Oil and gas producers' focus on cash returns instead of volume growth — combined with a 65% rise in West Texas Intermediate crude oil prices in 2021 — has lifted the North American industry out of a hole it spent years digging into, analysts said Jan. 4.

Stock market analysts and credit rating agencies had warned for years that producer spending to exploit shale oil and gas plays from Texas to Appalachia was crushing commodity prices as demand stayed constant and supply increased. When a combination of warm weather, the COVID-19 pandemic and an OPEC-plus increase in crude production pushed oil and gas prices to record lows in 2020, lenders pulled away from exploration and production companies, or E&Ps, which helped send some of the biggest spenders into bankruptcy.

Oil prices have climbed more than 300% since an April 2020 crash, with natural gas prices gaining 80% over the same time frame. The prices helped to balance the books at companies that survived the crash. The average risk that an oil and gas producer would default on its loans dropped from over 15% in April 2020 to 1.46% at the start of 2022, a lower risk than the 4.2% market signal probability of default at the start of 2020, before the crash.

In terms of market capitalization, shale gas producers Chesapeake Energy Corp. and Gulfport Energy Corp., along with oil producers California Resources Corp., Whiting Petroleum Corp. and Oasis Petroleum Inc., were all valued at more than $1 billion and all reorganized under Chapter 11 protection over the two-year period starting in January 2020.

"The commodity price rally was certainly a key driver that enabled the strong cash flow profiles many of the upstream issuers now have," CreditSights Inc. senior analyst Charles Johnston said, but he said a bigger factor was the change in focus from growth to positive cash flows. "The shift in capital allocation priorities in terms of what to do with that cash flow may be the most notable change for the industry; it was definitely the most discussed trend of 2021 for the sector."

"U.S. E&P capital discipline remains the most bullish long-term development for the commodities," Raymond James oil and gas analysts John Freeman and Pavel Molchanov told their clients Jan. 3. "We know we sound like a broken record, but the public E&P mindset has dramatically changed, and even in the face of higher prices we have seen minimal deviation from maintenance-type programs."

"Anyone who tells you they've seen this movie before, trust us — they haven't," the Raymond James analysts said.

Sanford C. Bernstein & Co.'s lead oil and gas analyst Bob Brackett said the oil and gas industry is poised to attract new investors in 2022. "The state of the energy sector — especially the upstream — versus a year ago is in many ways nearly unrecognizable," Brackett told clients Jan. 4. "Crude prices rose ~55%, equities did better, beating the S&P handily while U.S. shale held to the low growth, cash return mantra that many investors may have dismissed as empty promises at the bottom of the cycle."

"If 2022 is so different than 2021, is it time to leave? We'd argue no," Brackett said. "While the levels of returns will almost certainly not achieve last year's results ... we see E&Ps being on the right side of most every macro concern in the market."

Bond analyst Johnston at CreditSights was not ready to endorse the sector to bond buyers. Most of the spare cash generated by high commodity prices and low capital spending was not going to bondholders but to shareholders in the form of increased dividends and stock buybacks.

"While we do continue to see value in certain high yield E&Ps, it's difficult to characterize the entire sector as a value play at this point in the credit cycle given many upstream names have reached their leverage targets and the cash flow being generated will be direct toward equity holders," Johnston said.

"I'm not sure anything within energy can be considered permanent, but for now, both debt and equity investors seem to be maintaining pressure on management teams to focus on cash flow," Johnston said.

S&P Global Market Intelligence's market signal tool combines fundamental financial analysis with daily stock market activity to assign a probability percentage risk of default. The probability of default tool is not a credit rating and is not designed or used by S&P Global Market Intelligence's sister company, credit rating agency S&P Global Ratings.