Shale gas drillers promise to restrain spending despite higher futures prices
Heading into the first quarter earnings season, analysts were clear. They wanted no surprises from pure play shale gas drillers — no new spending, no new debt, no mergers and acquisitions — just cash discipline, despite the temptation of commodity prices set to rise near the end of the year.
The analysts mostly got what they wanted. SunTrust Robinson Humphrey shale analyst Welles Fitzpatrick summed it up with his note on Range Resource’s results April 30: “Thankfully boring quarter.”
Chesapeake Energy was an exception to the boring first-quarter reporting from the shale gas driller group. The company did not bother with an earnings release or a first-quarter conference call. It filed its quarterly results with the SEC. After struggling for years, pedaling uphill against the mountain of debt it ran up during the land grab phase of the Shale Revolution, it revealed it had engaged restructuring advisors and wrote off $8.5 billion worth of value in its shale oil operations.
But most shale gas producers kept to their pledges to dial back spending to stay within cash flows. They did not commit to adding rigs to chase the $1/MMBtu increase in gas prices or more, which is expected to happen this winter as oil production crashes, taking with it the “free” natural gas associated with shale oil wells and allowing the prices to rise for gas from other sources.
“Gas [exploration and production companies, or E&Ps] are hesitant to accelerate drilling until they are certain that higher gas prices are sustainable,” UBS oil and gas analyst Shneur Gershuni told his clients May 10. “Consequently, in the near term gas producers may elect to sit back and benefit from the potential free cash flow to reduce leverage instead of increasing capex.”
Shale executives appeared ready to do just that. “We really don’t see the need or benefit to return to high growth,” Range President, CEO and Director Jeffrey Ventura said on his company’s May 1 earnings call. “So prices are significantly higher, and we’re generating significant free cash flow; we’ll first direct that to bolstering the balance sheet. And then from there, we’ll look to position to expand cash returns to shareholders.”
Ventura’s views were echoed by other drillers. They planned to stand pat with maintenance drilling programs without much production growth in 2020, and they will use any extra cash from higher gas prices to pay down debt.
Cabot Oil & Gas, which has little debt, recommitted to sending 50% of its free cash flow back to investors as either a dividend or a stock buyback. Its CEO is suspicious that any winter price spike will not last, depending as it does on shale oil drilling staying in the dumps.
“Each time you get a little bit of growth or increase in price, everybody jumps in and tries to take advantage of that increase,” Cabot Chairman, President and CEO Dan Dinges told analysts on Cabot’s May 1 earnings call. “The issue for us is, before we would make a decision for growth, we would have to feel comfortable that there’s some fundamental changes and it’s sustainable in the long term.”
Dinges said the winter price spike is a one-off event caused by the loss of oil demand due to COVID-19. It is not a structural change in the gas market, he said, pointing to prices descending below $3/MMBtu level further out on the curve.
Earnings calls for shale gas companies took place against a backdrop of steadily climbing share prices, as investors bought gas stocks to capture the anticipated winter price spike. Several analysts said they thought some shale gas stocks are fully valued after the spring run up, with little room to move higher.
“Our outlook for a tighter gas market meaningfully improves free cash flow outlooks,” Morgan Stanley oil and gas analyst Devin McDermott said April 30. “Higher shareholder return at Cabot, and significant leverage reduction for EQT Corp., should support stocks relative to peers. However, intrinsic valuation appears full for both stocks, unless gas prices rise above current futures in-line with the upside risks we see in 2021.”
Morgan Stanley raised its forecast for average gas prices from $2.50/MMBtu to $2.75/MMBtu in 2021.