Investors sent a surprising message to U.S. shale producers as crude fell almost 20 percent in August: keep calm and drill on.
While most oil stocks have fallen sharply this month, the least affected by the slump share one thing in common: they don’t plan to slow down, even though a glut of supply is forcing prices down. Cimarex Energy Co. jumped more than 8 percent in two days after executives said Aug. 5 that their rig count would more than double next year. Pioneer Natural Resources Co. rallied for three days when it disclosed a similar increase.
Shareholders continue to favor growth over returns, helping explain why companies that form the engine of U.S. oil -- the frackers behind the boom -- aren’t slowing down enough to rebalance the market. U.S. production has remained high, frustrating OPEC’s strategy of maintaining market share and enlarging a glut that has pushed oil below $40 a barrel. West Texas Intermediate crude was trading at $39.08 a barrel, down 23 cents, at 1:03 p.m. New York time Wednesday.
“These companies have always been rewarded for growth,” according to Manuj Nikhanj, head of energy research for ITG Investment Research in Calgary. Now though, “the balance sheets of this sector are so challenged that investors are going to have to look at other factors,” he said.
Output from 58 shale producers rose 19 percent in the past year, according to data compiled by Bloomberg. Despite cutting spending by $21.7 billion, the group pumped 4 percent more in the second quarter than in the last three months of 2014.
That’s buoyed overall U.S. output, which has only drifted lower after peaking at a four-decade high in June. The government estimates production will slide 8 percent from the second quarter of this year to the third quarter of 2016.
The Organization of Petroleum Exporting Countries has been pumping above its target for more than a year. The oversupply may worsen if Iran is allowed to boost exports should it strike a deal with the U.S. and five other world powers to curb the Islamic Republic’s nuclear program.
Growth has been a key pillar of the revolution that helped transform the U.S. into the world’s largest producer of oil and gas. Frenzied drilling often distinguished the new technology’s winners, while profits or free cash flow were less important.
Even amid the worst price crash in a generation, that continues to be true for some companies. Pioneer is expected to spend$735 million more this year than it generates in cash. Cimarex, which lost almost $1 billion from January to June, has fallen just 6.4 percent so far in 2015 even as U.S. crude declined by more than a quarter.
Executives defend the grow-at-all-costs strategy by saying they’ve changed their methods to be more efficient. Costs for some companies have fallen more than 20 percent, according to Bloomberg Intelligence, and higher productivity has improved the outlook even at $40 oil. Growth is the natural outcome of drilling good wells, according to producers embracing such plans.
“At Cimarex, we’re not shipwreck victims waiting for a rescue ship,” Chief Executive Officer Thomas Jorden said in an investor presentation on Aug. 18. “That ship’s not coming.”
Wait for Rebound
Contrast that with EOG Resources Inc., which has little debt and has allowed its crude output to decline for the first time in eight years.
Chairman and CEO Bill Thomas has repeatedly stressed that returns will be better if the company waits for higher prices, even if the wait is longer than two years. Yet on Aug. 7, when EOG reiterated its plans to choke back the spigot, the stock fell more than 5 percent, the most since January.
For supply and demand to balance for the shale drillers, factors like free cash flow have to start being just as important to shareholders as growth, said Tim Beranek, an energy portfolio manager who helps oversee about $13 billion for Denver-based Cambiar Investors LLC.
“Returning cash to investors has never been rewarded in this space, but that’s going to have to change,” said Beranek, who has made long-term bets on some of the companies, including Cimarex and EOG. “I applaud executives at companies that are choosing not to grow when they know the oil market doesn’t need additional oil.”