By: Scott Carpenter – Forbes – Gone are the days when shale oil and gas companies could persuade investors to write checks by simply pumping lots of oil. These days a different and more conservative class of investor commands influence in the shale industry, demanding not head-turning oil production figures but consistent shareholder returns, positive free cash flow, and a smaller environmental footprint.
“The investor community that stuck with [the shale industry] is the steady ones, that want discipline, that want predictability,” said Regina Mayor, global head of energy at accounting firm KPMG, in an interview. “That’s the investor base they are all pandering to now. The growth investors are gone.”
Despite turning America into the world’s top oil-producing country, the U.S. shale oil industry succeeded in alienating the investors who enabled its astounding growth. Between 2010 and 2020 the industry had negative net free cash flows of $300 billion, more than the annual revenue of Exxon Mobil, according to a study last year by accounting firm Deloitte. Disillusioned venture capital firms and other high-growth-seeking funds were already exiting the sector before the pandemic, but the virus-caused oil rout accelerated their retreat.
Shale firms have now shifted focus to holding on to the investors that remain.
“They still have a mountain of debt, they have a bad track record, and they know that everybody doesn’t like them,” said Raoul LeBlanc, a vice president at IHS Markit, a research and analysis firm, in an interview. “So they’re really focused on trying to show that shale can be profitable.”
So far, the industry has shown commitment to that goal. Even as WTI oil prices return to pre-pandemic levels of just above $60 per barrel, shale producers are choosing to conserve cash rather than spend it on new production. Total spending on new equipment (capital expenditure or CAPEX) this year will be roughly the same as in 2020, a year when many operators made drastic cuts, according to a note by the consultancy Rystad Energy earlier this month. And despite rising oil prices, the weekly count of rigs drilling for new oil or gas in the U.S. — a common measure of future production levels and willingness to spend cash — is still well below before the pandemic.
This has meant a larger share of earnings is left over to hand back to shareholders. Historically shale companies have reinvested all of their discretionary cash flow back into new capital spending and then borrowed extra to reinvest on top of that. But now this reinvestment rate, once as high as 110-130% of cash flows, has now fallen to a far more frugal 60-65% or less, according to IHS Markit’s LeBlanc.
Investors don’t just want capital discipline; they are also clamoring for firms to reign in emissions and clean up bad practices such as methane flaring. Many of the largest institutional investors in the sector have now adopted protocols that require them to carefully scrutinize their holdings in fossil fuels.
Shale firms don’t want to get caught in the crosshairs. “The concern shale firms have is, ‘We really have to get in front of this ESG thing’,” said Scott Hanold, managing director of energy research at investment bank RBC Capital Markets, in an interview.
Several big shale firms have recently unveiled net-zero or reduced greenhouse gas emissions targets. In November Occidental Petroleum became the first major U.S. oil company to announce a net-zero target that included emissions from its own products. Pioneer Natural Resources recently has set a 2030 target to reduce its greenhouse gas intensity. And in a potentially seismic shift, the oil industry’s main lobbying arm, the American Petroleum Institute (API), this month endorsed putting a price on carbon, something that would previously have been anathema to the organization. Such a policy could help turn uneconomic carbon abatement strategies, such as direct air capture, into profitable activities.
There is “a lot of new information coming from the producers” about environmental sustainability, said Alisa Lukash, a senior analyst at Rystad, in an interview.
Besides the new targets, the industry’s new mantra was on display recently at the year’s big annual oil and gas conference, CERAweek. Typically featuring mainly talks by big oil and gas players, this year’s event gave top billing to Bill Gates, who extolled green hydrogen, and John Kerry, the U.S. Special Presidential Envoy for Climate.
Rising prices will test new creed of shale drillers
How serious is the shale industry about its new creed of cash conservation and environmental concern? Rising oil prices will quickly put that question to the test.
Goldman Sachs recently forecast that barrels of Brent crude oil could hit $75 by this summer, up from around $60 per barrel currently. At such prices, it’s much more tempting for producers to shift money back into new capital spending and to ramp up production, even if it comes at the expense of building up cash.
“There’s a small group of us that follow these companies and we always joke, ‘No, but this time it’s different!’ Right. Nobody believes that it really will be different this time,” said Mayor, the KPMG energy head.
At the same time, however, the chief executives of all of the top 10 big shale firms made strong commitments about their restrained spending priorities to shareholders this earnings season, and aside from an uptick in production plans by privately owned shale firms, so far the big independent players are sticking to their budgets. Based on her personal knowledge of the energy chiefs making these pledges, Mayor said, she believes that the firms will live up to their commitments.
For a while, anyway: if by 2022 WTI oil prices are still at $65 per barrel, she added, “All bets are off.”