It seems fitting that oil prices fell back under $30 on the day that two major oil companies reported disastrous earnings results showing the damage of the past year and a half. The decline in prices that began in mid-2014 has wreaked havoc across all different types of companies—NOCs, IOCs, independents, oil majors, oilfield services—and there seems to be no respite in the short run. Companies are continuing to lay off staff, cut back on projects, and report eye-opening losses.
These cutbacks will eventually bite at some point, whether as early as the second half of this year or later on this decade. The current low price environment, and its fallout, will lead to a tighter market and possibly a shortage given that supply projects are capital intensive and typically involve significant lags before coming online. The industry’s capital spending will drop for two consecutive years in 2016, for the first time since the 1980s.
Both Exxon and Chevron will slice capex by around 25 percent this year, while BP is also scaling back. Some of the biggest U.S. independents, which have been instrumental in the shale boom, are slashing spending at even more dramatic levels.
Both Exxon and Chevron will slice capex by around 25 percent this year, while BP is also scaling back after cutting spending by 25 percent in 2015. Some of the biggest U.S. independents, which have been instrumental in enabling the shale boom the first part of this decade, are slashing spending at even more dramatic levels. Continental, led by CEO Harold Hamm, announced that it would cut capex by an enormous 66 percent this year, with the company planning to reduce production by 10 percent. New York-based Hess, meanwhile, has said its capex would come it at $2.4 billion this year, down 40 percent from 2015. Independent Anadarko, which is active in U.S. shale and international markets, is slicing its capital spending in half for 2016, after a 40 percent decline last year. Reuters reported, citing analysts at Bernstein, that U.S. oil companies as a whole are expected to cut capex by 38 percent this year.
In a reflection of how dire the situation has become for oil companies, ratings agency S&P downgraded Shell, BP, Chevron, Repsol, and Total this week as a result of low oil price assumptions and weak debt coverage. The negative effects of the low price cannot be fully offset by capex and cost adjustments, S&P said. A host of others also saw their credit ratings lowered. Analysts worry Exxon could be next. The low oil price has forced all companies, from the majors to the independents, to slash capex by billions of dollars in 2016, after already making drastic cuts last year.
S&P also provided a warning for the longer-term effects of current cutbacks: “Reduction in investment will affect future cash-generating assets.” In other words, the industry will suffer setbacks from the current downturn for some time, even when prices recover.
Losses, layoffs mount
Losses in revenue and the need to lay off workers may persist throughout this year. The industry has to deal with a lot of headwinds on both the supply and the demand side. Global oil supply is still well ahead of demand, while commercial inventories in storage will take a long time to draw down. Meanwhile, the economic backdrop could very well slow oil demand growth. U.S. GDP barely grew in the fourth quarter, while China continues to decelerate. Europe is seeing stagnant growth, and Japan is experiencing ongoing weakness, as reflected in the fact that its central bank has adopted a negative interest rate strategy in order to stimulate growth.
Losses in revenue and the need to lay off workers may persist throughout this year, as the industry deals with a lot of headwinds on both the supply and the demand side.
Along with announcing capex cuts, Chevron, the second largest producer in the U.S., reported its first quarterly loss since 2002, and laid off 10 percent of its workforce in October. The company, which is prepared for a second round of layoffs, lost $588 million in Q4, compared to a profit of almost $3.5 billion during the same period in 2014. The situation is so bad for the California-based oil major that it continues to look to sell assets. Over the past two years, Chevron sold $11 billion worth of assets and is looking to raise as much as $10 billion from sales through 2017. Things are just as bad for Anadarko, who announced its Q4 and annual results this week too. The company reported a loss of $1.25 billion for the fourth quarter, and plans to sell $1 billion in assets. The company hasn’t announced any layoffs, but said some will likely occur.
British oil major BP is also under a lot of stress, too, reporting losses of $2.2 billion in Q4 and $6.5 billion for all of 2015. The annual results were worse than 2010, when the company dealt with the fallout from the Macondo explosion in the Gulf of Mexico. Since the accident, the company has paid out more than $55 billion related to the spill, forcing it to take on the strategy of “shrink to grow.” For Q4, the company performed below analyst expectations, and part of its cost-cutting measures includes reducing its workforce by 7,000. It is also looking to sell $3 billion to $5 billion worth of assets. Despite the troubles BP is going through, the fact that it is planning to keep capital spending between $17 billion to $19 billion and maintain its policy of dividend payouts is remarkable—though the situation could change if prices fall further. BP actually increased its total output last year by more than 5 percent to 2.26 million barrels of oil equivalent per day (boe/d).
Exxon – a bit more upbeat
Although Exxon’s 2015 earnings, at $16.15 billion, were half of the previous year’s levels and the company is moving forward with capex cuts, the Dallas-based major is more sanguine than the others. It is not going through a major restructuring; it hasn’t announced any layoffs; it says it is one of only a few companies able to invest during the current cycle; and it has been able to bring new projects online in a timely fashion.
Although Exxon’s 2015 earnings were half of the previous year’s levels and the company is moving forward with capex cuts, the Dallas-based major is more sanguine than the others.
Exxon’s profits declined 58 percent for the fourth quarter and 50 percent for the entire year. Even with the current environment of low prices and capex cuts, Exxon brought six major upstream projects on line last year, totaling about 300,000 boe/d. For 2016, it anticipates six more major start-ups with a combined capacity of 250,000 boe/d. Furthermore, the company is undeterred in the U.S. shale patch, which has typically been the territory of the independents. Exxon’s “measured ramp-up” of running rigs in the Permian Basin in Texas and the Bakken in North Dakota despite low prices will make the company better positioned than others to maximize the value of their assets when the market turns around, it says.
On its earnings conference call with analysts, when asked why Exxon hasn’t gone through a restructuring similar to its peers, a company official said that it learned from the lessons of the 1980s, when the oil price crash led to layoffs that negatively affected the industry for decades. The Exxon official said the company has been “diligent” in managing its headcount, but hasn’t needed to take drastic measures like others. Since Exxon is integrated, with both upstream and downstream operations, the company can be nimble in redeploying manpower from one part of the company to another, which may be more profitable. For instance, even though Exxon saw massive declines in earnings in its upstream business, the downstream operations performed relatively well.
The underinvestment risk
Big question is how much effect the current underinvestment has on prices and volatility in the longer term. The oil market may remain in a period of weakness for an extended period of time, but it is dangerously setting itself for a price spike in the medium term.