return more cash to shareholders in dividends and share buybacks’.”
In the first quarter of this year, with oil and gas prices lower, that reinvestment rate rose to about 60%. But that is still low by the standards of the 2010s, when the US onshore industry regularly ran at reinvestment rates of well over 100%, with capital spending greater than operating cash flow.
There have been some signs that investors are starting to reward this new capital discipline. The S&P Oil & Gas Exploration & Production Select Industry Index is broadly unchanged over the past 12 months, while WTI crude is down about 33% over the same period and Henry Hub gas is down about 60%.
However, Duman believes that shareholders will still need time to be certain that these new attitudes among US E&P companies are permanent. “The companies will need several years of this business model working to really convince investors that they have changed,” he says.
And just as investors will need time to adjust, the rest of the world will have to come to terms with the idea that the US oil industry’s wild days really are behind it.
Source : Hellenic Shipping News
