Shale oil players are cutting spending on drilling, and investors could reward them

Key Points
  • U.S. shale oil drillers are starting to cut their 2017 capital spending plans after oil prices slumped in the second quarter.
  • How investors respond to similar announcements going forward could determine whether they'll reward drillers for exercising financial discipline.
Shell CEO gives projections for oil price
Shell CEO gives projections for oil price

Shale oil drillers have seen the writing on the wall, and it says: "Slow down."

As the energy sector begins reporting earnings, independent oil companies are announcing plans to throttle back spending this year after a price rally stalled in the second quarter, leaving U.S. crude languishing below $50 a barrel for much of the period.

"What I've said in the past is $50 is kind of the line of demarcation," said Rob Thummel, portfolio manager at Tortoise Capital Advisors. "That's exactly what we're seeing. We're seeing a decline in capex."

The pullback started with Anadarko Petroleum, a global driller with shale oil assets in Colorado and Texas. The mini-major announced it would reduce its 2017 exploration and production budget by about $250 million. Going forward, the company will determine its spending depending on how much cash it generates and the returns on investments it realizes, Anadarko CEO Robert Walker said on Tuesday.

"We sincerely believe the volatility of the current operating environment requires financial discipline. And as I have said many times, pursuing growth without adequate returns is something we will avoid," he told analysts.

Over the last two days, big producers like ConocoPhillips and Hess, as well as smaller regional driller Whiting Petroleum followed suit.

That's welcome news to some analysts who are growing concerned that drillers are hiking output at the expense of financial discipline.

Until now, producers have been worried about cutting back spending because they believe investors want production growth above all else, said Timothy Rezvan, managing director of energy research at investment bank Mizuho Americas. Investor reaction to capital spending cuts announced during the reporting period will signal whether a shift in investor sentiment is underway, he said.

Investors have not historically rewarded drillers for cutting capital spending because it usually leads to lower production and revenues, but that could be changing, said Thummel.

"Spending within your cash flow is becoming a more important element for all oil and gas producers at this time," he said. "Outspending your cash flow is something that I think investors are becoming less comfortable with."

The man who called the crude rally now sees this
The man who called the crude rally now sees this

ConocoPhillips CEO Ryan Lance stressed the importance of generating cash flow while lowering the cost of producing oil.

"This is the right approach for value creation in the upstream sector, especially at a time of uncertainty in the commodity markets," he said in a statement.

There is some evidence investors like what they see, though Thummel cautioned against calling it a trend just yet.

Shares of Anadarko Petroleum are up about 4 percent over the last two days, despite the company missing expectations on key metrics. ConocoPhillips and Hess were up 1.2 percent and 0.5 percent, respectively, on Thursday despite posting quarterly losses.

Whiting, one of the dominant independent drillers in North Dakota's Bakken shale, saw its shares slump 4 percent on Thursday after also turning in a loss for the quarter.