Oil production is an incredibly capital-intense business. Producers need to pour billions of dollars into new wells just to maintain their current output rate, with billions more needed to increase production. In fact, the industry has a history of reinvesting every dollar of cash flow, and then some, into new oil projects. That said, this pursuit of growth at all costs hasn't paid off in recent years, actually contributing to crude's crash and currently keeping a lid on prices.
As a result, more oil companies are choosing to divert a portion of their excess cash to what they see as a more valuable pursuit: Share buybacks. The latest to hop on the buyback bandwagon is Anadarko Petroleum (NYSE: APC), which plans to spend up to $2.5 billion on repurchases by the end of next year because it believes it can create more value for investors with those repurchases than by investing that capital into more oil wells.
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Drilling down into Anadarko's buyback
Anadarko Petroleum spent the bulk of the oil market downturn focused on repositioning so that it could run on lower oil prices. That resulted in the company selling a slew of non-core assets, which significantly improved its balance sheet so that it's now sitting on $6 billion in cash. While the company could use that money to accelerate its oil growth rate -- which it currently forecasts to be 15% annually through 2021 while living within cash flow at around current prices -- it sees more value in using a portion of that cash to repurchase shares.
That's why the company unveiled a $2.5 billion buyback that it expects to complete by the end of next year. CEO Al Walker stated that Anadarko sees the buyback as "a very attractive use" of its cash because it would be highly accretive to both earnings and production per share. That's because the plan "represents approximately 10% of the company's outstanding common shares" at the current stock price, according to Walker. In other words, Anadarko can boost its output and earnings per share by an additional 10% over the next year by repurchasing stock, which given the volatility in oil prices is a safer bet for creating additional value for investors than increasing output, as the market remains oversaturated with crude.
A growing trend to grow value a different way
While oil companies have a long history of buying back their stock, those repurchases dried up during the oil market downturn because they needed that cash to stay afloat. However, buybacks have been making a comeback over the past year. Fellow U.S. oil giant ConocoPhillips (NYSE: COP) was one of the first to put a priority on repurchases when it unveiled its plan last November. The company's strategy was to sell up to $8 billion of assets by 2019 and use $3 billion of those proceeds to repurchase shares, with the rest going toward debt reduction. However, ConocoPhillips vastly outperformed its expectations by selling more than $16 billion in oil and gas properties this year, which enabled it to supercharge its repurchase program so that it now plans to buy back $3 billion in stock this year and another $3 billion by 2019. This buyback has the potential to significantly bolster ConocoPhillips' production per share, which it sees rising 8% this year on an asset-sale-adjusted basis, versus just a 3% increase without the buyback.
Meanwhile, Canadian oil giant Suncor Energy (NYSE: SU) unveiled a 2 billion Canadian dollar ($1.6 billion) buyback this spring, which it plans to complete over the next year. Those repurchase activities and subsequent authorizations are crucial to helping Suncor Energy meet its goal to increase output by 10% annually on a per-share basis through 2019 since it doesn't have any more major growth projects coming down the pipeline after it completes its Fort Hills and Hebron facilities later this year.
Even natural gas pipeline giant (and Texas' 13th largest oil producer) Kinder Morgan (NYSE: KMI), is getting in on the buyback game after unveiling a $2 billion buyback that will go into effect next year. One of the drivers of the repurchase decision is that its shares currently trade well below the peer group average. Because of its discounted valuation, Kinder Morgan could retire about 5% of its outstanding stock at the current price, which would boost per-share cash flow by a similar rate. Furthermore, investors would see that increase sooner than if the company were to use that capital to build a new pipeline or bring additional oil production online since those projects would take months if not years to complete (and carry more risk).
Making a wise choice
With the oil market stabilizing, oil giants have a decision to make with the cash they built up during the downturn: Either use it to fuel a faster growth rate in a fragile market, or spend it to gobble up their cheap stock and drive incremental growth that way. Many are choosing the latter option because that enables them to deliver an accelerated growth rate without upsetting the apple cart by unleashing more production on an oil market that's just getting back on its feet. It's a move that has the potential to keep their stocks moving higher even if oil takes a breather.
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Matthew DiLallo owns shares of ConocoPhillips and Kinder Morgan and has the following options: short January 2018 $30 puts on Kinder Morgan, long January 2018 $30 calls on Kinder Morgan, and short December 2017 $19 puts on Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool has a disclosure policy.