The Fuse

Oil Majors Take Major Hits in Q4, But Worst May Be Over

by Nick Cunningham | February 02, 2017

The fourth quarter earnings of the oil majors have so far proved to be highly disappointing for them, with a handful of the world’s oil giants reporting dismal figures. The numbers sparked a sell-off in stocks for energy companies, eliminating $53 billion in market value from the Bloomberg World Oil & Gas Index.

The industry appears to be rounding a corner, and top oil executives expect solid improvement in 2017 after more than two years of bloodletting.

The results were particularly disappointing because optimism among oil companies had returned to the market during Q4 for the first time in more than two years. The OPEC deal in late November sparked a rally in oil prices, pushing WTI and Brent safely above $50 per barrel, up from below $30 per barrel at the start of 2016. The worst had already appeared to be over for the industry, but even as oil prices have rebounded from their lows, it could take more time for the financials of the oil majors to show similar improvement. At the same time, the industry appears to be rounding a corner, and top oil executives expect solid improvement in 2017 after more than two years of bloodletting.

Oil majors disappoint

Chevron, the first to announce results for the quarter, reported the company earned $415 million in the fourth quarter, versus a loss of $588 million in the same quarter in 2015. But Chevron badly missed analysts’ expectations and also reported its first full-year loss in almost four decades. Company executives said they would continue to look for costs savings and consider further assets sales. Moreover, they planned to lower capex in 2017 by an additional 15 percent, the fourth consecutive year of lower spending levels. As a result of the bad news, Chevron’s stock is down more than 5 percent since it published its fourth quarter figures on January 27.

ExxonMobil, meanwhile, reported earnings of $1.68 billion, or $0.41 per share, missing analysts’ estimates of $0.70 per share. The earnings were 40 percent lower than in the same quarter a year earlier. The discrepancy between market expectations and actual numbers was the largest since 2006, according to a Bloomberg survey, and its full-year earnings of $7.8 billion were the lowest since 1996. Exxon has now posted nine consecutive quarters of year-on-year profit declines. The company’s share price fell more than 2 percent in the days following its recent news.

Royal Dutch Shell also announced a drop in earnings, posting a $1 billion profit for the fourth quarter, a more than 40 percent decline from the same period a year earlier. The figures were sharply lower than consensus estimates. Full-year earnings of $3.5 billion were the worst in a decade. Shell, however, struck the most optimistic tone of the bunch, arguing that with the takeover of BG Group complete, this year’s outlook is stronger. “We are really making good progress in reshaping Shell to a world class investment case,” Shell CEO Ben van Beurden said in a statement. “2016 was a transition year.” Shell says that its underlying costs levels are now $10 billion lower than the combined total of Shell and BG from two years ago.

Other majors, Total and BP, will report their figures in the coming days, and they aren’t expected to be any better.

Exxon’s Impairment charges

Exxon’s financial results were particularly eye-opening, but the figures were worsened by the Dallas-based major taking a $2 billion impairment charge in the quarter. This was an unusual development given that Exxon has refused to write down assets over the past few years, despite the historic meltdown in oil prices. Until now, Exxon has been the only oil major to not take any impairment charges, even as other oil companies have written down a collective $50 billion in assets since 2014.

The impairment was an unusual development given that Exxon has refused to write down assets over the past few years, despite the historic meltdown in oil prices.

The practice of refusing to write down assets attracted the attention of the U.S. Securities and Exchange Commission as well as the Attorney General of New York, both of which opened investigations into the company for possible securities fraud. The charge would be difficult to prove, and would hinge on whether or not the company is intentionally misleading investors about reserves the company knows will be left in the ground due to future climate policy. Exxon denies any wrongdoing. It is too early to say what may come of the investigations, but in light of the probes, the decision to finally write down assets is notable. The impairment charge was related to natural gas assets in the Rocky Mountains, but in the coming weeks, the company is also expected to take 4.6 billion barrels of oil reserves in Canadian oil sands off of its book, equivalent to nearly 19 percent of the company’s total reserves.

Better days ahead

Although the 2016 figures have brought about cause for concern, the worst could be over for the oil majors. According to Jefferies International, the oil majors are cash flow neutral with oil prices trading at $50 per barrel, a milestone achieved after relentless cuts to spending and payrolls. After the five largest majors doubled their collective debt to $220 billion since 2014, levels could finally stabilize this year. “As a group they are at peak debt levels now,” Jason Gammel, an analyst at Jefferies, told Bloomberg.

After the five largest majors doubled their collective debt to $220 billion since 2014, debt levels could finally stabilize this year.

Becoming cash flow positive means that dividend policies from the oil majors are likely safe, after two years of speculation about their sustainability amid rising debt levels. With dividends safe and cash flows likely moving into positive territory, the oil majors could decide to finally start paying down debt or step up spending on exploration and development. “A lot of fat has been cut,” Maxim Edelson, senior director at Fitch, said in an interview with Bloomberg. “The companies will have to think about if they want to keep cutting spending or start investing for growth again.”

Unlike some of its peers, Exxon is hoping to grow in 2017, ratcheting up spending by 14 percent. In fact, Exxon is mimicking some of the smaller shale drillers by increasing spending on smaller, short-cycle shale projects, a noticeable departure from the company’s traditional focus on extraordinarily large and complex offshore drilling projects. In January it spent $6.6 billion in order to double its holdings in the Permian Basin, a major bet on U.S. shale. Exxon is looking to more than double its production from the Permian Basin to 350,000 b/d, which together with its output from the Bakken would account for nearly 25 percent of the company’s total production. With that said, even as Exxon grows its presence in the U.S.’ most prolific shale basin, it is still expected to fast track development of its offshore discoveries in Guyana, as well as ramp up development of gas exports in Papua New Guinea.

Exxon is mimicking some of the smaller shale drillers by increasing spending on smaller, short-cycle shale projects, a noticeable departure from the company’s traditional focus on extraordinarily large and complex offshore drilling projects.

The oil majors all believe the worst of the downturn is in the rearview mirror, and some analysts agree. “Adjusted for the $2 billion write off, Exxon exceeded analyst expectations,” Fadel Gheit, a strategist at Oppenheimer & Co., told Bloomberg TV. “We are looking at 2017 to be significantly higher for the oil industry…Exxon, right now, is expected to almost double its earnings in 2017 from 2016 levels.”

Shell’s CEO echoed that optimism in his statement to shareholders and the media. He was particularly confident about the company’s cash flow position, which has been in positive territory for two consecutive quarters and is now able to cover capex and the company’s dividend. Shell has the second largest debt pile in the world out of any other oil company at $73 billion, behind only Brazil’s highly-indebted Petrobras. However, Shell was able to pay down debt in Q4 with oil hovering around the $50-per-barrel threshold, suggesting that it is now on sounder footing. With positive cash flow, Shell can safely guard its dividend and whittle away at its debt over time, especially if oil prices rise. “Our strategy is starting to pay off,” CEO Ben van Beurden said in a Bloomberg Television interview. “Free cash flow is well above requirements, we have started to pay down our debt in the fourth quarter. I do think we are on track. But we still have a long way to go.”

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