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A mix of high oil prices and capital discipline has led to strong balance sheets across the energy sector, but the trend of falling debt has started to reverse itself. If oil prices stay high — and especially, if they breach $100 a barrel — the companies are well positioned. However, should oil prices fall and debt levels continue to rise, some companies have boxed themselves into a corner with very generous dividends and share repurchase programs. Data from Evaluate Energy reviewed by CNBC shows that of 50 U.S.-based oil companies, 60% have increased total debt carried on their balance sheets from the first quarter to the second quarter. At the same time, operating cash flow has been declining. That could force management teams to decide between keeping these shareholder-friendly programs, and investing in future drilling. “What we’re looking at is companies trying to bridge a little gap while operating cash flow is going down,” said Mark Young, senior analyst at Evaluate Energy. “Companies are seeing more value in spending and shareholder returns than they are seeing risk in taking on extra debt to fund it.” Smaller companies in the sector are the ones taking on the majority of new debt, according to Young’s analysis. Of the $195 billion of total debt going back to the first quarter of 2018, about $3 billion is new, he said. The largest quarter-over-quarter increases in debt were made by Civitas Resources and Ovintiv , which added roughly $2.7 billion and $2.4 billion, respectively, from the first quarter to the second, said Young, who described the moves as mainly “one-off large financings to fund cash portions of acquisitions.” Oil’s total debt obligations had largely trended downward from 2020 until the middle of this year. The increase in new debt is the largest since before the pandemic, according to Young. The fastest rate of acceleration occurred between the first quarter and second quarter, where total debt increased 3% and net debt climbed 15%. Young attributed the rise in debt to falling financial assets, largely cash. “Since the end of 2020, operating cash flow has been able to cover all capital spending, dividend payments and share buybacks by itself. In Q2 2023, this was not the case [for the] first time in almost 3 years,” he said. Balance sheets overall are in healthy shape, which has influenced the decision to take on new debt to fund these programs. Conoco Phillips , Chevron and Exxon Mobil , for example, put effort into paying down debt. “At the sector level, balance sheets are in the best shape they’ve been in a long time, perhaps ever,” said Noah Barrett, analyst and head of utilities sector coverage at Janus Capital. But operating cash flow has declined meaningfully across the board over the past four quarters, and stood at roughly $49 billion at the end of the third quarter. That’s down from $57 billion in the second quarter and $66 billion the first quarter, according to Young. The cost of producing and drilling has increased and contributed to the drawdown in operating cash flow, Young said, but slack in both oil and gas prices are the biggest overall culprit. “[O]perating cash flow tracks the oil price pretty well,” Young said. The $70 to $75 per barrel range for oil prices in the first and second-quarter of this year compared with over $100 at the 2022 peak were a hit to operating cash flow this year, he said. With oil prices averaging roughly $80 per barrel in the third quarter, oil companies could once again see operating cash flow climb “unless there is a dramatic shift between now and the end of the year,” he said. At the same time, operating and transportation costs soared in the fourth quarter of 2021 into the first-quarter of 2022 and have stayed there, making oil companies even more reliant on high oil prices. Specifically, 81% oil companies tracked in the data showed higher costs in the second quarter of 2023 compared with a year earlier, Young said. The late-summer bounce back in oil prices will provide a cushion to companies deciding how much to allocate to drilling and production, buybacks and dividends. The environment for borrowing isn’t a welcoming one. The Federal Reserve has signaled that one more rate hike could come before the end of the year, while the central bank has penciled in two rate cuts in 2024, fewer than previously expected. Bringing investors back in Wall Street wasn’t always partial toward oil. The attractiveness of the sector picked up steam around 2019, according to Warren Pies, founder and strategist at 3Fourteen Research, when the energy sector became the highest yielding segment in the market for the first time. “Since April of 2019, the energy market became the highest yielding sector in the market, and in my view, that was a signal from shareholders telling the entire space this is a short duration asset now, we want a return of our capital as soon as possible,” Pies said. Investors have a range of options to choose from when chasing a dividend yield among energy stocks. If a trader wants to stick with blue chips, Chevron offers a 6% yield, while Conocophillips ‘ yield is 4.6%. But some yields are even larger. Devon Energy , for example, now sports a 7.6% yield. Stock buyback programs are equally vigorous. Many were shocked earlier this year when Chevron approved a plan to spend $75 billion on share repurchases . In April, the company said it increased its targeted annual share repurchase rate to $17.5 billion. In the second quarter alone, Chevron said it spent $7.2 billion on shareholder distributions, including $2.8 billion in dividend payments and $4.4 billion in stock repurchases. During the same quarter , Exxon Mobil spent even more, devoting $4.3 billion to share repurchases and $3.7 billion on dividends. Last year, after record profits, Exxon boosted its buyback plans by 10% to $50 billion through 2024. “I think the thinking has become, ‘we can’t just be in line with the S & P 500,'” Barrett said. “They’re starting to figure out that in order to get more investor capital into energy, you have to compensate them more than the market average.” Forecasting an ‘artificial’ market Pies, however, questions how sustainable the recent oil price rally is, and suggested that the rug could soon be pulled. Oil prices have risen nearly 30% in the third quarter, and Pies sees the gains as being artificially driven by lower production and steep cuts from OPEC, led by Saudi Arabia, and says that can’t last forever. “From here, the big question is when does that oil come back onto the market? In my opinion, the Saudis’ main goal with this new strategy is to keep the whole world guessing what they’re going to do next,” Pies said. “So to me, the elevator pitch on oil is that we’re close to the end of the rally [and] the big threat is when this OPEC production comes back.” Saudi Arabia, by far the largest producer in the Organization of Petroleum Exporting Countries, said it plans to keep 1 million barrels per day off the market through the end of the year. Russia, which isn’t a member of the cartel but is included in OPEC+, similarly pledged to lower output by about 300,000 barrels per day over the same period. “We’re constantly trying to balance something that’s very difficult to forecast,” said Matt Smith, lead oil analyst at Kplgr. He added that demand growth is hard to predict, and said companies could have trouble conjuring up models to accurately forecast how much revenue from higher prices will continue to flow, and in turn continue to fund dividend and buyback programs. “For companies like Chevron, the sweet spot for them is around that $80 mark, because it’s good for consumers and also good for producers,” Smith said. Finding a middle ground could prove difficult, according to Jason Mountford , trend analyst at Q.ai. “At this point, it seems like practically a given that Brent crude will breach $100 a barrel, with Goldman Sachs, Bank of America, Citigroup and Chevron CEO Mike Wirth all forecasting it to happen before 2024,” Mountford said. ‘There is no easy answer’ Some say oil companies aren’t interested in expanding capacity after unprofitably ramping up production following the global financial crisis, the price collapse at the start of Covid and in an era of expanding renewable energy. “It seems to me that there’s been an underinvestment long-term in oil and hydrocarbons,” Pies said. “I don’t think that demand is going to peak imminently despite a lot of optimistic predictions.” The issue isn’t a new phenomenon, Pies said. “The point is that the future is way different than the world you’re planning for, and this is a problem that constantly plagues this industry. There is no easy answer,” he said. But oil companies will have no choice but to contend with choosing between expanding refining capacity and putting cash back in investors’ pockets because of the decline in operating cash flow. Investors are drawn to the sector, in part, by the promise of strong dividends and buybacks. “I think companies, too, are trying to walk that fine line of continuing to deliver on the shareholder return side of the component, because that’s really what brought investors back to the sector. If there’s any sense that [dividends and buybacks] are getting materially cut, that might be the last straw and break the trust of the investor who has been burned multiple times by the energy sector,” Barrett said.
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