E&P Corporate Financing: Debt Dive

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E&P capital discipline gets painted with a broad brush. Tight controls on spending, returning cash flow to shareholders and share buybacks make up the glossy top coat on a much more complex picture.

Tucked among all that fiscal restraint, however, has been upstream oil and gas companies’ rush to burn its debt, or at least get rid of and refinance it as quickly as possible.

Debt, which took down so many E&Ps before and during the pandemic, is now a dirty word in the upstream space. No one wants it. So while E&Ps returned more cash to shareholders in 2021, they paid 1.7x more toward debt reduction than they distributed in cash to shareholders, according to Fitch Ratings.

While moderate capex increases are likely, shareholders and debt will come first, Fitch Ratings said in a March 14 report by analyst Mark Sadeghian.

“Significantly higher energy prices and operating cash flow will likely lead to leverage metrics that are below 2.0x and in some cases less than 1.0x for some issuers in 2022,” Sadeghian said. “E&P credit profiles have already improved since 2020 with debt reduction, refinancing activity, disciplined capex and improved FCF [free cash flow] generation. The effect of higher oil prices … will largely depend on capital allocation decisions and how much of the resultant cash companies will use for further capex versus distributions.”

That compares with Fitch’s 2021 outlook, at a time in which most E&Ps with investment grade credit were able to access public debt markets, but only a handful of upstream companies with B credit ratings were able to access the senior unsecured bond market following the pandemic.

A cursory glance at nearly three dozen E&Ps also shows 2021 turned into a year of massive debt refinancing. Among 32 E&P companies that issued debt last year, a review by Hart Energy found that they refinanced more than $22.2 billion.

Management teams have also set debt thresholds that would have baffled their spendthrift predecessors. Continental Resources Inc., for instance, is on track to meet its leverage target of less than 1.0x debt/EBITDAX in 2022, despite its $3.25 billion purchase of Delaware Basin assets from Pioneer Natural Resources Co.

Devon Energy Corp.’s capital program includes a $1 billion buyback, a variable dividend and a target of retiring $1 billion debt in 2022 and 2023, said David Deckelbaum, an analyst for Cowen.

Hess Corp. plans to pursue a $500 million debt reduction. Even Occidental Petroleum Corp. incurred the wrath of some investors when it purchased Anadarko Petroleum Corp. In May, the Wall Street Journal reported that Occidental was climbing out of its “Anadarko hole.”

“We would anticipate a focus on capital return as Oxy [Occidental Petroleum] has previously reiterated a $25 billion debt target before any decisions on capital return would be made, and we forecast the company hitting that level of net debt in 1Q22 and approaching ~1.0x leverage by year end at our current price deck,” Deckelbaum said.

Other companies are on track to be debt-free in the not too distant future.

Antero Resources Corp. (AR) is likely to target up to $700 million in debt reduction in addition to share buybacks. “We project AR to generate $1.4 billion of FCF in 2022 and with debt paydown to have just $1.6 billion of total debt. By the end of 2Q23, we project AR to be net debt free,” Deckelbaum said.

Fitch Ratings noted that strategic M&A will continue to be popular with companies as cash flows remain flexible and equity prices rise. But companies “generally remain averse to credit-dilutive M&A, preferring lower leverage levels and healthier balance sheets,” Sadeghian said.

Goldman Sach’s survey also continued to see debt reduction playing a major role in company plans for 2022, according to a March 14 report by analyst Neil Mehta.

Ovintiv Inc. is on track to achieve a $3 billion net debt target at the end of the second quarter based on above-strip prices and will turn additional free cash flow to debt reduction and small bolt-on acquisitions.

“We believe the focus for the company, aside from achieving its net debt target, will be on its ability to offset inflationary pressures through operational efficiencies,” Mehta said.

EQT Corp. is targeting a $1.5 billion debt reduction target by the end of 2023 and most recently tendered $206 million of its 3% notes of $568 million, according to Cowen. Goldman Sachs expects the company to improve its leverage from 2.3x in 2021 to 1.1x by 2023.

Companies such as Murphy Oil Corp. are prioritizing net debt, with the company’s goal to reduce debt to $1.4 billion and “remain on track to achieve its net debt target by 2H22,” Mehta said.

Gassier companies such as Southwestern Energy Co. have also reiterated plans to reduce net debt to EBITDA by 1.0x to 1.5x.