Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Here's a shocker: The oil business is cyclical.

Now, once you've had a chance to sit down, I'll lay this one on you: That cycle is speeding up.

Late on Wednesday, Anadarko Petroleum Corp., which closed at $44.81 a share, announced plans to buy back up to $2.5 billion of its stock; which is interesting, because almost exactly a year ago, it sold about $2 billion of new stock -- at $54.50 apiece.

This says a lot about Anadarko but also the whole E&P sector.

Anadarko's stock has lagged a largely beaten-down group of mini-majors this year.

'Darko Days
Anadarko has lagged its mini-major peers this year, and the group has largely trailed the broader E&P sector
Source: Bloomberg
Note: Performance indexed to 100.

The oil-price crash is partly responsible, but Anadarko inflicted one or two wounds on itself. In late 2015, it made an awkward attempt to buy rival Apache Corp. Then, a year ago, it bought $2 billion worth of deepwater assets in the Gulf of Mexico from Freeport-McMoRan Inc., which necessitated that sale of stock.

That deal wasn't terrible in itself. However, it reinforced a structural problem faced by Anadarko and its mini-major peers, which are too diversified to gain the multiples awarded pure-play shale developers, but not big or diversified enough to really count as a relative safe haven like Exxon Mobil Corp.

A year on, Anadarko must be looking over its shoulder. Activism has started cropping up in the sector, with EQT Corp.'s board the latest to get several not-so-friendly letters and helpful suggestions. Meanwhile, Anadarko has also long been talked of as a potential takeover target. And right now, it isn't just trading at a significant discount to Exxon Mobil -- the discount actually widens with time:

Further Markdowns
Anadarko's slide leaves it looking cheap (and getting cheaper) versus Exxon Mobil, long rumored to be a potential buyer
Source: Bloomberg

In an attempt to get out of the doghouse, Anadarko has sold assets and now has $6 billion in the bank. Using a big chunk of that to buy back roughly 10 percent of its own stock, therefore, looks like an attempt to appease a listless, but potentially restless, investor base.

Yet it also fits the E&P zeitgeist.

This summer has been a washout for the sector. Dan Pickering, head of TPH Asset Management in Houston, points to its "dramatic" underperformance, adding "no big long-only guys are buying; they're selling." 

The reason is that, as happens from time to time, investors are tiring of the sector's traditional growth mantra. One of the central criticisms leveled against E&P boards by activists is that executive compensation rewards getting bigger rather than better.

Evercore ISI analyst Doug Terreson published a detailed, and timely, report on the subject back in May (in which, incidentally, Anadarko scored relatively poorly). Only on Wednesday, Kevin Holt, chief investment officer for U.S. value equities at Invesco Ltd., published a report along similar lines with the ominous title "The Math on E&P Stocks Doesn’t Add Up." Looking at the sector returns he refers to in there, you sort of have to agree:

Drilled Down
E&P companies' focus on growth has come at the expense of generating cash flow
Source: Invesco
Note: Cash flow return on investment. "E&P sector" refers to the average CFROI for a group of 10 large U.S. E&P companies.

It is notable that, while the sector had no problem selling new equity in 2015 and 2016 to help it keep drilling through the downturn, this has slowed markedly:

Taking Stock
After several years of big equity sales, including a blowout 2016, the E&P sector's issuance has slowed to a trickle
Source: Bloomberg
Note: Data for 2017 are year-to-date, as of Sep. 20.

So while Anadarko's decision to return cash reflects its own particular challenges, it also looks like another sign of the industry responding to a wider shift in sentiment.

Net-net, this should be positive for investors -- and for oil prices. E&P firms forced to prioritize returns over growth should take some dollars away from marginal wells, slowing the recovery in U.S. production.

What's ironic is that this is happening because OPEC's strategy of cutting supply to raise oil prices has, thus far, largely failed.

Oil was trading in the mid-$40s when Anadarko sold stock last September, and the price is only a little higher now that the company is buying it back. Flat prices have numbed investors into a mix of capitulation and frustration.

Yet it probably wouldn't take much to change that.

OPEC and chums meet again this week in an effort to push prices higher (not least because one big member has an upcoming IPO to pitch). Anadarko's move suggests they should cancel the meeting if they really want to re-establish some authority. They will likely come to regret it if, for some reason, their efforts succeed.

Note that, even as Anadarko directs cash away from drilling or acquiring assets, it still targets growth within cash flow at $50 a barrel next year. If prices were to rise to, say, $60 or more, it is a fair bet that much of the pressure on E&P stocks would ease up and drilling budgets would benefit.

The nature of the shale boom, with its sharp drop in costs and relatively quick drilling schedules, is such that, within another year, a lot might be forgiven. As Pickering says: "Investors can change their minds faster than companies." Hardly shocking news, that, but apt nonetheless.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net