1 of 10/ ROCE vs Well IRRs and the Path Back for Old Energy
Since the shale revolution, there is a massive disconnect between promised well-level IRRs and actual, corporate-level returns on capital employed (ROCE) for the oil industry.
Since the shale revolution, there is a massive disconnect between promised well-level IRRs and actual, corporate-level returns on capital employed (ROCE) for the oil industry.
2/ Oil producers promised 30%-50%+ well IRRs at seemingly conservative oil prices (<$50/bbl). Over the previous 5 and 10 years, WTI averaged $51 and $68/bbl. Corresponding median ROCE for Old Energy averaged +0.6% and 3.9%. What the heck!?!
3/ Why the crazy big gap? It appears that numerous ongoing costs were not reconciled including for acreage, infrastructure, less successful drilling, DUC builds, etc. Why ignore so many costs? I have no explanation.
4/ Historically, the Major Oils were known as the better ROCE companies that prioritized corporate returns and dividends over the “drill-baby-drill” mentality of most E&Ps. The Majors were the “real” comanies that long only PMs could get behind.
5/ In the US, we are down to just two traditional Majors, one of which is under duress, and in Europe they all want to become “Energie Transition” heros. This has left a void of disciplined, returns-focused Old Energy mega caps in the US and globally.
6/ The good news is there is a new group of US-based Old Energy managements that recognize the failure of the “Well IRR” model. One, $EOG, has long been an ROCE leader; I credit its former CEO Forrest Hoglund with educating me on the subject at a 1993 analyst meting.
7/ Over 1991-2003, median Old Energy ROCE averaged over 12%. Including the super spike period (i.e., thru 2008) boosts that to 14.5%. Point being, higher ROCE is possible and does not require a new super cycle.
8/ It remains my view that Old Energy ROCE reached a generational trough in 2020 and that a new, multi-year ROCE improvement cycle may be at hand.
9/ The pushback: E&Ps have never in 150 years remained disciplined. I agree. But I do think a new group of companies across all facets of the sector are capable of significantly improved ROCE, consistent with what the former Majors achieved.
10 LAST/ I see the growing likelihood of new Climate policies/regs as being supportive of Old Energy ROCE. Old Energy needs to be part of the Climate solution and I reject the idea that addressing Climate concerns is definitionally negative for Old Energy ROCE.
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