The Fuse

Oil Majors Turn a Corner, Post Strong Profits in Q3

by Nick Cunningham | November 01, 2017

The oil majors have kept spending in check and deferred projects no longer deemed profitable with oil prices trading in the $40s and $50s.

The oil majors are posting their best quarterly figures in years, an indication that they are adapting to the new price environment. After several years of spending cuts and rising debt, the largest integrated oil companies have turned a corner. Here is a quick rundown of some of the highlights:

  • ExxonMobil: Third-quarter profit of $4 billion, up 50 percent from $2.7 billion a year earlier.
  • Chevron: Profits of $2 billion, also a 50 percent jump from the $1.3 billion in Q3 2016.
  • ConocoPhillips: Earnings of $0.4 billion, up sharply from a third-quarter loss of $1 billion in 2016.
  • Total SA: Adjusted net income of $2.7 billion, up nearly a third from the prior year.
  • BP: Replacement cost profit of $1.87 billion, double the total versus Q3 2016.
  • Statoil: Adjusted earnings of $2.3 billion, up from $0.6 billion a year earlier.

The substantial improvement in earnings will likely restore investor confidence in the oil majors. All of them saw their share prices rise over the past week on the improved outlook. But the progress is not just from higher oil prices during the latest quarter. The oil majors have kept spending in check and deferred projects no longer deemed profitable with oil prices trading in the $40s and $50s. They are still pursuing growth opportunities, but they are prioritizing only the most appealing projects–a more frugal mentality that will likely stick around even if oil prices rise. BP, for example, is on track to spend $16 billion in 2017, in the middle of its $15-$17 billion guidance, and down a third from 2014. For the next four years, BP plans to keep spending flat in the $15-$17 billion range, “with flexibility to go lower” if the market takes another dive.

Breakeven prices fall

The critical ingredient in the financial turnaround for the oil majors is the remarkable decline in the oil price at which their operations break even. That has allowed the largest oil companies to turn a profit even with oil trading at half of the level it did back in 2014. “The break-even cost of oil and gas companies is going to the $40s and $30s today,” BP CEO Bob Dudley said at the Oil & Money conference in London in October. “It’s actually healthy. I think $100 a barrel was not healthy.”

The critical ingredient in the financial turnaround for the oil majors is the remarkable decline in the oil price at which their operations break even.

BP is probably the starkest example of the recent turnaround. Earlier this year, the British oil giant said that it would need an oil price near $60 per barrel to breakeven. Yet, in the third quarter, it reported a replacement cost profit of $1.87 billion, double the figure from a year earlier and a definitive sign that dramatic cost-cutting is bearing fruit. BP has performed better than its own executives had expected, and the company says its breakeven price in the first half of the year was approximately $47 per barrel. BP is aiming to lower its breakeven threshold to just $35 to $40 per barrel by 2021.

“We are back to a new normality,” Brian Gilvary, BP’s CFO, told the Financial Times. “We’ve come through the oil price correction and we’ve got things back into balance earlier than planned.” The major is taking a conservative assumption regarding oil prices, basing its 2018 plans on a $50 to $55 per barrel oil price. “If we’re wrong and it’s higher, it will leave us in a stronger financial position,” Gilvary added, according to the FT.

Integrated oil companies more stable than shale

U.S. shale has garnered a lot of attention during the multi-year oil market downturn, seeming to offer investors several advantages over the oil majors. Shale projects are short-cycle, with quick payback periods. Unlike the majors, which often tie up cash for years, shale drilling appeared to be less risky in a volatile oil market. Also, shale drilling could ramp up when market conditions improved, offering a significant upside that the oil majors could not replicate. In short, nimble U.S. shale drillers became highly sought after, and even the oil majors began paring back spending on large-scale projects and scaling up investment in shale plays.

Most shale E&Ps have been cash flow negative, burning through capital to fuel growth.

But the shale industry, by and large, has had its share of troubles. Most shale E&Ps have been cash flow negative, burning through capital to fuel growth. There is no doubt the shale industry can add a substantial volume of new oil supply at a rapid clip, but a few years on from the shale bonanza, investors are starting to ask when they will see returns.

The third quarter earnings reports from the oil majors highlight the virtues of the integrated model. BP, for example, posted $2.3 billion in earnings from its downstream assets, or 43 percent higher than its upstream unit. The oil majors are once again posting profits, whereas their more nimble peers in the shale business are not.

Shareholders to benefit from rebound

BP’s improved financial position led it to announce a return of its share buyback program, which was shelved three years ago when oil prices fell sharply. That is welcome news to shareholders who were offered a scrip dividend, a program that offers shares to investors in lieu of cash payments. The scrip dividend allows oil companies to hold onto cash that would otherwise go to shareholders, and it was a tactic that several oil majors relied on during the depths of the market downturn. But it is a strategy that will likely dilute the value of its shares. BP issued the equivalent of $1.6 billion in shares each year under its scrip program–BP’s CFO said that the company would repurchase that amount going forward. Statoil said that it too would end its scrip dividend program in the fourth quarter, paying out cash to shareholders instead of equity.

BP’s improved financial position led it to announce a return of its share buyback program, which was shelved three years ago when oil prices fell sharply.

BP’s move is significant because it seems to mark a turning point. After years of spending cuts, layoffs, project cancellations and lower ambitions, BP is sending “an important signal” that “financial and operating momentum is building,” argues Lydia Rainforth of Barclays, cited by the FT. Put simply, BP is rebounding, and its improved financial position is allowing it to dish out more rewards to shareholders. That is a remarkable turnaround after years of cuts. And it likely portends more share buybacks and dividend hikes for shareholders from the other oil majors.

Credit analysts have previously warned that dividend payments at the oil majors were on an unsustainable path. ExxonMobil even lost its sterling AAA credit rating from S&P in 2016 because it steadfastly refused to touch its dividend even as debt mounted. But a year and a half later, the cost-cutting has paid off for the majors, and the dividends appear to be on sound footing.

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