The Fuse

Oil Major Debt at Record Level as Companies Refuse to Cut Dividends

by Nick Cunningham | May 26, 2016

OIL MAJOR DEBT

The oil majors—ExxonMobil, Royal Dutch Shell, Chevron, Total SA, BP, and Eni—have issued $37 billion in new bonds so far in 2016: Double the amount issued in 2014, and nearly as much as was issued in all of 2015, according to Bloomberg. As the oil price collapse approaches the two-year mark, the industry has been forced to take on higher levels of debt to plug the massive holes created by collapsing oil revenues, and so far, efficiency gains and asset sales have only gotten them so far. Most have refused to cut their dividends, viewing the shareholder payouts as a sacrosanct policy that helps them attract investors.

The oil majors have issued $37 billion in new bonds so far in 2016: Double the amount issued in 2014, and nearly as much as was issued in all of 2015

The strategy of acquiring debt can be maintained for a little while, but unless oil prices rise and cash flow turns positive, the mounting piles of debt could eventually force the oil majors to backtrack on their promise to defend their generous dividend policies at all costs.

Rising debt

With oil prices falling by more than 80 percent between mid-2014 and early 2016, it was inevitable that debt levels for the oil majors would rise. But the numbers are probably causing some heartburn in corporate board rooms.

The sharp rise in debt is starting to take the sheen off of the stellar credit ratings of the world’s largest oil producers.

For example, ExxonMobil saw its total debt rise above $43 billion in the first three quarters of this year, up $10.3 billion from a year earlier. Shell’s ratio of net debt to total equity—known as “gearing”—has jumped from 14 to over 26 percent since the end of 2015, although part of that was due to the takeover of BG Group. Total SA saw its gearing ratio climb to 30.2 percent after the end of the first quarter, up from 28.3 percent at the end of 2015.

BP saw its debt rise by nearly $5 billion between in first quarter of 2016 compared to a year earlier, bringing its gearing ratio up from 25 to 30 percent.

The sharp rise in debt is starting to take the sheen off of the stellar credit ratings of the world’s largest oil producers. In April, Moody’s Investors Service downgraded Chevron, Shell, and Total over concerns of the companies’ rising debt levels. The credit ratings agency knocked Chevron and Shell down one notch, and Total by two levels. Moody’s says that Chevron will be cash flow negative for at least two more years. More shockingly, ExxonMobil lost its coveted AAA credit rating in April from S&P. Up to that point, Exxon was one of only three U.S. companies that had the highest possible credit score.

oil major debt 2

Debt not an emergency

The top executives have shrugged off concerns about swelling debt levels.

“We’ll be flexible around the gearing levels, we’ll see what oil prices do,” BP’s CEO Bob Dudley told Bloomberg Television in February. He added that his company’s rising debt ratio, for now, does not make him “nervous.” His priority is still on maintaining the company’s dividend.

Oppenheimer & Co. estimated earlier this year that the four largest companies—Exxon, Shell, Chevron, and BP—will pay $35 billion in dividends over the course of 2016, which accounts for a whopping 40 percent of their cash flows.

The dividend payouts look increasingly generous given the poor investment climate in the oil business. The oil majors paid out a combined $14 billion in dividends in the first quarter, according to Bloomberg. Oppenheimer & Co. estimated earlier this year that the four largest companies—Exxon, Shell, Chevron, and BP—will pay $35 billion in dividends over the course of 2016, which accounts for a whopping 40 percent of their cash flows.

“What that means is the CEOs have convinced the boards that they should borrow to pay their dividend,” Jim Chanos, founder of Kynikos Associates, said in an interview with Bloomberg Television. “How long that will be sustainable, we don’t know.” Chanos is shorting Shell and Chevron because of their negative cash flows and increasing debt piles.

credit ratings and oil major debt

The oil majors still have solid credit ratings despite the recent downgrades, and the debt markets are all too willing to lend.

The one thing working in their favor is that debt is still cheap, despite the companies’ battered financials. Although the Federal Reserve is starting to hike interest rates, borrowing rates are still at incredibly low levels. The oil majors still have solid credit ratings despite the recent downgrades, and the debt markets are all too willing to lend. Bloomberg notes that Shell sold $1.5 billion in five-year bonds in early May at a rock bottom rate of just 1.99 percent, which was lower than the 2.13 yield the company sold bonds for in 2015. In other words, the bond markets do not yet see the oil industry’s rising debt level as an urgent problem.

Exploration a casualty of dividends

The oil majors can only keep up generous shareholder payouts if they reduce costs elsewhere. Capex has borne the brunt of cost-saving measures throughout the industry—which has long-term downsides for both producers and consumers of oil.

Cutting spending on exploration means the oil majors will fail to find new reserves. Several of them posted negative reserve-replacement ratios last year, a metric that measures their ability to book new reserves to replace oil that was produced. Typically, they shoot to hit at least 100 percent, allowing them to at least replace all the oil that they burned through in a given year. But many missed that target in 2015. BP’s ratio fell to 61 percent. Exxon’s dropped to 67 percent, the first time it failed to replace its reserves in over twenty years. Shell’s reserve-replacement figure fell to staggering negative 20 percent in 2015, due to not only a shortage of new discoveries, but also because it scrapped several high-profile projects, forcing them to remove those reserves from their books.

In 2015, the global oil industry only discovered 12.1 billion barrels of oil, which is the lowest level in over sixty years, according to Rystad Energy.

Of course, those poor figures are in part a reflection of low oil prices. Once oil prices rise, many of those reserves will become economical again, allowing the companies to rebook them. Nevertheless, exploration for entirely new sources of oil has been drastically cut, with predictable effects. In 2015, the global oil industry only discovered 12.1 billion barrels of oil, which is the lowest level in over sixty years, according to Rystad Energy. The oil majors are living off of yesterday’s discoveries, and choosing to pay shareholders at the expense of future growth.

There are some exceptions. Italian oil giant Eni bit the bullet and cut its dividend early on, becoming the first major to do so in March 2015. ConocoPhillips followed one year later. Both saw their share prices plummet immediately following their decision. On the flip side, Eni posted the highest reserve-replacement ratio in 2015. It was also the only oil major to reduce its total debt levels over the past year.

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