A version of this story appears in the December 2017 edition of Oil and Gas Investor. Subscribe to the magazine here.

Investors can be quite fickle, as CEOs and investor relations folks know all too well. For years they’ve demanded production growth almost regardless of cost. In the 2000s, they pushed E&P companies hard to bulk up on acreage in the latest unconventional resource plays and boost natural gas production.

But Guggenheim Securities LLC analyst Subash Chandra noted this year, after studying 45 E&P companies, that a correlation between stock performance post-earnings and production growth “is difficult to find.”

Now, investor sentiment has changed direction once again: E&Ps must deliver a return on capital employed, send some cash their way in the form of dividends or share buybacks, and reduce or stop overspending. That is, grow within cash flow while producing in a low-cost environment.

More E&Ps are jumping on the Returns Bandwagon, and that’s a good thing. Guggenheim also found 27 of 38 public operators surveyed this earnings season emphasized returns over growth, and 28 highlighted the goal of becoming cash-flow neutral in 2018 or 2019.

BP Plc (NYSE: BP) said it will restart buybacks this quarter. ConocoPhillips Co. (NYSE: COP) will continue the $3 billion buyback initiated a year ago and just increased its dividend 6%. In November, CEO Ryan Lance also vowed to deliver 20% to 30% of cash flow as total shareholder payout each year.

Anadarko Petroleum Corp. (NYSE: APC) announced $2.5 billion of share repurchases authorized to extend through the end of 2018, with $1 billion by year-end 2017. More significantly, chairman and CEO Al Walker said executive compensation going forward will reflect earnings per debt-adjusted share, not just production or reserves growth.

Capital will be allocated on Anadarko’s higher-margin upstream assets in order to generate free cash flow at $50 oil. Total capital spending, including some midstream, is to remain within discretionary cash flow from operations.

Analyst Bob Brackett with Bernstein & Co. weighed in: “Walker made it clear that the company was not going to manage its business to hit any specific growth target in the coming years and that growth would be a result of managing the business for high returns on capital." (His emphasis.)

“Management made it clear that … higher oil prices than $50 would result in free cash flow, not higher capital spending. This latter piece is a significant departure from typical capital allocation strategy and messaging in the E&P sector,” Brackett wrote.

When we discussed investor’s shift to returns recently, a prominent E&P chairman told me, “Wait a minute. Investors told us for years they wanted growth at any price and rewarded us for that, and now you’re telling us you want returns? If we do that but don’t deliver growth, will you reward us for that? Give me a break.”

Still, anything that attracts investors to the E&P sector merits a second look.

“The biggest thing we could do as an industry is lock arms and work to get investors back. There’s been what I’d call ‘a buyers’ strike,’’ said Maynard Holt, speaking at Hart Energy’s Executive Oil Conference in Midland in November. That’s why many E&P CEOs mentioned returns in their third-quarter conference calls, and pledged to convert assets into cash flow. It’s all part of the shift to resource play development and longer-term changes in the industry.

Chandra said in a June wrap-up after second-quarter earnings, “Operators must contend with the possibility that this is a mature industry until proven otherwise. Business can’t continue as usual. While a simple fix is elusive, we believe companies should address leverage and outspend above all else. That is what the market is telling us.”

Indeed, outspend is a perennial problem. The E&P industry average is to spend $1.40 for every $1 of revenue that comes back out.

Clay Gaspar, COO of WPX Energy Inc. (NYSE: WPX), also commented on this need for better returns during his remarks at the Midland conference.

E&P companies have generated “neither compelling returns nor free cash flow over the past five years,” he said, showing data from Capital IQ to prove it. From 2011 through 2016, the E&P industry’s growth in cash flow per share ranked dead last among 12 industries and last in return of capital as a percent of market cap. This dismal record occurred during times when oil was rising to $100 per barrel. But to be fair, prices fell by half near the end of the period.

Few have responded as dramatically as WPX, which tore down and rebuilt, going from 75% gas to 70% oil in a $7-billion buy-sell binge. Skeptical investors were not happy. They told WPX that “they were not sure the industry has the discipline to make the most of the good years or the discipline to tap on the breaks in the bad years,” Gaspar said.

The results speak for themselves: WPX’s discretionary cash flow rose 67% and unhedged EBITDAX rose 87%. It expects to generate positive cash flow from operations in 2019.

Also in Midland, Citi’ s Jeff Sieler said the problem is that investors see E&Ps boasting about good single-well economics at $50 oil, but they’re not seeing that reflected in higher stock prices, which mostly have underperformed in 2017.

Delivering returns is the answer.

Leslie Haines can be reached at lhaines@hartenergy.com.

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