The Fuse

Oil Majors Continue To Take On Debt to Pay Dividends

by Nick Cunningham | August 02, 2016

The second quarter of 2016 will go down as one of the worst in a long time for the oil majors. Exxon’s second quarter profit was the worst since 1999, while Chevron’s loss was the widest since 2001. Shell’s earnings were the lowest in over a decade, and several other companies posted similarly dismal results.

The second quarter saw a remarkable plunge in refining margins, taking away the one source of comfort for the integrated oil majors.

The poor showing came as a surprise since oil prices rallied sharply in the three-month period between April and June, hitting a high in June above $50 per barrel. But aside from the oil price gains, the second quarter was not kind to the oil industry. Although crude prices were rising, they were still less than half of what they traded for in 2014. On top of that, the second quarter saw a remarkable plunge in refining margins, taking away the one source of comfort for the integrated oil majors.

Despite the lamentable performances from the largest oil companies in the world, the majors are clinging to their dividend policies, steadfastly refusing to cut them even during the worst oil market downturn in decades. That has led to a predictable rise in debt across the industry.

Poor Q2 results

Nearly all of the oil majors missed expectations, reporting earnings that were substantially lower than what the markets were predicting beforehand. ExxonMobil’s earnings per share (EPS) for the second quarter missed the consensus by 23 cents; BP disappointed by $0.05 per share; ConocoPhillips missed by $0.18 per share; and Chevron’s loss came in a whopping $1.10 per share lower than what analysts had expected. Only French oil giant Total beat expectations. Nearly all of them saw their earnings fall year-on-year:

  • ExxonMobil’s profit fell by 60 percent to $1.7 billion.
  • Chevron lost $1.5 billion in the second quarter, made much worse by the $2.8 billion write-downs the company took.
  • Royal Dutch Shell saw profits plunge by 93 percent to just $239 million, down from $3.4 billion a year earlier.
  • BP lost $2.3 billion, an improvement from the $6.3 billion loss from 2015. The loss included a $5.2 billion pretax charge related to the 2010 Deepwater Horizon disaster.
  • Total earned $2.2 billion in the second quarter, down 30 percent year-on-year.
  • ConocoPhillips reported a net loss of $1.1 billion, compared to a loss of only $179 million a year earlier.
  • Eni posted a loss of 290 million euros in the second quarter, compared to the 510 million euros it earned in 2Q2015.

Refining no longer cushioning upstream losses

The poor results from selling crude oil have been partially offset over the past two years by stronger earnings from the oil majors’ downstream units. Refineries could buy up cheap crude and process it into refined products, and fat margins made 2015 a strong year for the downstream sector.

However, so many refineries chased high margins that by the second quarter of 2016, global demand was no longer keeping up with supply. The result was a large build up in gasoline and diesel inventories, a development that led to rock bottom oil prices earlier this year. The stubbornly high levels of refined products sparked a renewed downturn in oil prices beginning June, as the promise of robust summer demand fell short—motorists and consumers failed to burn through elevated stockpiles of products. Since then, the glut of refined products has caused refining margins to shrink.

Figure 1 Source: BP

refiners omg

Shrinking margins hit the downstream earnings of the oil majors. Exxon saw its downstream earnings fall by $681 million year-on-year; BP’s refining earnings fell by $300 million; Shell’s refining earnings declined by more than $900 million; and Chevron saw downstream earnings fall by over $1.6 billion.

“What we’re seeing is that there’s just no place for the supermajors to hide,” Brian Youngberg, an analyst at Edward Jones & Co., told Bloomberg in an interview. “Oil prices, natural gas, refining, it all looks very bad right now.”

Debt and dividends

When spending outstrips revenue, oil companies face several tough choices. They can cut spending, sell off assets, take on more debt, and adjust dividend payouts. All of the oil majors have undertaken some combination of the first three options, with only Eni and ConocoPhillips choosing to cut their dividend.

“What we’re seeing is that there’s just no place for the supermajors to hide,” Brian Youngberg, an analyst at Edward Jones & Co., told Bloomberg in an interview. “Oil prices, natural gas, refining, it all looks very bad right now.”

But selling off assets only provide a one-time injection of cash. Spending cuts make sense, but companies are in danger of eating into future production if they cut too much. ExxonMobil, Royal Dutch Shell, BP, Chevron and Total have slashed capex by a combined $50 billion from 2013 levels. Given the very generous levels of dividends that the oil majors pay their shareholders, the cuts have not been enough to stop a deteriorating balance sheet. Debt continues to rise to cover dividends.

BP’s debt-to-equity ratio, known as “gearing,” is at the highest level since 2002, increasing to 24.7 percent from 18.8 percent a year earlier. Shell’s gearing ratio surged from 12.7 to 28.1 percent, although much of that had to do with the BG takeover.

Debt can be useful, especially when interest rates are low, and debt is cheap for companies with top credit ratings. However, there is a limit on how much debt a company can prudently take on, even if there are a wide variety of opinions on where that threshold might be. But one thing is for certain: The oil majors are taking on debt at a rapid rate in order to pay dividends.

Take ExxonMobil, the most financially sound out of the bunch. In the first half of 2016 the oil major doled out $6.2 billion to shareholders. But its cash flow of $9.3 billion was not enough to cover the shareholder payouts and the $8.7 billion in investments it needed to make. Since the company is committed to maintaining its dividend, it had to take on $5.1 billion in fresh debt. Exxon’s total debt level now stands at $44.5 billion, up from $33.8 billion a year earlier.

Earlier this year, S&P stripped ExxonMobil of its AAA credit rating because of rising leverage, explaining that the “company’s debt level has more than doubled in recent years, reflecting high capital spending on major projects in a high commodity price environment and dividends and share repurchases that substantially exceeded internally generated cash flow.” Exxon’s debt pile continued to climb in the second quarter.

Figure 2: ExxonMobil’s sources/uses of cash YTD 2016

xom debt

Oil prices

Many are holding onto their dividends or even growing them—a policy that they and their shareholders consider sacrosanct. But the oil majors cannot stay on this course indefinitely. The only way to bridge the gap between revenues and expenses (including shareholder payouts) is for oil prices to rise, something entirely outside of an individual company’s control.

The only way to bridge the gap between revenues and expenses (including shareholder payouts) is for oil prices to rise, something entirely outside of an individual company’s control.

The worrying thing for the oil majors is that oil prices are not rebounding. WTI and Brent have taken another dive in recent weeks on concerns about a glut of refined products and crude oil storage, high OPEC production, and the early signs of renewed drilling in U.S. shale. That suggests there is still a ways to go before oil prices rebound. The oil majors may succeed in maintaining their dividends, but if oil stays low through this year and next, it will require a lot more debt to do so.

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