By any measure, 2018 was a good year for the oil majors. Just about all of the world’s top integrated oil companies beat earnings estimates, reporting the best financial results in years. Share prices across the board jumped on the news.
The progress is real, but the oil majors still face a litany of risks both in the near-term and in the years ahead.
The world’s largest integrated oil companies have dramatically overhauled their businesses since the market collapsed in 2014. The majors have sold off assets they view as either not profitable or superfluous to their core business. They have tweaked their strategies to focus on a smaller number of priorities. The majors have cut costs and reoriented themselves around lower oil prices, achieving lower breakeven prices for much of their operations. “The Majors spent the downturn shoring up finances, reducing investment, cutting costs and selling non-core assets to raise funds,” Norman Valentine, director of corporate research at Wood Mackenzie, wrote in a report. “At the start of 2018, most were set to cope at US$50/bbl. When oil prices rose well beyond that in the early months of the year, there was cash to spare.”
The result was the best financial performance in years. Here are the annual figures for 2018 from the five key oil majors:
- ExxonMobil reported $20.8 billion in earnings, up modestly from $19.7 billion in 2017.
- BP earned $12.7 billion, more than double the $6.2 billion from a year earlier.
- Chevron earned $14.8 billion, up from $9.2 billion in 2017.
- Royal Dutch Shell earned $21.4 billion, up from $15.7 billion in the prior year.
- Total SA earned $13.6 billion, a 28 percent increase from the $10.6 billion earned in 2017.
A few common threads stand out. First, most of the oil majors have scaled up investments in U.S. shale (Total is a notable exception), viewing short-cycle drilling as less risky than long-term multi-billion-dollar megaprojects. That transition began a few years ago, but the majors are starting to see the fruits of this pivot with increases in production. Exxon’s upstream production from the Permian basin surged by 90 percent. Chevron too saw its Permian output jump, pushing production to an all-time high for the company.
Another common theme was strong earnings from the downstream sector. ExxonMobil reported huge earnings from its refining unit at $2.7 billion, more than double the figure from a year earlier. These were “blow-out downstream results,” according to Jason Gammel, an analyst at Jefferies LLC.
At the same time, cost-cutting and higher oil prices lifted all segments. As the Wall Street Journal noted, the top five oil majors earned more money in 2018 when Brent crude averaged just $71 per barrel than they did in 2014 when it averaged over $100. Indeed, the five largest companies took in roughly $84 billion in profits in 2018, an eight-fold increase from the $10 billion they earned in 2014.
“The 12-month rolling cash flow continues to point upwards, and I think that’s what’s important,” said Oswald Clint, an analyst at Sanford C. Bernstein Ltd., according to Bloomberg. “It isn’t just refining-led improvements, it isn’t just an upstream oil price, it’s widespread across the businesses.”
Shareholders demand more cash
Share prices for the top oil companies rose strongly after the fourth quarter and full-year 2018 results were reported, restoring some confidence in the sector. But the oil majors are desperate to hold onto the restoration of their reputations in the eyes of Wall Street.
Chevron purchased $1 billion in shares while also announcing a $25 billion share buyback program, pleasing its investors. When Bloomberg asked BP’s CFO Brian Gilvary what his company’s focus would be in 2019, he said: “Capital discipline, capital discipline, capital discipline.”
The overarching mantra from the oil majors, even after posting fat profits, was that they will prioritize shareholder payouts above all else. That was very welcome news for Wall Street.
But they are not entirely out of the woods yet. Profits are back to 2014-levels, but are only now returning to those lofty levels. Oil prices are currently trading below the 2018 average, so it is not clear that the same financial performance from last year can be replicated if the oil market does not rebound.
In addition, the pressure from shareholders is more intense than it used to be. Because of the ups and downs of the past half-decade, investors turned on the industry. The share prices of much of the energy industry lagged that of the broader S&P 500 for the past two years. Exxon, in particular, fell behind in 2018 as it announced plans to increase spending. Its stock fell 15 percent last year, the worst performance in two decades. Even one of the largest oil companies in the world seems to have somewhat fallen out of favor.
In order to keep shareholders happy, the oil majors are shoveling more of their resources into the pockets of investors. Share buybacks and dividend increases are the new currency of a well-regarded oil major, rather than rapid production growth. Shareholders will keep up the pressure, expecting that they see a slice of any additional revenue coming in the door.
“Shell, Total and Chevron all began substantial buy-back programmes during the year. This was the first important signal to investors: returning cash to shareholders ranked higher than growth expenditure,” Norman Valentine wrote in the WoodMac report. “Bolstering defensive credentials seems an important step towards regaining investor confidence.”
Long-term risks loom
However, funneling money to shareholders presents a conundrum, deterring oil companies from developing new reserves because of the pressure to turn a profit.
Royal Dutch Shell’s CFO Jessica Uhl said that the company can “do it all,” referring to reducing debt, completing share buybacks, paying dividends while also growing production. Investors were assuaged and the company’s share price jumped after it reported its figures for 2018.
But not everyone is so sure. Ahead of the earnings report, Morgan Stanley downgraded Royal Dutch Shell from “equal-weight” to “underweight,” arguing that “doing it all” would require $66 billion in cash through 2020, which leaves almost no room for any spending increases on developing new projects. In other words, Shell is handing over too much cash to shareholders to allow it to invest in future growth. And with a lower reserve-replacement ratio than its peers, the lack of growth could become a problem in the relatively near future.
“If stock market outperformance is the metric of success, defensive is winning. We’d expect the Majors to keep the winning formula in 2019 and return surplus cash to shareholders,” WoodMac’s Norman Valentine concluded. “But it’s not a sustainable strategy for the long run and, in the not-too-distant future, the Majors will rely again on new growth opportunities from exploration to keep the business ticking over.”
More importantly, the supply growth of years past is long gone. The majors are investing heavily to ratchet up output in the Permian basin, but that is merely offsetting the legacy supply base that depletes year after year. On top of that, a growing number of analysts are calling into the question of medium- and long-term oil demand. In a February 4 report, Bank of America Merrill Lynch was only the latest in a string of forecasters predicting peak oil demand by 2030.
That is exactly why the majors put a premium on short-cycle investments. To be sure, they are also starting to dip their toes back into new large-scale projects, though not on the same level as in years past. Exxon is the most aggressive, developing its string of discoveries off the coast of Guyana, green-lighting a major refinery and LNG export terminal in Texas in the past few weeks, and stepping up exploration in Brazil. In October, Royal Dutch Shell gave the final investment decision on a massive LNG project in Canada. In December, BP gave the greenlight on an LNG project in Mauritania, billing it as the beginning of larger plan to develop gas production and exports in West Africa.
But those are the exceptions, and in the case of LNG, investments that executives think will pay off even after the peak in oil demand. It is not clear how the oil majors will navigate the turbulent waters in the years ahead. For now, they are focused on boosting short-cycle output, investing in downstream assets that they believe will be more resilient, and returning excess cash to shareholders. “The key going forward will be maintaining discipline. This is now a low-growth industry, so you’ve got to invest well,” Brian Youngberg, an analyst at Edward Jones, told the Wall Street Journal.