We are at or near the inflection point many experts predicted for an industry turnaround. The outlook for oil and gas is increasingly optimistic, buoyed as much by financial restructuring as by movement in commodity prices. Real opportunity in oil and gas investment remains.
It’s a difficult time to select stocks, however. While E&Ps have slashed production, uncertain global demand and other factors darken forecasts.
In 2010, Bernstein Energy’s oil and gas research team wrote a report titled the “Five Habits of Highly Effective Oil Companies and the Unwritten Rules of Energy Investing.” This June, the group revisited its thesis based on the operating performance of 36 global oil and gas companies over the past decade.
The authors identified four “pillars” of oil and gas management that drive shareholder returns. Foremost is capital allocation, followed by project execution, organic exploration and operational expertise. The executives helming E&Ps are the most significant determinant in the success or failure of any of these measures, the analysts said.
For investors, return on capital, organic reserve replacement, production growth and operating margins are the corresponding metrics for judging E&Ps’ performance.
“Over the past decade, the most successful companies have been able to deliver exceptional growth in production and reserves while maintaining returns,” the report said. “The worst-performing companies have been unable to do either. As a general rule, we find that very few companies are able to grow production and reserves at the same time.
“For small to mid-cap E&Ps, reserves accretion and production growth (without destroying the balance sheet) is the optimal strategy for value creation, while for larger integrated oil majors, the focus should be on growing returns [more] than scale.”
CEOs are generally either “growth junkies” or “prudent operators,” according to Bernstein. The former are true believers in drilling, while the latter are devotees of costs and value.
Executives’ worth is most clearly realized in capital allocation outcomes. “From the myriad projects any company can throw money at, superior capital management is about selecting the right projects to develop at the right point of the cycle,” the analysts said. Superior projects deliver the highest return on capital relative to peers and “maximize net present value.”
For A&D strategists, this translates to acquiring companies at the right point in the cycle.
The industry typically overinvests at the top and underinvests at the bottom. “When oil prices are high, returns are above the cost of capital, and share prices are rising, companies often get carried away, investing in expensive projects which fail to deliver their cost of capital,” the analysts said.
Acquirers fall into a similar trap during booms, “acquiring expensive assets in the pursuit of growth rather than conserving capital.”
It takes a strong-willed CEO to show restraint when times are flush and embark on investments or acquisitions at the bottom of the cycle, when costs and price are low, the analysts said. “But this is exactly what a great management team does.”
The second pillar of Bernstein’s effective investing strategy, exploration success, is measured by organic reserves replacement, or the ratio of reserves added (excluding acquisitions) to production. “Companies with a high recycle ratio (high cash flow per boe and low finding costs per boe) should be able to grow more quickly than others,” the analysts said.
Effective project execution, the third pillar, requires that E&Ps deliver projects on schedule and on budget. And the fourth, operational expertise, rest on efficiencies and managing costs. Downcycles and upturns throw these talents into sharp relief.
Based on its comparison of total shareholder returns, stock performance and other measures, Bernstein identified Cimarex Energy Co., Oil Search Ltd., Range Resources Corp., EOG Resources Inc., Thailand’s PTTEP, Shell’s BG Group, and China’s CNOOC as some of the best performers over the decade. Among those at the other end of the spectrum were Austria’s OMV Group, supermajor BP Plc, Canada’s Enerplus Corp. and Pengrowth Energy Corp. and Encana Corp.
While reserve replacement rates and production growth are strongly correlated, the connection between production growth and average return on capital is weak, they said.
"In fact, the correlation is towards an inverse relationship if anything, suggesting that companies can either have high returns or high growth, but not both.”
Recommended Reading
US Energy Corp. Closes Divestiture of East Texas Assets
2025-01-07 - U.S. Energy Corp. said proceeds from the divestiture will be used to fund the company’s industrial gas project in Montana.
TotalEnergies Plans 300 MW Renewable Projects in Oman
2024-12-11 - Wind and solar power will be supplied to Petroleum Development Oman, aligning with TotalEnergies' multi-energy strategy in the country.
Asia, EU Buyers Warming Up to US Shale M&A Again—Jefferies
2024-10-29 - Foreign asset buyers are considering U.S. upstream M&A to lower their LNG supply costs and avoid windfall taxes on European operations, Jefferies Managing Director Bill Marko says.
TerraVest’s Green Energy to Acquire Aureus’ Canadian Water Management Services
2024-12-04 - TerraVest Industries Inc.’s partially-owned subsidiary Green Energy Services is buying Aureus Energy Services Inc.’s water management and hot oiling services in Alberta and British Columbia.
Crescent Energy Bolts On $905MM Central Eagle Ford Acreage
2024-12-03 - Crescent Energy will purchase Eagle Ford assets from Carnelian Energy Capital Management-backed Ridgemar Energy for $905 million, plus WTI-based contingency payments of up to $170 million.
Comments
Add new comment
This conversation is moderated according to Hart Energy community rules. Please read the rules before joining the discussion. If you’re experiencing any technical problems, please contact our customer care team.