As commodity prices have trended higher, there’s a natural tendency to relax a little. The discipline of living within cash flow becomes less onerous, and the impetus to capture production growth in a rising price environment takes hold. The notion that what works on a micro level—in terms of production growth—may not work as well for E&Ps collectively on a macro level is falling by the wayside.

And much depends on the strength of E&P balance sheets and their access to capital markets. North American E&Ps and, more recently, oilfield service companies, have been able to access capital markets on a scale unthinkable a year ago. This has set them apart from other corners of the world, where the oil price collapse left some producers with plummeting revenues and, in some cases, currency crises.

The North American access to external capital was a point that Schlumberger’s CEO, Paal Kibsgaard, underscored in outlining a two-speed energy recovery in the company’s fourth-quarter earnings call.

The upturn in E&P investments, said Kibsgaard, will be led by the North American land sector, where E&Ps appear to be “unconstrained by years of negative free cash flow, as external funding seems more readily available, and the pursuit of shorter-term equity values takes precedence over a full-cycle return.” This is in contrast to a slower recovery in international markets, where “the various operator groups determine their investment levels based on full-cycle returns and their available free cash flow.”

Having highlighted the issue of free cash flow—or frequently the lack thereof in unconventional plays—Kibsgaard went on to paint a positive outlook for global energy. The current year marked, he said, “the starting point of a new, multiyear cycle that will require a broad-based increase in E&P investment in order to reverse the effect of several years of global underinvestment.”

How will E&Ps move forward in such an environment? Will domestic E&Ps fall back into their former habits of outspending cash flow as they fixate on production growth? Or, will they venture along a path of more moderate production growth with an eye to generating free cash flow?

Pioneer Natural Resources Co. recently offered a template for the latter strategy, setting goals to grow output organically to 1 million barrels of oil equivalent per day (MMboe/d) over a decade—and, in the process, generate substantial free cash flow.

Several analysts anticipated the move by Pioneer.

“High-growth E&Ps have come and gone without reaching sustainability,” observed RBC Capital Markets analyst Scott Hanold. “Pioneer could be the first to achieve a long-term sustainable model, producing desirable mid-teens growth while generating free cash flow for a respectable dividend and flexibility for stock buybacks.”

“Long-term investors should rejoice,” cheered J.P. Morgan analyst, Arun Jayaram, who likewise had anticipated a shift by Pioneer from a “hyper growth” focus to instead a “consistent growth objective of approximately 15%.” And with a “laser focus on capital efficiency,” Pioneer was expected to return “significant excess cash to shareholders.”

Pioneer’s CEO, Tim Dove, emphasized on the company’s fourth-quarter earnings call that there was upside to the targeted 15%+ compound annual growth rate (CAGR), with 15% growth to be considered the “bottom of the range.” In the current year—its last to outspend cash flow—Pioneer guided output to grow 15% to 18%, with its oil component increasing by 24% to 28%.

Dove outlined plans calling for Pioneer to spend within cash flow in 2018 and to be “free cash flow positive thereafter.” Cash flow is expected to increase at a CAGR in excess of 20% through 2026, he said, and Pioneer would continue protecting cash flow with an active hedging program. It would also maintain its net debt-to-cash flow below 1.0x.

Prior to the announcement, J.P. Morgan had projected production for Pioneer reaching an average of 965,000 boe/d in 2026, based on a CAGR of 15%. Oil was estimated to comprise 72% of production in 2026, up from 57% last year, while cash flow was expected to grow at a CAGR of 23%.

The model had Pioneer generating $15 billion in free cash flow over the 10-year period at strip pricing.
Given criticism that few E&Ps can achieve strong production growth and generate free cash flow, will other producers strive to follow suit?

Some are skeptical, including Wells Fargo Securities. “Old habits die hard,” it said, noting E&Ps spent 126% of cash flow in the 10-year period since 2007.

Time will tell.

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