Oil and Gas Investors’ Happy Place, Brought to You by the Letters M and A

Production growth is limited by investment, and investors want fewer and larger companies, Wood Mackenzie’s Benjamin Shattuck says. Here’s how the oil and gas industry can return to growth.

Lay of the Land

The U.S. #oilandgas sector's met the elevated global energy demand, Shattuck says. North American rig counts are up 28% in 2022, with oil rigs rising 23.5% and natural gas rigs a whopping 46.7%

At a recent Baker Institute for Public Policy event, WoodMac’s research director for Americas upstream oil and gas said that, after spending 130%-140% of cash flow on an annualized basis in the 2010s, “we came into this decade with, effectively, a financial hangover. After years of talking about capital discipline, we started to see some of that being implemented in the end of ’19 coming through ’20.”

Outlier Years

#HartEnergy has created a chart based on Wood Mackenzie's reach team, Shattuck's insights, and data from the U.S. Energy Information Administration. It aims to show how oil price and output from the #shale sector had a strong connection up through 2020.

Note that this chart is not chronological.

The x-axis represents the average annual price of a barrel of #WTI. The y-axis represents the change in WTI production from year to year. So, to plot 2015, subtract 2014’s average daily output (about 8.75 MMbbl/d) from 2015’s (about 9.4 MMbbl/d) to get 650,000 bbl/d. The average price for the year was $49/bbl, so the vertical is 650, the horizontal is 49.

“For all of last decade, there was a pretty tight correlation between oil price and output from the shale sector.” - Benjamin Shattuck

The pattern ended in 2021, and the outliers continued this year and are projected to hit next year.

“These are representative, obviously, of unprecedented circumstances within the space, but they also represent a shift in mindset that we think is structural in the sector moving forward,” Shattuck said.

Show Investors the Money

After a decade of companies using excess cash flow for growth, #investors are ready to see that money returned to them moving forward. It's also part of the investor mindset to curb growth and avoid volatility.

“The reason investors don’t want that to happen is every time title grows too fast, returns are driven downward,” Shattuck said. “If you were to track the XOP (S&P Exploration and Production EFT) … from 2008 until today, it’s in negative territory."

“Investors, especially generalists, are myopic on the compounded annual return,” Shattuck said. “The No. 1 thing that has drawn the XOP down, that draws any equity down, is big downward movements.” - Benjamin Shattuck

As Shattuck points out, oil sees downward trends more than any other commodity. Since 2008, it's the only major commodity to crash three times, and investors connect the crashes with oversupply and overproduction.

Size Matters

So, those two letters: M and A. To meet growing demand, you need a growing product, and investors are signaling that the best, most stable approach to that is through consolidation.

“Fewer, larger companies make investors more comfortable that we won’t overshoot or undershoot in terms of the oil price signal,” Shattuck said. “It’s a sustainable business model before tight oil and ultimately is a more predictable and stable contributor to global oil markets.”

Want to learn more about how to reach oil and gas investors' happy place? Read the full article from Joseph Markman on HartEnergy.com.