US exploration and production (E&P) companies will likely report higher organic reserve replacement and proven (1P) reserves as part of upcoming 4Q21 and YE 2021 earnings, says Fitch Ratings. This increase will likely be driven primarily by significantly higher yoy price revision-related gains and, to a lesser degree, relaxed trends in well spacing. Fitch expects increases in reserves to have a limited impact on credit quality, given energy price volatility and the risk that price-driven reserve additions could be reversed in the long term, particularly if oil prices decline due to future demand issues.

We view efficient reserve replacement as a key indicator of financial health for E&Ps, given the link to future production through drilling wells. A low-cost reserve base supports the ability to repay debt and underpins other key metrics used to assess the financial health of upstream companies. This includes full unit economics, finding and development costs, cycle ratio and debt/barrels of oil equivalent.

Reserve gains in 2021, and those occurring longer term, may be somewhat capped by producer capex discipline. Public E&Ps continue to prioritize FCF generation, by maintaining moderate levels of capex, despite significantly higher oil and gas prices.

Over the longer term, producer capex discipline will depend on whether investors continue to reward FCF, or whether they will revert back to rewarding production growth, as they historically have done. At a minimum we expect the theme of capital discipline will continue in 2022 for public E&Ps. However, a number of issuers have recently adopted rules earmarking an increasing percentage of FCF for shareholder distributions, and a lower amount for debt paydown, resulting in a potentially slower pace of deleveraging in the future.
Source: Fitch Ratings