The Fuse

Oil Majors’ Earnings Disappoint on Shrinking Refining Margins

by Nick Cunningham | February 06, 2018

  • Exxon’s total oil and gas production dipped 3% in Q4.
  • Chevron’s international downstream earnings dropped 76% year-over-year.
  • During Monday’s equity selloff, energy was one of the worst-performing sectors.
  • BP’s Dudley: “We want higher returns…It’s all about returns, not production.”

Earnings season for the oil majors is underway, and Royal Dutch Shell kicked things off last week, reporting fourth quarter earnings that doubled from a year earlier. The report was not entirely free of blemishes, but the performance appeared to be strong—another quarter in which profits rose, debt fell, and the overall outlook proved to be trending in the right direction.

Fourth-quarter earnings significantly missed expectations, but they do not necessarily negate the broader improving trend for the oil majors.

However, the quarterly reports from other oil majors revealed disappointment. Downstream earnings, a rare bright spot for the largest integrated companies during the oil market downturn, came in lower than expected. Chevron and ExxonMobil saw their share prices dive by more than 10 percent in two trading days, which was magnified by the broader selloff in equity markets. Taken together, fourth-quarter earnings significantly missed expectations, but they do not necessarily negate the broader improving trend for the oil majors.

Earnings miss expectations

Shell posted robust results, earning roughly $16 billion on a current cost of supply (CCS) basis, a metric similar to net profit, excluding one-time items. The Anglo-Dutch oil major also paid down its debt by $8 billion over the course of 2017, a priority after its debt reached a peak of $70 billion in 2016. The one area of disappointment was that Shell’s cash flow actually shrank from a year earlier, missing estimates.

Exxon and Chevron fared much worse. Exxon’s earnings dipped to $3.7 billion excluding one-time items, down from $3.8 billion a year earlier. On a per share basis, profits were just $0.88, a decline of two percent. Perhaps more importantly, analysts had expected earnings of $1.04 per share. The miss sent Exxon’s stock tumbling by six percent on February 2. Meanwhile, Exxon’s total oil and gas production dipped 3 percent, as the supermajor has been struggling with stagnant production for several years.

The story for Chevron was similar. The company earned just $0.72 per share—sharply lower than the $1.22-per-share estimate by the market. Chevron’s share price crashed as a result. BP’s results looked more positive in comparison, and it avoided some of the criticism that its peers received. Earnings jumped for BP as new projects came online, boosting output. Overall oil and gas production increased to 2.58 million barrels per day (Mbd) in the fourth quarter, up from 2.19 Mbd a year earlier. Earnings for the British oil giant quintupled from a year earlier, making it the most profitable quarter since 2015.

Poor quarterly numbers from some of the largest oil companies scared investors who expected a more solid performance.

Still, the oil majors have suffered steep declines in the stock market. The drop was certainly in part due to some poor timing—the global financial system sold off on Friday, February 2, dealing sharp losses across equity markets. Losses continued on Monday. But while broader financial turmoil deserves partial blame, the poor quarterly numbers from some of the largest oil companies scared investors who expected a more solid performance. “Earnings were significantly weaker than expected,” Rob Thummel, portfolio manager at Tortoise Capital Advisors, told CNBC. “That’s what’s really driven the S&P energy stocks off more significantly.” Amid the remarkable selloff on Monday, energy was one of the worst performing sectors. The S&P 500 energy sector posted its worst single-day performance in two-and-a-half years, losing 4.4 percent.

“We got carried away with our expectations, and by we, I mean Wall Street as a whole,” said Oliver Pursche, of wealth manager Bruderman Brothers LLC, according to Reuters.

Poor refining margins

A deterioration of refining margins in the fourth quarter was a major factor behind the disappointing results. Shell’s downstream earnings fell quarter-on-quarter from $2.6 billion to $1.4 billion, and BP’s profits from its downstream unit also fell, dipping from $2.3 billion to $1.5 billion (although BP reported strong figures for the full year). Chevron’s U.S. downstream earnings rose, but that was obscured by tax benefits and the lack of maintenance at its facilities in the fourth quarter. Internationally, Chevron saw its earnings from refining fall sharply, dropping to just $84 million, down from $357 million a year earlier.

A deterioration of refining margins in the fourth quarter was a major factor behind the disappointing results.

Global average refining margins shrank from $16.30 per barrel in the third quarter to $14.40 per barrel in the fourth, according to BP. That narrowed even further to $12.10 per barrel in the first few weeks of 2018. BP says that as a rule of thumb, its earnings fluctuate by $500 million for every $1-per-barrel change in the refining margin. While the figures are different for other companies, the general result is the same. Shell said it realized average margins of $8.59 per barrel in the fourth quarter along the U.S. Gulf Coast, compared to $13.04 per barrel in the third.

Integrated oil majors

During the depths of the oil market downturn, the integrated oil majors performed better than U.S. shale drillers, owing the relative success to their integrated business model. When oil prices collapsed, so did upstream earnings. For pure-play shale drillers, their balance sheets worsened. But for the oil majors, poor upstream performances were partly offset by stronger earnings from their refineries. Low oil prices stimulated global demand, widening margins.

Refining margins in key regions, such as the U.S. Gulf Coast and northwest Europe, have fallen by more than 50 percent in recent weeks.

However, the same integrated companies may miss out to some extent as prices increase. Rising oil prices brings a windfall to the shale driller, but higher upstream earnings for the oil majors are offset as refining margins are squeezed. Margins in key regions, such as the U.S. Gulf Coast and northwest Europe, have fallen by more than 50 percent in recent weeks, according to Reuters. “Margins have suffered and the biggest factor behind the weak margins we’ve seen is the run-up in crude prices,” Jonathan Leitch, research director with‎ consultancy Wood Mackenzie, told Reuters in January.

Nevertheless, the trend for the oil majors, and the rest of the oil industry, is still improving. Earnings are rising, even if they missed analysts’ expectations. Most of them foresee ongoing improvements in cash flow. “The company is operating and firing on all cylinders,” CEO Bob Dudley said in an interview with Bloomberg television. “We’re looking to generate much higher levels of free cash flow all the way through to the end of the decade and beyond.”

The improved cash flow could create more room for output growth, but the oil majors are still clear that they are favoring restraint. “We’ll have more options than I think we can afford. We’ve got a sight of projects all the way out well into the next decade,” BP’s Bob Dudley told Bloomberg. “We’ll pick them carefully. We want higher returns…It’s all about returns, not production.”

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