The Fuse

Oil Majors Turn the Corner With First Quarter Profits

by Nick Cunningham | May 04, 2017

Quarterly profits for the oil majors surged in the first quarter as higher oil prices boosted earnings across the board, likely marking a turning point for the world’s largest oil companies. They may not be entirely out of the woods yet, but the first-quarter performances suggest that the majors are on the upswing after nearly three years of mostly red ink.

First quarter profits surge

The oil majors smashed analysts’ expectations, posting the largest first quarter profits in years.

The oil majors smashed analysts’ expectations, posting the largest first quarter profits in years. Several factors contributed to the strong improvement, including efficiencies and cost reductions, asset sales, canceling or deferring projects, and, in some cases, higher production. But the jump in oil prices compared to the first quarter of 2016 is the single largest reason for the improvement—Brent prices averaged $53 per barrel in the first quarter, roughly $20 per barrel more than a year earlier. Higher crude prices lifted all across the industry:

  • Royal Dutch Shell: Profits more than doubled to $3.75 billion, up from $1.55 billion a year earlier.
  • Statoil: Profits of $1.06 billion, compared to $611 million in earnings in 1Q 2016.
  • BP: Replacement cost profit (similar to net income) hit $1.4 billion, compared to a loss of $485 million a year earlier.
  • ExxonMobil: Profits more than doubled to $4 billion, up from $1.8 billion in 1Q 2016.
  • Chevron: Recorded profits of $2.7 billion in the first quarter, compared to a loss of $785 million a year earlier.
  • Total SA: Profits of $2.6 billion, up 56 percent from $1.6 billion a year earlier.
  • ConocoPhillips: Profits rose to $800 million, compared to a substantial loss of $1.5 billion in the 1Q 2016.

Dividends safe for now

A few companies have also benefitted from fortuitous timing. After years of hefty spending, a handful of megaprojects have come online, reducing spending needs while also bringing in new sources of cash. Royal Dutch Shell and Chevron are perfect examples of this, both having spent tens of billions on major LNG export projects in Australia, which weighed down their balance sheets for years. The more than $50 billion Gorgon LNG project came online in 2016, adding new revenue and allowing the two majors to cut spending. Compared to the first quarter of 2016, Shell’s much-improved figures this year reflect the startup of several other projects, including its Stones project in the Gulf of Mexico and the Kashagan in Kazakhstan, in which it has a minority stake.

After years of hefty spending, a handful of megaprojects have come online, reducing spending needs while also bringing in new sources of cash.

Shell’s cash flow from operations jumped to $9.5 billion, ten times higher than the first quarter a year earlier and its highest level in six quarters. The impressive haul allowed it to cover both capex and dividends, even leaving enough cash leftover to whittle away at its enormous debt pile. Shell’s total debt is still vast, but it has fallen for two consecutive quarters to $72 billion.

The jump in profits relieves pressure on the dividends for all of the oil majors. The companies left their shareholder payouts untouched in the most recent announcements, and ExxonMobil even continued its 35-year streak of dividend increases, announcing a two-cent per share hike at the end of last month. Over the past three years, dividend payouts have exhausted the oil majors of much-needed financial resources, raising questions about their sustainability as debt levels climbed even higher. ExxonMobil lost its coveted AAA credit rating a year ago because it continued to increase shareholder payments in the face of ballooning debt. However, scrutiny is subsiding as free cash flow turns positive. Royal Dutch Shell still has a dividend yield over 7 percent. That is a level many analysts believe is unsustainable, but the reduction in debt since the fourth quarter of 2016 and the surge in profits so far this year have put the company on sounder footing. The oil majors view their dividends as crucial to remaining highly attractive to Wall Street, and surging first-quarter profits likely ensures shareholder payments remain intact.

Diverging paths forward

The oil majors all enjoyed a sharp improvement in first quarter profits, but their strategies going forward vary greatly. ExxonMobil, for instance, saw its production decline by 4 percent last year and is stepping up spending this year to reverse the decline. It embarked upon a take a two-track strategy with a handful of large-scale projects such as offshore Guyana, while also making big investments in U.S. shale. French oil giant Total SA is also aiming for growth after reporting impressive cash flow figures in the first quarter, money that it plans to use to greenlight 10 new projects over the next 18 months. Last month, Total announced its first substantial final investment decision in several years—new drilling in Argentina’s Vaca Muerta shale.

Chevron and Shell, having spent large sums on LNG export terminals over the past half-decade, will be content to move more cautiously. Chevron cut its drilling budget by 30 percent in the first quarter and is aiming for a 15 percent full-year reduction. The California-based oil major had to sell off assets to help cover its dividend, but it argues its cash position will improve on the startup of several major projects.

One common strategy is to continue to reduce spending on large-scale projects and instead invest in short-cycle shale.

One common strategy is to continue to reduce spending on large-scale projects and instead invest in short-cycle shale. Chevron CEO John Watson said that 75 percent of the company’s spending will be dedicated to U.S. shale, reflecting a lower risk appetite at $50 oil. The oil majors are all doing much better than they were a year ago, but with high debt loads and uncertainty over the future of oil prices in the near term, shale offers production increases without the risk of tying up cash for years to come.

Hangover from oil price downturn  

Despite the dramatic improvement in the financials for the oil majors in the first quarter, their share prices have not responded in corresponding fashion. Most have seen their stocks decline so far in 2017. The broader S&P 500 energy sector has declined by 10 percent so far this year. The majors have succeeded in significant cost reductions and have largely restored their cash flows to levels from several years ago, but the fortunes of their share prices are still tied to the price of crude oil, which has not fared well as of late. On May 4, Brent dropped below $50 per barrel for the first time in 2017.

While cash flow has improved considerably compared to previous quarters, the oil majors are still stuck with enormous debt loads.

Moreover, while cash flow has improved considerably compared to previous quarters, the oil majors are still stuck with enormous debt loads—and will continue to be for some time. That will hamper their ability to invest in long-term production, even as market analysts such as the IEA caution that the industry threatens to leave the world short of supply toward the end of the decade because of the ongoing steep cuts to exploration and development.

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