Inflationary pressures have eased in the oil patch, and the significance of that relief is something analysts will want independent Permian Basin shale oil drillers to reveal during upcoming earnings calls for the first quarter.

Lower costs mean less corporate spending. With OPEC helping out with an oil production cut that stiffened crude oil prices, the big Permian-focused exploration and production (E&P) companies likely generated plenty of free cash and will continue to reward investors with share buybacks and dividends.

Hovering over the earnings reporting season is a hot merger and acquisitions market. The charged atmosphere formed in the wake of Ovintiv Inc.'s $4.3 billion purchase of three small private Permian E&Ps and rumors that supermajor Exxon Mobil Corp. is getting ready to cut a megadeal with a large Permian independent driller to bolster its inventory.

Inflation easing?

"Inflation has been a hot-button topic for the better part of a year now, but the pendulum is clearly swinging back toward E&Ps," Raymond James oil and gas analyst John Freeman told clients April 21. "We are hearing there are meaningful conversations on the services side, where a slowly shrinking rig count is boosting E&Ps' leverage." Raymond James thinks lower costs in the field will have an even greater impact on results in the second half of this year.

Morgan Stanley oil and gas analyst Devin McDermott is hearing from his covered companies that they are seeing inflation ease. "Companies highlighted that costs have largely stabilized and some are beginning to see deflation across items like steel tubulars and sand," McDermott said. "Lower energy prices, which represented ~5% of average 2022 well costs, are also a tailwind. Some also noted softening in rig rates, though frac capacity remains tight."

McDermott said it is too early for the reduced costs to show up in company plans, but like Raymond James, he expects the impact will be more pronounced in the second half of this year.

Analysts' estimates compiled by S&P Global Market Intelligence indicated that Permian producers will likely spend more in 2023 than they have in the previous four years.

Shareholder returns continue

Drillers will not recycle the cash saved in the field into more wells and fresh volumes, however, analysts said.

"Energy investors can be assured that E&Ps will likely not go back to their prior ways of outspending to achieve material growth as the group has instead become and will likely continue to be a shareholder return story," Truist Securities Inc. analyst Neal Dingmann told clients on April 11.

Dingmann picked out Diamondback Energy Inc., ConocoPhillips, Northern Oil and Gas Inc. and EOG Resources Inc. as the drillers with the best capital discipline.

Payouts to shareholders will continue to follow the individual plans of each company with regards to share buybacks, base dividends and variable dividends, with lower amounts because of lower oil and gas prices, analysts said.

"We anticipate investors to continue to desire strong shareholder returns from E&Ps (especially large cap) and we believe investors will not be disappointed," Dingmann said. "There is not a single company that plans to reduce previously stated minimum percentages of free cash flow or cash from operations payouts though the absolute totals will likely be less this year given lower commodity prices and higher oilfield service costs than last year."

Free cash flows follow formula

Morgan Stanley's McDermott expects drillers to divide up their free cash based on formulas they already have in place. "Those with formulaic distributions should generally have lower payouts quarter over quarter," McDermott told clients April 18. "The recent rally in crude is supportive of shareholder returns for the remainder of the year, with median total yield remaining attractive across oil E&Ps (6%), majors (8%) and Canada (9%)."

McDermott said if companies have a choice of rewards, they will use share repurchases to benefit investors, "either in place of or in addition to variable dividends. Relative to 4Q, we expect stronger share repurchases from Pioneer Natural Resources Co. and Devon Energy Corp."

S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.