Thursday, July 27, 2017

Investors To Big Oil: Restrain Yourselves

Exxon, Shell, BP, Chevron are under pressure to show they can keep spending under control.


By Sarah Kent
The Wall Street Journal
July 27, 2017

Three years into an oil-price slump, investors want the world’s biggest oil companies to do something they have historically struggled with: Maintain some financial discipline.

The companies are under pressure to show they are continuing to move on from budget-busting projects once common in the industry, as they head into second-quarter financial disclosures that begin on Thursday with Royal Dutch Shell RDS.B 0.49% PLC and Total SA TOT 1.14% .

Shell, Total and peers such as Exxon Mobil Corp. XOM 0.12% and Chevron Corp. CVX 0.70% , which both report earnings Friday, have reined in spending through an oil-market downturn during which crude prices fell from $114 a barrel to $27 a barrel and remain about $50 a barrel. Those efforts paid off in the first quarter, when the companies returned to billion-dollar profits after years of losses or anemic earnings.

Now, said Jags Walia, senior portfolio manager at Dutch pension-fund manager APG Asset Management, “there’s no room to take your foot off on capital discipline.”

“I think that would be quite unforgivable,” said Mr. Walia, whose fund invests in several large oil companies, including Exxon, Shell and BP BP -0.17% PLC.

It is a call for big oil companies to keep their businesses steady in a tricky financial environment.

International oil prices were up nearly 10% in the second quarter compared with the same time last year. But prices are still likely too low for many companies to cover spending and dividends with cash, or break even. At the same time, the companies have to keep finding new oil to replace the barrels they are pumping. That means spending money on exploration, development and acquisitions.

BP, which reports earnings next Tuesday, faced criticism from investors and analysts after a flurry of acquisitions inflated its investment plans for 2017 and pushed up the oil price at which the company could break even to $60 a barrel. The company’s shares fell 4% after the February announcement. It has since said it is working to drive down its break-even oil price to between $35 to $40 a barrel by 2021.

It isn’t just BP. The number of new projects approved this year across the industry is expected to creep up to between 20 and 25 from just 12 in 2016, according to Edinburgh-based consultancy Wood Mackenzie.

The oil companies declined to comment ahead of their earnings reports.

But they have moved to tackle the challenges.

BP’s costs are down 40% since 2013 and it has vowed to maintain a budget cap of $17 billion a year out to 2021.

At BP’s first-quarter results in May, Chief Financial Officer Brian Gilvary said the company intended to deliver on promises to increase cash flow and dividends in coming years by “maintaining strict discipline within our financial frame and staying focused on delivering returns.”

Exxon’s capital spending last year was $12 billion lower than in 2015, though it has crept higher this year. The company says it is focusing a chunk of its firepower on shale developments that start to generate cash quickly.

Chevron has said it will be able to cover its spending and dividends with cash at $50 a barrel this year with the help of asset sales. In April, Chevron said it had lowered capital spending 22% compared with its average quarter in 2016 and 56% versus the average quarter in 2014. The company plans to spend $17 billion to $22 billion a year out to the end of the decade.

“If oil prices remain near the $50 per barrel mark, you can expect to see our future spend near the bottom of this range,” Chief Financial Officer Patricia Yarrington told analysts in April.

The companies have said that they still have room to cut further and that they can start to invest in new projects without returning to the spendthrift era that eroded returns before the oil-price crash in 2014. Capital spending on new projects sanctioned so far this year is on average just $11 per barrel of oil equivalent, down from $15 in 2015, according to Wood Mackenzie.

“I think a lot of these companies have found religion,” said Brian Youngberg, senior energy analyst at brokerage firm Edward Jones. “They realize now they can’t just spend, spend, spend. They have to be more disciplined with their capital.”

Exxon, Shell, BP and Chevron have all indicated they will be able to generate enough cash this year to cover spending and shareholder payouts at $60 a barrel, but at $50 the picture is more mixed. Even next year, many of them will still need higher oil prices to cover their costs, according to analysis by Macquarie.

Investors remain cautious. Big oil companies’ share prices are little changed or lower than at the same time last year, even though oil prices are higher. For instance, Exxon’s share price is down more than 10% from a year ago.

The companies still have high debt levels, and some—like Shell and Total—offer dividends as company shares, known as scrip, helping them to preserve cash but also diluting investors’ earnings per share.

“We need to see discipline and people being more realistic about where oil prices could remain for quite a long time,” said Jason Kenney, an oil-company analyst at Spanish lender, Banco Santander .

It is a tall order for an industry that struggled to break even when oil was at $100 a barrel. And the challenge facing the companies could be more difficult after banks revised their oil-price forecasts downward in recent months.

“The goal posts have moved,” Deutsche Bank said earlier this month. “It’s time to go away and remodel for a $45 to $50 a barrel world.”


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