A Study of Oil and Gas Companies' Over-Investment of Free Cash Flow

In this study, I examine the use of internally generated cash flows by oil and gas companies, and whether oil and gas companies over-invest in the presence of free cash flow. I find that oil and gas companies with positive free cash flow (FCF) tend to over-invest: over-investment by these companies amounts to 2% of their asset base and accounts for 33% of their FCF. In comparison, companies with negative FCF on average do not over-invest. In fact, these companies under-invest to help cover free cash flow shortfall. On average, 7% of cash shortfall is covered by investing less than what is needed for maintaining future growth. A regression investigation of the interaction of free cash flow and over-investment indicates that over-investment is not concentrated in companies with positive FCF. Among companies that over-invest, 66% companies have negative FCF. The average over-investment by these negative FCF companies amounts to 11% of their asset base, exceeding the 9% for over-investing companies with positive FCF. The over-investment by companies with negative FCF is mainly financed with capital raised from shareholders. Received permission to include on 3/21/19, but no other info as to DIO, embargo, or permissions going forward.