European oil majors, including Shell, Total and BP, have broadly adapted to oil prices under USD60/bbl thanks to improved spending discipline, cost deflation and lower cash dividends, Fitch Ratings says.
The companies all generated neutral-to-positive free cash flows in 2017 (after dividends, before M&A), according to their recently released annual results. Developments in their credit quality will largely depend on their ability to preserve financial flexibility, as oil prices are likely to remain volatile.
Despite Brent averaging just USD55/bbl in 2017, free cash flow before working capital changes ranged from minus USD0.5/bbl for BP to USD6.6/bbl for Total, significantly better than in previous years. Oil majors used to burn cash even when oil prices exceeded USD100/bbl, as they were less operationally efficient and more capital-intensive. In 2013, when Brent averaged USD109/bbl, European majors’ cash flows ranged from minus USD14/bbl for Total to minus USD3/bbl for BP.
The improved cash flow is a result of multi-billion-dollar cost-cutting initiatives, higher focus on the downstream and petrochemicals segments, and the introduction of scrip dividends, which has helped to reduce cash payouts. Cash flows were also helped by external factors such as cost deflation, including rates charged by oilfield services firms, and depreciation of petrocurrencies, which reduced dollar-denominated costs.
Oil majors expect this progress to continue; BP plans to reduce its organic breakeven price to USD50/bbl in 2018 and to USD35-USD40/bbl by 2021. However, history shows that companies tend to give away their cost savings as oil prices rise, and we believe that oil majors’ cash breakeven oil price is more likely to stabilise around USD50-USD60/bbl in the medium term. Nevertheless, this should allow integrated oil companies to generate neutral-to-positive free cash flows through the cycle under our price deck assumptions, which supports their current ratings.
The main threat to the ratings of the oil majors would be a push from shareholders to re-prioritise dividends ahead of debt reduction, driven by the recent recovery in oil prices above USD65/bbl. We doubt that current prices will be sustained. Our base case is that the Brent price will fall from current levels and stabilise in the USD50-USD60/bbl range, as US shale production is set to increase further.
Shell’s (AA-) Outlook remains Negative, largely due to relatively high debt, following its acquisition of BG, coupled with the cancellation of the scrip dividend at end-2017 and the announced share buy-back for at least USD25 billion in 2017-20. A mitigant is Shell’s successful disposal programme, which brought in USD22 billion in 2016-2017; however, this is coming to an end, with assets worth about USD8 billion left to be sold. Other companies have remained more conservative, but higher payouts could put their ratings under pressure.