Oil majors on road to recovery after years of pain
The surge in profits that Royal Dutch Shell announced on Thursday brought to a close a strong set of third-quarter results from the world’s biggest oil and gas groups, where higher crude prices and lower costs are finally bringing recovery after three years of financial pain.
Shell’s forecast-beating 47 per cent increase in earnings to $4.1bn followed similar performances from BP, Total, ExxonMobil and Chevron. At the same time, Brent crude, the international benchmark, has risen to more than $60 a barrel for the first time since 2015 as rising demand begins to outstrip supplies after the deepest downturn for a generation. However, just as important has been the sharp spending cuts that have created a leaner industry capable of generating more cash at current prices than companies did before the crash from more than $100 a barrel in 2014. “
All the majors are proving they can work at $50 oil, which the market was sceptical could happen this quickly,” said Rohan Murphy, energy analyst at Allianz Global Investors. Shell’s turnround has been stronger than most, helped by new production and cost synergies from its $50bn acquisition of BG Group, completed last year. At an average oil price of $52 a barrel, Shell generated cash flow of $10.1bn in the three months to the end of September, enough to cover capital expenditure and the dividend for a fifth successive quarter.
The improving financial picture owes much to the delay and cancellation of some new oil and gas developments, which has helped protect the dividend by reducing spending but raises questions about future growth.
Capital expenditure by the enlarged Shell is on course to be about $25bn this year, compared with $40bn in 2013 before the BG deal. Similar cuts have been made across the industry, pushing investment down to historic lows.
The average number of new oil and gas developments given the go-ahead globally has fallen from 35 a year between 2010 and 2014 to just 12 since 2015, according to Patrick Pouyanné, Total chief executive. This number will have to increase, he said, if a supply crunch is to be avoided in the 2020s. He and other executives stress that reduced spending also reflects efficiency gains in the industry, allowing companies to do more for less.
Eldar Saetre, Statoil’s chief executive, cites his company’s new Johan Sverdrup oilfield in the Norwegian North Sea. Its development cost has fallen by a quarter from an initial budget of NKr123bn to the latest estimate of NKr92bn ($11bn). “I’ve never seen a reduction like that after an investment decision has been taken,” he said. Many of the savings stem from cuts forced on suppliers, such as rig operators, which were in no position to resist as business dried up after the oil price crash.
But Bernard Looney, head of exploration and production for BP, insisted that two-thirds of reductions are structural, rather than cyclical, and would be sustainable. “It’s as much a story of how bad the past was as how good we have become,” he said. “We got the cost of Mad Dog 2 [a development in the Gulf of Mexico] down from $20bn to $8bn but frankly we should never have been at $20bn in the first place.”
Examples of cost savings include more standardisation of design from one project to another. “In the era of $100 oil, the industry prided itself on bespoke designs,” he said. “That has changed and we’re seeing more off-the-shelf procurement.” Digital technology, such as machine learning to improve drilling accuracy, and data analytics to optimise production, is also helping, Mr Looney added. Many people are sceptical that such a cyclical industry will be able to avoid a return to past excesses.
Costs are already rising in US shale fields and oil services executives say rock bottom rates their companies are being paid elsewhere in the world are unsustainable. But Jessica Uhl, Shell chief financial officer, said on Thursday there was no sign of cost inflation outside North America and she saw “further to go” in the drive for efficiency. “We’re trying to build a company resilient to low oil prices,” she said, adding that new projects were being designed to make money at prices “well below $50” a barrel.
Total is going further still. Its pre-dividend break-even point — the oil price needed to cover expenses — will be less than $30 this year, with an aim for it to reach $20 in 2019. Alasdair McKinnon, fund manager at Scottish Investment Trust, which owns shares in ExxonMobil, Chevron, Shell and Total, said the oil majors had the “whip hand” on costs as long as the oilfield services market remained saddled with overcapacity.
But claims of lasting efficiency improvements would be tested if the industry became less cautious on investment as prices recover, he added. Total’s Mr Pouyanné said that, having found a profitable sweet spot at current prices, big oil producers would not welcome a return to the ill-disciplined days of $100 crude. “The business model of the majors is working better at this level,” he said.
Shell hints buyback is not far away
BP’s decision this week to launch a share buyback scheme was a sign that oil companies are becoming confident enough to think about improving returns for investors after the pain of the past few years.
Like most European oil majors, BP eased pressure on its balance sheet after oil prices dropped by paying some of its dividend as “scrip” — in shares rather than cash. This allowed companies to avoid cutting dividends but at the expense of diluting existing stock.
BP committed on Tuesday to offset this effect by buying back shares broadly equivalent to the amount issued in future through scrip dividends. Royal Dutch Shell stopped short of such a step when it reported results on Thursday, but chief financial officer Jessica Uhl hinted that a buyback was not far away.
Shell promised as part of its deal to buy BG Group in 2015 that it would repurchase at least $25bn of shares by 2020. Ms Uhl said Shell was “on track” to begin buybacks and remove the scrip, without giving a timetable. While Shell plans to move to an all-cash dividend, BP said it would continue offering the scrip option because some shareholders preferred it.
Of Shell’s $4bn of third-quarter dividends, $900m was paid via the scrip scheme. The focus on how Shell and BP distribute their dividends — among the highest-yielding in the FTSE 100 — marks a change from previous concerns about whether they would be cut. “Investors now believe the dividends are sustainable,” said Alasdair McKinnon, fund manager at Scottish Investment Trust.
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