Consolidation Seen as Only Major Change on E&P Finance Radar for 2024

Two sides of the same coin are expected in E&P finance in 2024—ambition balanced with responsibility. Ambition is expected in the form of more consolidation, and responsibility is expected in continued capital discipline with companies staving off temptations to drill more.

Possible changes on the horizon, such as tweaks to hedging and more reliance on credit, are seen as slight adjustments to a financing model that’s been working for E&Ps.

“I am extremely bullish [on] publicly listed energy companies,” BlackRock’s head of public energy equities, Will Su, said at a recent energy finance conference at Rice University. “If you look at the S&P 500, the energy sector produces more than 10% of its net income, and its current weighting is less than 5%.”

He said E&Ps’ strategy to provide growth in the form of capital return to investors has clearly worked.

“When you value a company, it’s not just growth in revenues, because you can always go out and buy another company. It’s always about appreciation, it’s always about growth in the per share value to the shareholder,” he said. “I think that’s why these companies are really in the sweet spot here.”

‘Win the day’

Nitin Kumar, an energy analyst at Mizuho, told Hart Energy that E&Ps’ protectiveness of their strong balance sheets was shown in Exxon Mobil and Chevron’s decisions to make major acquisitions as all-stock transactions in late 2023.

“They don’t want to spend a bunch of cash, increase their balance sheet and then have to worry about downside,” he said.

Josh Martin, a managing director at Pickering Energy Partners, told Hart Energy that E&Ps’ financial game plan for 2024 should largely be what it was for 2023 because it worked. He expressed doubts about CEOs’ assurances in recent earnings calls that they are not looking at consolidation deals.

“I just don’t think a company can say, ‘We’re not going to do something’ because things change,” Martin said. “There are obviously fewer companies than there were 12 months ago or 24 months ago—but there’s still some things to be done.”

Experts dove into great detail about consolidation at the Rice conference, suggesting they believe more acquisitions are coming.

Jonathan Cox, global co-head of energy investment banking at J.P. Morgan, said while higher commodity prices tend to suppress M&A activity, higher interest rates and inflation make M&A easier because there’s more pressure on costs.

Alexander Burpee, senior managing director at Guggenheim Partners, said E&Ps need to compare their project level IRR to their cost of capital when evaluating deals.

“If the project level IRR is greater than your cost of capital, then you can do that deal,” he said. “The lower your cost of capital, the greater your ability to beat out the competition in some of these competitive processes. We have seen a lot of processes recently that have had worse competition, and those with advantaged cost of capital can win the day.”

Konnie Haynes-Welsh, ConocoPhillips’ vice president and treasurer, said reducing costs is still one of the main drivers of consolidation.

“Some of the reason consolidation is necessary is to get the G&A out, take the best ideas and really make sure that those are being consolidated,” she said.

Give credit where banking is through

Holt Foster, co-leader of Sidley Austin’s Global Energy Practice Team, told Hart Energy more consolidations could significantly increase financing activity in the oil and gas sector. If this occurred, he said it would further impact an already rapidly changing banking landscape in the oil and gas sector. Many banks have left the space, and many of the remaining regional banks have reached their desired oil and gas lending allocations. That, Foster said, coupled with a potential real estate crash, has many banks even less inclined to issue more debt. That capital void could be enough to lure some of the larger banks back to the E&P space.

“Recently, I’ve seen some large global banks such as J.P. Morgan start dipping their toe back in the oil and gas financing space, but you’re also seeing increased activity in the space from alternative credit sources such as credit funds and family offices,” Foster said.

At Hart Energy’s Executive Oil Conference in November, Michael Bodino, managing director of energy investment banking at Texas Capital, told attendees that smaller banks don’t want to be part of large syndicates, so credit is showing up to fill the capital need.

“Things are changing. What we see in the market is this rapid expansion of the private credit markets,” he said. “Private credit has really come in and created solutions for a lot of these companies.”

Bodino said $250 billion of senior note offerings were once commonplace, but now banks require a $500 million minimum for such offerings. Many banks are too small for this—and private credit is stepping in to make up for it, he said.

Nimesh Bhakta, head of investments for the Americas for the Swiss energy trader Vitol, said Vitol recently moved into the private credit space to meet some of the capital need.

“We are stepping into that space, especially in this higher-rate environment,” he told Hart Energy. “The risk-adjusted return profile is simply too attractive to ignore.”

Drill, barely, drill

The U.S. Energy Information Agency predicts Brent crude oil prices will rise to an average of $93/bbl in 2024, but there is barely interest in new drilling.

In a recent survey by the law firm Haynes Boone, 7% of reserve base loan lenders expressed great interest in new drilling.

Virendra Chauhan, head of upstream at British energy research company Energy Aspects, said inflation and E&Ps’ focus on maximizing recovery rates has E&Ps drilling slower. Martin said only increases in strip pricing would get E&Ps to drill significantly more.

Hedge, a smidge less

An analysis from Capital One Securities shows that E&Ps will ease up on hedging in 2024, but just slightly. Chauhan said this is a sign of the strong shape E&P balance sheets are in; there’s less need for caution. PPHB Managing Director Jim Wicklund told Hart Energy that hedging is easing because of expected increases in commodity prices.

“No one wants to hedge out all of next year at $72 [a barrel] and then have the consensus prediction actually come true and all the prices be higher,” he said.

Kumar said lighter hedging shows how the industry—and investors—have changed.

“If you employ too much hedging, you’re only going to lock in cash flows. You’re taking the upside away from investors, which is not where investors’ minds are today,” Kumar said.

Go with the free cash flow

With some small changes in credit and hedging, experts are nearly all of the opinion that E&Ps will stay away from heavy capex spending to keep their hefty free cash flows supportive of capital return to investors.

“The energy industry struggled to deliver returns to shareholders in the decade between 2010 and 2020. That record has been corrected, but operators will be keen to keep the momentum up in order to keep long-only type investors,” Chauhan said. “Producers that are confident in their long-term inventory will continue to de-lever their balance sheets, which should allow them to ratchet up the proportion of free cash flow that they can return directly to shareholders.”

“The most important message we keep hearing here is, ‘just keep focusing on shareholder returns, and the market will come to us eventually.’” Martin said.