The Fuse

Big Oil’s Best Quarter in Years

by Nick Cunningham | August 03, 2018

The oil industry is coming off of its best quarter in years, having capitalized on rising oil prices and cost reductions. Years of cost-cutting are finally paying off, and the oil majors have broadly outlined an optimistic outlook going forward.

However, challenges remain. Investors are pressuring companies to return more cash to shareholders, which comes at the expense of investing in growth. For a few of the largest oil companies in the world, that is a problem considering they have struggled with an eroding resource base for quite some time.

Best quarter in years

  • Below is a quick rundown of the earnings from some of the oil majors for the second quarter:
  • ExxonMobil: Earnings of $3.95 billion, up 18 percent from the second quarter of 2017.
  • Chevron: Earnings of $3.4 billion, more than double the $1.45 billion from a year earlier.
  • Royal Dutch Shell: Current cost of supply (similar to net income) of $4.69 billion, up 30 percent from a year earlier.
  • BP: replacement cost profit of $2.8 billion, four times that of 2Q2017.
  • Total SA: Net income of $3.6 billion, up 44 percent from a year earlier.

Looking at the earnings reports, a few trends quickly jump out. First, rising oil prices and years of spending cuts are finally bearing fruit in a big way. In the second quarter, crude oil prices were up roughly 50 percent compared to the same period a year earlier, leading to a surge in profits. The five largest western oil majors are set to earn a combined $90 billion in free cash flow in 2018 and 2019, according to the Wall Street Journal, figures that surpass the 2008 record high. “I can’t remember when it has looked this good,” BP Chief Executive Bob Dudley said.

Second, the focus on shareholder returns, which really became a top priority during the market recovery phase in 2017, remains front and center. Flush with cash, the oil majors announced a series of dividend increases and share buybacks. Royal Dutch Shell initiated a $25 billion share buyback program and Chevron announced a $3 billion annual share buyback program of its own. BP hiked its dividend by 2.5 percent. “The market loves capital discipline and shareholder returns,” Kris Nichol, an analyst at consultancy Wood Mackenzie Ltd, said in a Wall Street Journal interview. “The majors, so far, have been adhering to capital discipline, but they haven’t been on the front foot in terms of shareholder returns.” That started to change significantly after the second quarter.

Third, despite the best quarterly performance in years, investors and shareholders were still somewhat disappointed by the earnings figures. After underperforming the broader S&P 500 last year, the energy sector is now back in favor by Wall Street, with share prices up sharply since the start of the year.

The two majors posted earnings increases of 30 percent and 18 percent, respectively, a disappointing performance given the 50 percent increase in oil prices.

However, shareholders had expected better figures from several of the top oil companies. Shell and ExxonMobil in particular saw their share prices slide after their second quarter earnings came in under expectations. The two majors posted earnings increases of 30 percent and 18 percent, respectively, a disappointing performance given the 50 percent increase in oil prices. Shell cited the strong dollar, which negatively impacted its Brazilian assets. ExxonMobil saw its production base continue to erode, a problem that has bedeviled the Texas-based multinational for several years. Exxon also had several refineries go down for maintenance, which also impacted production and sales. “They are disappointing the market,” Brian Youngberg, an analyst at Edward Jones, told the Wall Street Journal. “You keep thinking the worst is over, but then they lay another egg.”

Fourth, some of the top companies are returning to growth, stepping up spending. ExxonMobil laid out an aggressive spending plan earlier this year, aiming to boost spending to $24 billion in 2018, $28 billion in 2019 and to an average of $30 billion between 2023 and 2025. That announcement was not received well by Wall Street, demonstrating the preference of investors for capital discipline. Exxon is barreling forward anyway, prioritizing the development of multiple discoveries in offshore Guyana, a ramp up in drilling in the Permian basin, and LNG exports in Mozambique.

To varying degrees, the other majors are also beginning to inch forward on more aggressive spending plans. Shell is reportedly considering a $30 billion LNG export facility on Canada’s Pacific Coast, a proposal that was shelved several years ago.

In the most prominent move of the recent earnings season, BP announced a $10.5 billion acquisition of shale assets from BHP Billiton, one of the largest moves by the British oil major in almost two decades. BHP had been trying to unload those shale assets after having overpaid for them, and the acquisition instantly makes BP a significant player in U.S. shale. BP joins Chevron and Exxon in the Texas shale patch, aiming to ramp up production on short-cycle projects over the next decade.

Challenges remain

The second quarter was clearly the best three-month period for the oil majors in years, but they all face substantial challenges ahead. There is a tension between preserving cash for shareholders and increasing spending on growth, and up until now the oil majors have demonstrated restraint.

For the largest oil companies in the world with a lot of mature assets, too much caution risks presiding over an extended period of decline.

But for the largest oil companies in the world with a lot of mature assets, too much caution risks presiding over an extended period of decline. ExxonMobil’s production fell by another 7 percent in the second quarter, although some of that can be chalked up to maintenance. Still, output dipped to 3.6 million barrels of oil equivalent per day, the lowest level in more than two decades. Shell has also seen production dwindle over the past two years, some of which is due to asset sales.

The urgency to grow production must be balanced against the pressure from shareholders to maintain capital discipline and offer more attractive returns. The majors are navigating this tension in various ways. Shell and Total SA are pivoting to natural gas, but held off on hefty spending. BP and Exxon, on the other hand, are increasing capex to grow production, both in onshore shale and offshore deepwater. While there is a long way to go before the oil majors return to pre-2014 spending levels, their ambitions are rising again. Higher oil prices and surging profits in the second quarter are giving them a lot more leeway, definitively putting an end to years of austerity.

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