In a market that has been both fickle and unforgiving, delivering the “right” message during earnings season has been tough for many E&Ps. Fall short of production guidance, or outspend capex for a given growth target, and you risk a sell-off. Deliver outsized growth without requisite returns, and you are compounding the macro problem, risking a sell-off for lack of capital discipline.

Or maybe it’s just one of those days where fundamentals don’t provide an explanation. As Tudor, Pickering, Holt & Co. commented one day last month, “Yesterday felt like the machines just took over,” with “a monster up day for some energy stocks while crude took a leg down.” The E&P Index was up 5.5%, only to have money flows reverse, with a bruising 2.7% drop the next day.

Generally, E&P capex programs have been front-end loaded, with about 65% of full-year 2015 capex spent in the first half. But far from this auguring a sharp decline in industry output in the second half, a frequent theme has been the E&P’s ability to be adept in achieving higher levels of capital efficiency and “doing more with less.”

One of the earlier reporting companies, Anadarko Petroleum Corp., delivered quarterly production above the high end of guidance and guided to higher full-year production at a revised lower capex level. A key tenet is to keep capex close to cash flow plus proceeds from asset sales. Capital allocation is driven by returns, not growth.

“Our objective is to get better, not bigger,” said Anadarko chairman, president and CEO Al Walker. “I don’t believe we, as an industry, are anywhere close to the type of margin improvement that’s needed before we go back to a growth mode that would then be rewarded by investors.”

In a tough tape, the message of returns went largely unrecognized.

In delivering an earnings beat on lower costs, EOG Resources Inc. also exemplified capital discipline, trimming its full-year 2015 capex by $200 million while maintaining its oil production guidance. “The company chose the reduced capex/less growth path over unchanged capex/more growth,” said a Simmons & Co. note. “We commend this decision.”

In addition, EOG predicted U.S. oil production would show “significant month-over-month declines” in the second half, noting the expected July-August monthly data would, with a two-month lag, appear in September-October. With continued declines in U.S. and other non-OPEC supply in 2016, EOG expected to be well-positioned early next year to bring on an expanded inventory of 320 uncompleted wells, with high capital efficiency, in a potentially higher oil price environment.

In essence, this is designed to help EOG achieve what many of its peers are also striving to do: strike the “right” balance between maintaining or growing the asset base while spending within cash flow and protecting the balance sheet.

Of course, energy investors aren’t purists in wanting capital discipline to be shared evenly. As one analyst noted, investors want E&Ps whose stocks they don’t own to cut production, making the macro environment better for E&Ps whose stocks they do own.

Several E&Ps—including Newfield Exploration and PDC Energy, to name just two—have announced capex increases drawing an initial benign or positive market reaction, typical for E&Ps with healthy balance sheets and hedge books.

PDC Energy Inc. provided perhaps the most visibility, assuring investors by comparing its recently revised production and financial metrics to those of its analyst day in April. Although 2015 capex is raised 13%, accompanied by only a 6% increase in production guidance, projections for 2016 call for 35% output growth while spending within cash flow.

Due to greatly improved rig efficiencies, PDC plans to drop down to four rigs in Wattenberg Field next year, each drilling 35 wells per year versus 25 wells per year previously, enabling the company to target almost the same well count as earlier. Over the 2015-2016-2017 timeframe, in which it previously projected a 31% to 36% compound annual growth rate, PDC now models a 34% to 38% CAGR.

Notably, PDC’s latest projections incorporate a $52.49/bbl Nymex oil price for next year, a drop of almost $5/bbl, in its neutral cash flow scenario. Moreover, debt to adjusted Ebitda is maintained at about 1.5 times through 2016.

In a rare outperformance, PDC’s stock rose by double digits that day. In a market steeped with uncertainties, visibility is your friend.

Comments