We would all like to know how to run an E&P to its optimum advantage, including stock price. You know, just turn a knob or two to make a couple of adjustments, and then see its operations and profitability hit full stride. However, changing one or two of the many variables can set off a chain reaction. Further, if you’re in a commodity business, the swings in terms of economic outcomes can be notoriously wide.

Since the summer slump in energy equities, the oil and gas industry’s mantra of capital discipline has only grown louder. In seeking an appropriate balance between value and growth, prioritizing value and a return of capital to investors—through, say, a dividend or a stock buyback—clearly has the upper hand.

“Looking into next year, it is clear that management teams have gotten the memo that investors won’t reward outspending (cash flow) to deliver growth,” said Guggenheim analyst Michael LaMotte.

Analysts’ score cards of E&Ps’ third-quarter earnings confirm the shift in strategy. For example, of 38 E&Ps it covers, 28 emphasized returns over growth, according to Guggenheim. For North American E&Ps covered by Tudor Pickering, Holt & Co. (TPH), free cash flow (cash flow in excess of capex) was cited as an issue dominating 80% of earnings calls.

Anadarko Petroleum Corp., in particular, has long said that it runs its operations “with growth as an output, not an objective.” In mid-November, it set 2018 capital investment guidelines at $4.2- to 4.6 billion, a level representing cash-flow breakevens at $50 per barrel (bbl) and $3 per thousand cubic feet. At strip pricing, generating $5- to 5.4 billion in cash flow, Anadarko clearly would enjoy “material free cash flow.”

In such a scenario of higher strip pricing and substantial free cash flow, Anadarko would look at ways it could “most efficiently” provide shareholder returns, according to CEO Al Walker. “If we have a whole lot more cash than we anticipate today, we’ll look for different ways beyond share buybacks in order to bring some of that cash back to the shareholder,” he said.

Last September, Anadarko led its peers in announcing a $2.5-billion program to buy back about 10% of outstanding shares. The program set a target of completing a $1 billion accelerated share repurchase by year-end 2017 and completing the remaining $1.5 billion over the course of this year. In addition to the share repurchase program, Anadarko said it expects “cash dividends to increase over time.”

Along with Anadarko, Devon Energy Corp. is highlighted in a report by Macquarie Capital (USA) titled, “The Race to Embrace Returns.” Analyst Paul Grigel studied moves made in the energy industry to link management incentives more closely to return metrics. He cited favorably comments by Devon that its 2018 capital program “is being designed to optimize returns, not production growth.”

Among changing trends in how investors evaluate the E&P sector, TPH reported less weight given by the buyside to a traditional net asset value (NAV) metric. Instead, over the last year, it observed a “growing emphasis on Enterprise Value-to-EBITDA, cash flow growth per debt-adjusted share, free cash-flow yields, return on capital employed, etc.” It attributed the shift in part to analysts having to cover more sectors than just energy “to stay relevant” in their firms.

But if the seeds of these changes were sown in the downturn, will the post-OPEC oil price run-up lure E&Ps back to a growth metric—especially if West Texas Intermediate moves up to the mid-$50s and higher, allowing E&Ps to lock in hedges at attractive prices?

In a report preceding the Nov. 30, 2017, meeting, Macquarie analyst Grigel said if crude prices move significantly higher, steps to grow production “should only be taken if the company is able to capture the same or better margins, as service costs will likely increase as well.” Increased hedging would “provide a cushion should prices fall and margins contract,” he noted.

If this means a more moderate, returns-based strategy ends up incorporating incremental growth, do U.S. producers risk overproducing again? Do analysts really have a handle on the eventual trajectory of the U.S. industry?

Those sharing in the gamble are OPEC and its non-OPEC allies, who also struggled to get their arms around the likely growth of U.S. unconventional production. Industry analysts invited to present to OPEC reportedly presented U.S. growth trajectories ranging from 500,000 bbl/d to 1.7 MMbbl/d—no small spread for a bet critical to oil.

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