Where America’s Oil Majors Stand as Prices Fall
(Bloomberg Opinion) -- No sooner did North America’s energy majors finish up a mostly positive earnings season but the oil market took a swan dive. These two things aren’t entirely unrelated; the E&P industry’s success at boosting supply stokes fears of a renewed glut.
But the other critical element is spending and, in particular, keeping a lid on it while still growing output. On that front, third-quarter earnings were much better than the previous set, which were replete with budget increases but not much to show for them.
So with the numbers in, guidance updated, and forecasts recalibrated, the chart below looks at how the biggest oil and gas producers in North America are performing on two important metrics: free cash flow yield and production growth. Using the Bloomberg Terminal, I screened integrated and E&P companies based in North America with a market cap of $10 billion or more, with 21 making the cut:
At a high level, things are as you would expect. Higher-growth companies — particularly in the top-left area — generally yield less as they are reinvest more of their earnings. The group slopes down and to the right, as lower-growth companies — especially the larger ones — generate more free cash flow.
Here are three observations:
- The Big Divide: A clear gap has opened up between the two supermajors, Exxon Mobil Corp. and Chevron Corp. A few years ago, Chevron was like a distended python swallowing an alligator, its budget swollen by a string of mega-projects. Now that those are digested and spending has abated, the company is enjoying growth from new projects and free cash flow.
In contrast, Exxon’s production growth through 2020 is expected to be the weakest of the entire group, and it is spending heavily on new projects. Forecast free cash flow of $39 billion over the next two years isn’t small. But there’s no sign of buybacks returning. Moreover, it is smaller than Chevron’s $41 billion, and Chevron’s market cap is a third smaller (and it has started buying back stock again).
Meanwhile, ConocoPhillips may lack the integrated model of Exxon and Chevron, but is the biggest E&P company out there and offers a better combination of growth and free cash flow than either of them.
- The Sweeter Spot?: If Chevron and Conoco are in the sweet spot for bigger oil producers, look further up the chart and you’ll see the likes of Anadarko Petroleum Corp., Continental Resources Inc., and EOG Resources Inc. This middle tier of E&P companies offer supermajor-like free cash flow yields but much higher growth rates. Anadarko has been preaching payouts and returns over growth for more than a year now, revitalizing its stock (at least until the recent sell-off in oil).
EOG, meanwhile, has now racked up four quarters in a row of positive free cash flow. While a bump in the capex budget spooked investors when the company reported earnings, forecasts imply EOG providing a similar cash flow yield to Exxon but with production growing eight times as fast. Similar to Exxon, calls for EOG to start buying back stock are likely to grow if those cash flow forecasts turn out right.
Occidental Petroleum Corp. and Marathon Oil Corp. also offer a mini-model of the majors, with high free cash flow yields and some diversification across different regions and businesses, but offering higher growth centered on their shale operations.
- Northern Exposure: No one yields more than those Canadians in the bottom right. Oil sands might not offer much in the way of growth, but their leverage to oil prices and low depletion rates make for a lot of cash flow. But beware.
First, Canadian Natural Resources Ltd. and Cenovus Energy Inc. are trying to cut their debt piles, so some of that free cash flow will go to bondholders rather than shareholders. Second, leverage to oil prices means the recent sell-off could rein in those cash flow forecasts significantly. That’s especially so considering Canadian crude is suffering huge discounts due to logistical bottlenecks that make the Permian basin’s problems look easy. While the rest of the industry takes fright at sub-$70 Brent crude oil, barrels in western Canada go for $16. Cenovus took the extraordinary step this week of calling on the Albertan government to mandate production restrictions (a bit like OPEC, eh?) Meanwhile, new rules on emissions from ships due to come into force in 2020 present a risk to Canadian producers of heavy, sour barrels (see this).
Suncor Energy Inc. stands apart in several respects. Leverage, along with sensitivity to Canadian crude oil discounts, is lower, the latter reflecting Suncor’s greater degree of downstream integration. Production growth of high single-digits a year is more like that of an Occidental or Marathon than a supermajor. As if to reaffirm this, Suncor recently bumped up its buyback program from $2 billion to $3 billion.
In a week as bad as this one for oil, the most pertinent thing to keep in mind is that all forecasts are subject to change. If the industry really has learned the lesson of the past few years, it is the yield axis on that chart that should dominate planning. It is almost certainly where the firmest support lies in this market.
—Graphic by Elaine He
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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