Big Oil cut spending during crash, now focus on returns, not volume

Big Oil
Of the seven Big Oil companies, Royal Dutch Shell appears the strongest performer among the group in terms of organic free cash flow. Shell photo.

Of the Big Oil companies, Royal Dutch Shell appears the strongest performer among the group in terms of organic free cash flow. Shell photo.

Big Oil expected to generate more cash in 2018 than any other time in past decade

With crude prices rising over 50 per cent in the past six months, Big Oil is expected to generate more cash in 2018 than any other time in the past 10 years.

But, after three years of deep cuts, companies are not focussing on increasing production, but to boosting shareholders’ returns and growth.

As well, companies are concerned that the oil recovery will be slow, so frugality is a priority for boards and investors eager to see energy majors produce enough cash to pay dividends and reduce their debt.

“The companies will need to demonstrate over time that lower capital spending can be sustained and that their dividends will remain fully covered,” Jonathan Waghorn, energy fund manager at Guinness Asset Management told Reuters.  Guinness holds shares of Chevron, Total and BP

“We are cautiously optimistic on their ability to do this, given the dramatic cost reductions in the industry.”

After oil prices crashed in 2014, Big Oil responded by transforming their operations.  They cut spending nearly in half, and axed tens of thousands of employees and diluted their share value.

In 2017 as oil prices recovered, oil majors showed investors they could adapt to a lower price environment and generate profits even at $50-$55/barrel oil, without borrowing.

And in 2018 with prices expected to be in the $60/barrel range, BMO Capital Markets analyst Brendan Warn told Reuters that Big Oil will generate more cash than it did in 2011 when a barrel of oil traded at an average of $112.

Royal Dutch Shell is leading the pack in terms of organic free cash flow. Warn says Shell will account for about one quarter of the roughly $80 billion of organic free cash flow that is expected to be generated by the seven oil majors in 2018.

The company’s free cash flow yield is set to double in 2019 from 2011-2014 to 8.84 per cent, according to BMO.

Exxon will have a free cash flow yield of 5.39 per cent, according to BMO, while BP’s yield is forecast to rise to 6.55 per cent in 2019 and Chevron is expected to hit 7.16 per cent.

This year, the priority for boards and many investors is buying back stock to increase share value and reverse years of stock dilution caused by scrip programs.  However, Exxon and Chevron both say they will focus more on boosting dividends.

“With the scrips coming off and share buybacks to commence, we expect an uplift in shareholder distributions by around $24 billion, led by Shell,” Warn told Reuters.

Also, companies that borrowed in recent years to maintain dividends will turn their focus to reducing debt levels.

“The best use of excess fund flow now would be a little further debt reduction for those companies that need it, and then an end to the scrip dividend,” Darren Sissons, partner and portfolio manager at Campbell, Lee & Ross Investment Management told Reuters.

Sissons adds that he expects boards to also invest a “small but increasing allocation to growth initiatives”, such as exploration for new oil and gas resources, renewables and chemicals.

Despite recent cuts to E&P budgets, Big Oil’s output will rise until 2020 as projects that were approved during the pre-2014 boom come online.  But, after 2020, the outlook is somewhat hazy with chief executives saying their focus is on raising returns, and not volume.

The rise of electric vehicles may have an impact on oil majors long-term outlooks with many companies focussing on supplying natural gas to the power sector as well as investing in renewables.



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