With a surprise spike in U.S. natural gas prices producing unexpectedly strong positive cash flows, analysts want U.S. shale gas exploration and production, or E&P, companies to detail how they will send cash back to shareholders.
The natural gas futures contract for November delivery is at its highest point in seven years, Raymond James & Associates oil and gas analyst John Freeman said. "While you'd be hard-pressed to find an E&P complaining about the current strip, the level at which operators are (and will be) benefiting from higher gas prices varies dramatically," Freeman said.
Higher commodity prices combined with no-growth maintenance spending for new wells should produce millions in positive free cash flows in the third quarter, analysts surveyed by S&P Global Market Intelligence said, a significant reversal from a year ago. With that, analysts expect companies to start detailing how they will return cash to investors in the form of dividends and share buybacks.
"We forecast ~10% payout capacity next year on average for the group, increasing to ~11.5% in 2023 as hedges roll off," Mizuho oil and gas analyst Vince Lovaglio told clients. "We believe that EQT Corp., Southwestern Energy Co. and Antero Resources Corp. are all in positions to announce cash return frameworks near-term, potentially with upcoming results and likely early next year when 2022 budgets and outlooks are announced."
High prices are a double-edged sword for most Appalachian gas producers who have hedged much of their 2021 production volumes under $3/MMBtu, while the futures price has marched past $5/MMBtu.
E&Ps book noncash charges or gains to account for the change in value of their future hedges marked against a benchmark, most commonly the Henry Hub futures price. No cash changes hands; the charge is an accounting device to track changes in the value of the company's asset, which in this case is the hedge portfolio. The noncash charge does impact headline GAAP profit and loss numbers, although analysts strip out the charge to calculate adjusted profits or losses.
"We caution there could be some noise in [third-quarter] free cash flow vis-à-vis consensus due to nuances of hedge losses as commodity prices rise," U.S. Capital Advisors LLC analyst Cameron Horwitz told clients. "But this is transitory, and the real juice comes with '22 where the industry is relatively less hedged."
U.S. Capital indicated that stock buybacks and variable dividend plans like that of Coterra Energy Inc. — a combination of a base dividend with a variable payment depending on results — will become the choices for companies announcing shareholder return plans.
"The current commodity price backdrop has meaningfully accelerated sector de-levering goals, which in turn is pulling forward shareholder returns," U.S. Capital said. Coterra is the new name for the merged combination of Cimerex Energy Co. and Cabot Oil & Gas Corp.
Tudor Pickering Holt & Co., too, sees strong potential for capital returns and expects these to drive the segment's share prices higher through the end of the year. "What could ruin the party? Growth, plain and simple, but we expect public operators to reiterate their commitment to capital discipline for next year, so we think there is little risk in that being a major concern for the next twelve months," analysts at the energy investment bank said.
The potential of outsized cash returns to shareholders is attracting new investors into oil and gas, according to Raymond James.
"Increasingly, we are fielding calls from a completely different investor base than years past when the overwhelming inbound was that of only energy dedicated investors," Raymond James said. "These market-leading shareholder return plans are generating an increasing interest in the space, and, as these companies demonstrate the sustainability of the new E&P business model, the valuations will begin to improve as well."