May 2, 2021 [Oil Price] – Earnings season in oil and gas has begun, and expectations are much different from what they were just three months ago.

Oil prices are stronger, and the outlook for demand is more positive even though uncertainty remains. No wonder, then, that expectations about financial reports are brighter. However, challenges remain.

Strong cash flows

Oil producers should report a substantial increase in free cash flow both on a quarterly basis and on an annual basis, according to Troy Vincent, a market analyst at DTN. Vincent also told Oilprice that companies would likely use that higher free cash flow to pay down debt and prop up their balance sheets.

Surprises are possible, mostly in production growth and spending plans but are not very likely, according to Vincent. Like other industry observers and insiders, Vincent noted that the industry is still taking a guarded approach to the future, likely to focus not on production growth at all costs but on sustainable production growth.

“While there may be a few surprises by way of companies announcing stronger production growth expectations and capital spending than in Q4 in light of the strength of the global demand recovery, Q1 earnings should continue to reflect an industry that is more focused on sustainable production growth and returns to shareholders rather than rushing to drill and complete wells (particularly in the US shale patch) as fast as possible as prices rise,” Vincent said.

The Freeze effect

The positive news from above is largely a result of the slow return to normal, where normal means higher oil prices make for higher company profits. Yet this quarter featured, besides higher oil prices, the Texas Freeze, which paralyzed the United States’ oil heartland and removed thousands of barrels in oil production from the market as well infrastructure froze.

Shell has already warned that its first-quarter figures will be affected by the Texas Freeze. The impact will be to the tune of up to $200 million, the supermajor said in a first-quarter update. Of this total, the damage would be up to $40 million on the upstream segment, up to $80 million on oil products, and around $60 million on the chemicals business, Shell said earlier this month.

Exxon also warned about the Freeze’s impact on its earnings for the first quarter. This impact will be much larger than Shell’s, at $800 million. However, it would be offset by the strong performance of its main business divisions, driven by stronger oil and gas prices.

Generally speaking, everyone involved in oil production and refining in Texas is likely to suffer some damage from the February Freeze, with its size depending on the size of the company’s exposure to the state’s oil and gas industry.

The investor challenge

While the losses suffered from the Texas Freeze are now in the past and a one-off event, oil companies this quarter are facing a trickier challenge: convincing investors they are on the right track.

A lot of attention has been given to decarbonization efforts and how oil and gas is allocating capital to alternative businesses,” says Mitch Fane, EY U.S. Oil & Gas Leader. “Companies will need to display tangible actions to decarbonize and must align with a larger strategy that demonstrates financial discipline and strong returns, as this will be important for their access to capital going forward.”

While not all investors and oil and gas belong to the ESG wave, the sheer amount of attention that decarbonization is getting these days makes it a priority. Also, the fact that all Big Oil majors have—albeit forcedly—committed to lowering their emissions footprint means that the ESG investors are gaining strength, as evidence by more climate-related resolutions being drafted for this year’s annual general meetings.

Financial agility

Agility in finance is the other thing we can expect to hear on conference calls this month and next as the oil industry reports first-quarter results. With the pandemic and the renewables push, things are no longer as simple as “Drill when oil’s high, stop when it’s low.”

Now, after surviving a brutal 2020, oil and gas companies will need to continue prioritizing capital discipline and betting on the best assets only. This was already made evident during last earnings season, and despite the tangible improvement in both oil prices and demand outlook since then, chances are the priorities will remain unchanged.

“Though the timing is unclear, the resolution of the pandemic is in sight,” EY’s Fane told Oilprice. “Vaccine distribution continues to make a significant difference in countries around the world, and oil and gas demand has recovered substantially. But long-term uncertainty and stakeholder pressure has forced companies to continue capital discipline and prioritize spending on critical assets and short-cycle projects. Investors will want to see how agile oil and gas companies can be as decarbonization and the energy transition gain momentum.

It seems that according to analysts, surprises are quite unlikely this season. Oil companies will post stronger results than last quarter’s on the back of the combination of vaccine drives, economic improvement in key markets, and OPEC+’s continued control of production.

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