The U.S. oil and gas industry “is cyclical in a myriad of ways,” said JP Hanson, managing director of Houlihan Lokey.

Supply and demand cycles. Business cycles. Discovery and development cycles.

But capital discipline has reshaped the business and perhaps will be its wisest investment, Hanson and other panelists said at the Independent Petroleum Association of America’s annual Private Capital Conference on Jan. 23.

The results— free cash flow, stock buybacks and dividends— have proven up the new upstream model.

Banks are taking notice, and they want in.

“Banks are hungry right now. They're looking to put capital work,” said Mari Salazar, senior vice president and regional manager at BOK Financial.

E&P capital discipline took hold in the late 2010s in the aftermath of shale producers’ early ‘growth for growth’s sake’ penchant. The practice blew through billions of dollars that translated into lackluster returns, overleveraged balance sheets and alienated—OK, deeply annoyed and aggrieved—investors so much that many gave up on oil and gas.

But as Hanson described the recurring phenomenon on a blustery winter Houston afternoon, this time capital discipline is a stoic response that is ingratiating the industry with its fans and former foes alike.

“Now there's been a resurgence of that same mindset, really driven by capital availability. What we have seen is capital come back into the space. We're seeing generalist capital come back. We're seeing, in 2024, a small crack in even the IPO window,” he said. “Certainly, the yield markets have reemerged and reopened for even upstream, let alone midstream [which] is a big aggregation of infrastructure capital.

“It's driven by that capital discipline mindset that we're actually able to demonstrate to the markets the robustness of potential cash-on cash-returns.”

The industry has tightened its spending, embraced manufacturing mode and severed its debt by almost 42% since 2020 when the companies in the S&P Oil & Gas Exploration and Production Select Industry Index racked up a tab of $311 billion. At the end of the 2023, S&P Global estimated the annual total was close to $182 billion.

Salazar said many of the firm’s clients have actually paid off their credit facilities, either by selling the company or using free cash to reduce debt.

While banks want a piece of the action, that doesn’t mean it’s necessarily easy, she said. For a second lien, the market remains tough for a traditional credit facility.

“It's amazing to me that even now, with the amount of runoff that banks have seen, we're still holding tight on those structures,” she said. “We're looking at companies that are one times lever, they're focused on distributions or focused on getting down that which gets them to that lower tier but bridge capital.”

Still, the capital discipline question is “relative,” said Charles Meyer, senior vice president and technical head at Stephens Inc. The spending approach is “pretty much 180 degrees different” from the pre-COVID era, but cash is coming back. Some green shoots for growth-oriented vehicles are coming to market, and road shows are, well, getting on the road. The forthcoming deals may shrink in size compared to pre-COVID, but then again, “It’s very relative,” he said.

An undercurrent—if not actual wave — of anxiety is focused on remaining upstream supply. Greg Suellentrop, managing director at Evercore, said inventory challenges largely dictate this round of capital discipline.

Particularly for public operators, the market values are scale and runway. During the last 18 months, a veritable Who’s Who among key U.S. producers have used M&A to achieve the scale they needed to “become investible,” Suellentrop said.

“I think the reality is inventory has become scarce, so people rather than using that to grow, we're using that to maintain … their current scale, their current cash flows and that's another reason that you're seeing a lot of capital discipline that's currently in the space,” he said.

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