Murphy Shifting From Deleveraging to Capital Returns

Director

Dave Meats

Murphy Oil has been a pure-play exploration and production company now for close to a decade, having spun off its retail gas and refinery businesses back in 2013. The firm produces oil and natural gas in the U.S. and Canada. Unlike most upstream firms, it focuses heavily on offshore resources, primarily in the Gulf of Mexico (where it is a top five operator). Offshore production accounts for about half of its total volumes.

The firm expanded its Gulf of Mexico footprint in late 2018, signing a joint venture agreement with Petrobras that gave it an 80% stake in the combined assets of the two companies. It recently brought on line a number of major expansion projects in the region, including Samurai, Khaleesi, and Mormont, and it still has a number of development opportunities on deck. These projects should should offset legacy declines and enable it to hold production flat in the next few years. There remains some incremental regulatory risk for Gulf of Mexico operators but this has substantially receded in the past couple of years. Upon entering office, U.S. President Joe Biden pledged to halt offshore oil and gas permitting activity to demonstrate his climate credentials. But high crude prices made it politically unpalatable to follow through, and so far the only action taken was a temporary permitting suspension that came into effect in early 2021 and was rescinded a few months later.

The onshore portion of the portfolio includes 120,000 net acres in the Eagle Ford Shale play in South Texas. Like other shale producers, Murphy has made considerable progress cutting costs and boosting productivity since the post-2014 downturn. However, while the firm still has over 1,000 drillable locations in its Eagle Ford inventory, only one third of them are in the prolific Karnes County area. To avoid exhausting its core acreage too quickly, management has started layering in development activity in other regions of the play, which affects well performance, and thus returns. And in Canada, the firm is currently prioritizing the Tupper Montney gas play to take advantage of higher natural gas prices supported by rising LNG export demand.

Business Strategy & Outlook

The ability to generate durable excess returns on invested capital is a hallmark of companies with economic moats. Before 2022, Murphy had not earned its cost of capital since 2013 (when Brent crude averaged $108 per barrel). The near-term outlook for crude is exceptionally strong once again and could commensurately drive up corporate returns, but we see this as a cyclical upswing and not a secular shift. Murphy is now investing in projects that offer decent returns at midcycle prices, but its capital base is still inflated by less attractive investments during previous cycles. As such, we see little chance that Murphy can maintain corporate returns in excess of the weighted average cost of capital, and accordingly we assign a no-moat rating.

Today, the firm is focusing on offshore exploration and development. This is probably the right move, since the company has a relatively short runway of top-tier drilling opportunities in the shale portion of its portfolio. We'd rather see it cherry pick low-cost high-return projects offshore than pour capital into lower-productivity shale acreage. Nevertheless, we doubt that Murphy's offshore portfolio can consistently compete on costs with the best shale opportunities, leaving the company with a higher average cost of production than the best of its shale-focused peers. In addition, like all E&P firms, the firm is exposed to a range of potential environmental, social, and governance issues that could hurt its ability to generate strong returns.

The most significant ESG exposures are greenhouse gas emissions (both from extraction operations and downstream consumption) and other emissions, effluents, and waste (primarily oil spills). Greenhouse gas emissions are the biggest threat and are unavoidable for oil producers. Firms can clean up their operations in the field as much as possible by avoiding unnecessary flaring and using technologies like electric fracking and carbon capture to reduce CO2 volumes being released into the atmosphere during the extraction process. Downstream emissions—at the refinery and beyond—are beyond producers' control, yet these account for the vast majority of total emissions. So, there's no such thing as a "green" oil producer. As consumers grow more averse to fossil fuels, the reputational risk increases for producers and the probability of widespread substitution away from fossil fuels rises. This also makes value-destructive regulatory intervention more likely (think fracking restrictions or carbon taxes). These threats are not likely enough to be included in our base-case forecasts, but because the impact would be material, it does further erode the firm’s moat potential.

Likewise, spills are a significant concern for firms operating offshore, as Murphy does. Though the probability is very remote, a devastating accident like the BP Macondo disaster in 2010 would have a material adverse impact on Murphy, if it were forced to cover cleanup costs and other legal penalties. Spills also occur from time to time during long-haul transit over land, but Murphy has limited exposure, as this activity is typically outsourced to midstream firms. So there is no chance that the firm would be on the hook for an event like the Kalamazoo River (Michigan) spill, which also occurred in 2010.

None

Economic Moat

Murphy Oil

Murphy Oil Corp. is a holding company, which engages in the exploration and production of oil and natural gas. It operates through the Exploration and Production and Corporate and Other segment. The Exploration and Production segment includes the United States, Canada, and all other countries. The Corporate and Other segment focuses on interest income, other gains and losses, interest expense, and unallocated overhead. The company was founded by Charles H. Murphy Jr. in 1950 and is headquartered in Houston, TX.

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Earnings data Q2 2024

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