Investors pressuring Big Oil to loosen the purse strings
Executives at the world’s biggest oil and gas companies are under growing pressure to loosen the purse strings to replenish reserves, halt output declines and take advantage of a crude price rally after years of austerity.
With oil at a four-year high of $85 a barrel, exploration departments are urging company boards to drill more, wages are creeping higher, service companies say rates will have to rise and some investors say Big Oil must start growing again soon, according to Reuters.
For the heads of companies such as BP, Chevron and Royal Dutch Shell who have pledged to stick to lower spending after slashing budgets by as much as 50 per cent since 2014, the pressure may become hard to resist.
As in previous oil price cycles, there are concerns about the strength and duration of the business cycle, now in its 10th year of growth after the 2008 financial crisis.
Unlike previous oil price cycles, there is the prospect, eventually, of an end to growth in oil demand as the world shifts to cleaner energy.
But there are already signs some cost cuts implemented after oil slumped from $115 a barrel in 2014 to $26 in 2016 are being rolled back.
Shell, for example, said last month its teams in the U.K. North Sea will switch to a less tiring rota of two weeks offshore then three weeks onshore. During the austerity years, teams spent three weeks offshore then four onshore.
More frequent rotations mean more ships and helicopters will need to be chartered. Shell says the change will increase costs slightly but is convinced it will make its North Sea operations more cost effective and productive.
More generally, salaries across the oil and gas sector have edged up about six per cent so far in 2018 after declining in the previous three years, according to a survey published by Rigzone.
At one major firm, senior managers who had been meeting by video conference for several years are now getting flights approved for face-to-face gatherings, according to an executive at the company.
The boards of large oil firms are facing more internal requests to invest in new projects and acquisitions, and to beef up staff, according to senior executives present at such discussions.
“There is lots of pressure from all the units to get more money,” an executive at a large European oil company told Reuters.
New project approvals are picking up. Shell and its partners this week gave the green light to LNG Canada, one of the largest liquefied natural gas (LNG) projects in recent years.
“Shell’s motivations for the project are clear: without this project, the company’s upstream, LNG contract portfolio and LNG production was set to go into decline early next decade,” Wood Mackenzie analyst Dulles Wang told Reuters.
Typically, after a period of lower capital spending, or capex, and low prices comes an era of rapid investment as oil recovers and supplies tighten.
During the lean years, companies cut back sharply. Now, they generate as much cash as in 2014 and are vowing to remain thrifty to focus on higher dividends, buying back shares and reducing debt. But in an industry where reserves and production decline naturally as oil is pumped from fields, continued investment is considered critical.
“We are likely in need of more long-cycle investments given the persistent and accelerating base declines observed in global conventional and offshore projects,” a source at in investment firm with large stakes in big oil companies told Reuters.
Although some companies such as BP (BP.L) were able to stem production declines thanks to technology and lower costs, a drop in new production has taken a toll on the longer-term outlook for many companies.
Oilfield decline rates doubled from 3 percent in 2014 to six per cent in 2016. For the big oil firms, rates went from 1.5 percent to just over 2 percent during the same period, according to Morgan Stanley.
“I expect capex rises due to a significant drop in reservoir life. Some capex will be used to reinvigorate existing wells,” Darren Sissons, partner at Campbell Lee & Ross Investment Management told Reuters, adding that increases would be cautious initially.
Spending by the world’s top seven oil companies is expected to rise to a combined $136 billion by 2020 from $105 billion in 2017, according to analysts at Morgan Stanley and Jefferies.
Starting from the middle of next year, boards will change their tone to prepare shareholders for higher spending from 2020, Morgan Stanley analyst Martijn Rats told Reuters.
“New project awards will likely already accelerate in 2019, but for major developments, capex in the first year tends to be limited. From 2020 onwards, capex is likely to go higher.”
Boards are not blind to the pressure. Many companies have defined a range for spending, while committing to the lower end. Shell, for example, has a “soft floor” and a “hard ceiling” for spending of $25 billion to $30 billion per year.
For some companies such as Italy’s Eni, which is developing major gas projects in Egypt and Mozambique, boosting costs may be unavoidable.
“(Oil companies) proved themselves in a low oil price environment, but at some point they do need to start respending on new projects to keep getting oil out of the ground,” David Smith, fund manager of the Henderson High Income Trust, told Reuters.
Patrick Pouyanne, chief executive of French oil company Total, conceded this week that while it aimed to stick to its spending range of $15 billion to $17 billion a year beyond 2020, capex could rise to $20 billion.
“Our view is that the majors’ capex is probably 5 to 10 percent or so too low if they are to maintain their current reserve lives,” Jonathan Waghorn, co-manager of Guinness Asset Management’s global energy fund, told Reuters.
The pressure to increase spending also comes at a time oil services companies are slowly increasing rates, saying their sacrifices to help Big Oil weather the slump should now be rewarded as crude prices rise.
“Current investment levels, particularly in the international market, are clearly not sustainable to meet either medium-term demand or long-term reserves replacement needs,” Paal Kibsgaard, Chief Executive Officer of Schlumberger the world’s largest oil services provider, told a conference last month.
He said the international production base needed double-digit growth in investment for the foreseeable future just to keep production at current levels.
But investors and executives say reserve life – which was at its lowest in at least two decades in 2017 – is no longer the gold standard for measuring the health of oil companies.
A spending splurge could also eat into profits and revive fears oil companies are returning to the wasteful practices of the first half of the decade when crude prices soared.
“Historically, excess free cash flow above dividend cost has seen capex rise in the industry but the sector is trying to shake off the capital indiscipline tag and I believe they will stick to that,” Rohan Murphy, analyst at Allianz Global Investors, told Reuters.
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