The Fuse

Despite Optimism, Oil Majors Hampered by Refining Margins, Higher Debt

by Nick Cunningham | November 02, 2016

As a result of higher prices, major oil companies reported better numbers than earlier in 2016, but based on comparisons to last year, the industry is clearly still struggling.

Third quarter earnings figures for the oil majors reveal a mixed picture for the industry: Companies are dealing with more debt, weaker refining margins, and deeper spending cuts, but they are also experiencing increased optimism that the worst might be over.

As a result of higher prices, major oil companies reported better numbers than earlier in 2016, but based on comparisons to last year, the industry is clearly still struggling:

  • Statoil lost $432 million, sliding from the $348 million the company earned in 2015.
  • Total SA earned $2.1 billion in adjusted net income, a strong result relative to its peers but still down by 25 percent from Q3 2015.
  • Eni lost €484 million in the quarter, down from a €127 million loss last year.
  • ExxonMobil took in $2.65 billion in net profit, down 38 percent from the $4.2 billion in earnings a year earlier.
  • Chevron posted a $1.3 billion profit, a 37 percent drop from the $2 billion it reported in the third quarter of last year.
  • ConocoPhillips lost $0.8 billion in adjusted earnings, slightly better than the $0.5 billion loss in Q3 2015.
  • BP reported an underlying replacement cost profit of $933 million, down by about half from the $1.8 billion it posted in 2015.
  • Shell’s current cost of supplies – similar to net income – excluding one-time items hit $2.8 billion, up 18 percent from the $2.4 billion it took in last year.

Oil prices averaged $45 per barrel over the course of the quarter, down just slightly from the $47 per barrel average in the third quarter of 2015. However, year-on-year earnings dropped for many of the oil majors because refining margins continued to narrow, erasing one of the few sources of strength in 2015. Global refining margins averaged $11.60 per barrel in the third quarter of 2016, down 42 percent from the same period last year, according to BP. Aside from the first quarter of 2016, refining margins have fallen to the lowest levels in nearly three years.

Debt levels continue to rise

Despite ongoing efforts to cut costs, major oil companies have become more leveraged quarter after quarter.

The third quarter saw more of the same on the debt front. Despite ongoing efforts to cut costs, major oil companies have become more leveraged quarter after quarter. The three-month period ending in September was no different. As Bloomberg Gadfly noted, the top five oil companies—Exxon, Chevron, Shell, BP and Total—saw their gearing ratio, a measure of indebtedness as described by the amount of debt to equity, rise by an astounding 8.5 percentage points. Shell posted the most alarming rise in its gearing ratio, although the increase was mostly the result of its purchase of BG Group. Shell’s gearing ratio jumped from 12.7 percent to 29.2 percent in the third quarter from a year earlier, close to the threshold that company executives have said is still in its comfort zone.

Shell now has $78 billion in debt, an astronomical number no matter how the company tries to spin it. The good news for Shell is that it could become cash flow positive if oil prices rebound above $50 per barrel. That situation would allow it to whittle away at debt levels and still meet its spending goals and pay dividends. But the flip side of that equation is that Shell and its peers will be in deeper trouble if oil prices fall back again, as they appear to be doing now. A longer period of low prices will force oil majors to make some tough decisions—cut spending deeper, cut dividends, or pile on more debt. None of those options are attractive. Deeper spending reductions will jeopardize future growth; slashing dividends will scare away investors and threaten share prices; and adding to the swelling debt pile could put otherwise stellar credit ratings at risk.

Companies more upbeat

Although the industry is still suffering from the market downturn, oil executives see reasons for optimism.

For the most part, the recent quarterly earnings for the oil majors substantially beat market expectations, and although the industry is still suffering from the market downturn, oil executives see reasons for optimism. Oil prices did spend most of October over $50, in part because of rumors surrounding an OPEC production cut. Moreover, supply and demand continue to converge, with the IEA predicting a more balanced market at some point in the middle of 2017. Many of the majors believe they can breakeven at around $50 per barrel, meaning that anything north of that will allow them to cover all of their spending needs and dividends without taking on more debt.

Oil majors are budgeting for prices to remain relatively flat in the near term, but some companies are moving ahead with new drilling projects, confident enough in the fundamentals to pull the trigger on new spending. BP is a few weeks away from greenlighting its Mad Dog 2 project, an offshore drilling project in the Gulf of Mexico. Emboldened by its ability to cut the estimated cost of the project to less than half of the originally expected $20 billion, BP is expected to officially move forward with the final investment decision before the end of the year. Altogether, BP has made three FIDs this year with two more expected. It also sees more room for growth in 2017. “As we now look going forward, we’re now starting to work our way through some of that back inventory of projects, and I think you’ll start to see more FIDs come through next year,” Brian Gilvary, BP’s CFO, told investors on its latest earnings call.

Peak demand?

The relatively optimistic tone struck recently by many oil CEOs stands in stark contrast to some of the industry’s long-term threats, which are more existential in nature.

The relatively optimistic tone struck recently by many oil CEOs stands in stark contrast to some of the industry’s long-term threats, which are more existential in nature. In an Oct. 28 filing with the SEC, ExxonMobil disclosed that it might have to write-down some assets before the end of the year if oil prices do not rebound. That would force Exxon to take some 4.6 billion barrels of oil off of its books—3.6 billion barrels in Canada’s oil sands and another 1 billion barrels elsewhere in its North American operations—or just under 20 percent of the company’s total reserves. Exxon is the only oil major that has not written down assets during the more than two-year oil price downturn, and it has come under investigation by the New York Attorney General and the U.S. SEC over its accounting practices.

Meanwhile, Royal Dutch Shell is not confident about the long-term outlook for oil companies as it predicts that global oil demand could peak in the 2020s. “Oil, we’ve long been of the opinion that demand will peak before supply,” Shell’s CFO Simon Henry warned shareholders on November 1. “And that peak may be somewhere between 5 and 15 years hence, and it will be driven by efficiency and substitution, more than offsetting the new demand for transport.” Shell is aggressively trying to steer its ship toward a more natural gas-based company, so that it can continue to sell products well after demand for oil is in decline.

 

 

 

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