The Remarkable Recovery Of Big Oil

Royal Dutch Shell kept the party going this week, reporting a huge jump in profits for the third quarter. It is something of a clean sweep for the oil majors, who posted sizable increases in quarterly earnings compared to the same period a year earlier.

Shell said its profit on a cost-of-supplies basis – similar to net income – hit $3.7 billion in the third quarter, more than double the $1.4 billion it took in a year before. The sharp improvement echoed the results of Shell’s peers, which reported a few days earlier. ExxonMobil and Chevron reported a 50 percent increase in profits. ConocoPhillips reported a loss last year, but swung to a small $0.4 billion profit in the third quarter of 2017. BP doubled its profits to $1.87 billion, and Statoil nearly quadrupled its profit to $2.3 billion.

There are multiple reasons for the brighter outlook. The most obvious is the slight uptick in oil prices. More importantly, however, is the cost cutting and spending reductions that the entire industry undertook.

There are a few important conclusions that can be drawn from the earnings reports. First, the pressure on cutting the dividends is all but gone. In 2015 and 2016, analysts and credit watchers began asking tough questions about the sustainability of the generous shareholder payouts. Eni, the Italian oil giant, became the first to reduce its dividend in 2015. BP offered a scrip dividend to its shareholders, a half-measure that offers equity instead of cash. Statoil did the same.

But times have changed and the oil majors have made a lot of progress in cutting costs and improving their financial health. The results are evident. BP and Statoil just announced in recent days that they would end their scrip dividend program and pay cash to shareholders. BP even said it would repurchase shares equivalent to the amount it issued during its scrip program.

That decision represents a dramatic turnaround for the embattled British oil giant. A few years ago, BP was suffering under the weight of low oil prices at the same time that it was dishing out billions of dollars in fines related to the 2010 Deepwater Horizon disaster. It is now a smaller company, having sold off assets during the downturn. But it is once again a profitable one.

And while BP is rewarding shareholders with a share buyback program and an end to its scrip, Shell is concentrating on lowering its debt. Shell had been one of the most indebted oil companies in the world (although well behind Petrobras), and its third quarter total debt fell to $67.7 billion, down from $77 billion a year earlier. It should be noted, however, that its debt ticked up from the second quarter.

The other oil majors, by and large, also appear able to cover their capex and dividends with their cash flow, or at least are coming pretty close.

In other words, they have successfully lowered their breakeven prices by a staggering amount. Before 2014, some of them were running up debt even when oil prices traded north of $100 per barrel. Now with oil in the $50 to $60 range, most of them are profitable again.

The results are notable because much smaller shale companies had become the darlings of Wall Street over the past half-decade or so, with the lumbering oil majors starting to fall out of fashion. The hype around shale even had the largest oil companies disposing of conventional assets and stepping up spending on shale drilling. But the third quarter results highlight the strength of the integrated model – the shale industry is largely unprofitable while the oil majors appear to be rebounding strongly.

If the oil downturn had been brief, things might not have changed. But with oil prices stuck at low levels for more than three years, the thinking among oil executives is decidedly different. And with the prospect of peak demand not necessarily near, but eventually coming down the pike, none of the oil majors are betting that oil prices will go back to $100 per barrel. Shell’s CEO Ben van Beurden said that his company will assume that oil will be “lower forever.” That means that they will likely continue to be much more conservative than they were pre-2014.

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