After Crash Diet, Oil Majors May Need New Growth

The global oil majors' crash diets may be going too far.

That at least is the view of a small number of critics who believe sweeping programs of asset sales and the trimming of investment plans risk doing longer-term damage.

Pushed by investors demanding higher returns, the industry's slimming regime after more than a decade of acquisitive expansion in search of scale is worrying, argue some oil executives and bankers.

They say the need to build new income streams for a new decade may see the cycle turning back to growth again only a few years down the road.

"It will be difficult to grow unless we spend some money on mega projects," said a senior executive at an oil major, who declined to be identified. "No one apart from the majors can do mega-projects - but the focus now will be on execution."

Such projects are important both for the companies' future, a retired top executive said, as well as the wider world.

"It would be a pity if they got put off the larger projects," said Mark Moody-Stuart, who was Shell chairman from 1998 to 2001. "They are capable of doing it and the world in supply terms needs large projects."

Super-large projects are to a large extent the main culprits for the current shrinking models executed by most oil majors after spectacular failures, delays and cost overruns at projects in Kazakhstan, Australia and Qatar.

Many shareholders found it hard to swallow the fact that the $50-billion Kazakh Kashagan project has failed to pump crude since last year due to technical errors even thought it has already been delayed by almost 10 years.

It was such investments that yielded $40 billion of negative cash flows in 2013 for European oil majors BP, Royal Dutch Shell (RYDAF), Total, Eni and Statoil (STO) , according to calculations by investment analysts that included dividends and buybacks.

However, even with delays and cost overruns the super-large projects are set to deliver over $35 billion of net cash flows to the same companies over the next five years.

"We are in a period when they (majors) are collecting the fruits of the last cycle of large capex. But that won't be enough to sustain the model by, let's say, 2020 and beyond," says a senior banker from a major Wall Street bank specialising on oil majors.

"I think two or three years down the road majors will start asking themselves how long a model of shrinking capex can be sustained," he added.

Moody-Stuart is also questioning the reasoning behind the sale of mature oil and gas fields by the majors.

"I can see there are some assets you should probably dispose of in order to concentrate your capital, but I would be cautious of divesting oneself of fields whose ultimate recovery can probably be increased by technology," he said.

Output and Refining Shrinks
Global majors saw their oil and liquids output fall by more than 17 percent to about 9.5 million barrels per day (bpd) over the past decade, just over 10 percent of global output, according to Reuters calculations based on disclosures by Exxon Mobil (XOM), BP, Shell, Total, Chevron and Eni.

Refining capacity at those firms fell by 16 percent over the past decade to around 15 million bpd.

In an industry that tends to move in cycles, the latest super-major era kicked off in 1998, when BP embarked on $100 billion of acquisitions and bought up U.S. rival Amoco Corp., later added Atlantic Richfield and expanded in Russia.

"It all really started at the end of the 1990s when everybody was seeking scale and trying to get big enough to be able to afford large projects," BP Chairman Carl-Henric Svanberg told the annual shareholders' meeting last month.

"Then we started to see a lot of people - including shareholders - question are we seeing the returns?

"And when is the payback going to come?"

Back in the late 1990s, BP saw things differently and thought scale would be key to future success.

"The best investment opportunities will go increasingly to companies that have the size and financial strength to take on those large-scale projects that offer a truly distinctive return," then Chief Executive John Browne said in a statement with Amoco boss Larry Fuller when the pair announced the merger.

BP is now blazing the trail in reverse gear, selling a total of $50 billion of assets following the 2010 Macondo oil spill in the Gulf of Mexico from which the company is still recovering.

The company's market value is now $156 billion, down from $181 billion at the end of 2009 when Brent crude prices were trading below $80 a barrel, as opposed to over $100 today.

Rival Shell is also following a shrinking strategy albeit less extreme than BP's, planning to sell $15 billion of assets in 2014. Total of France is curbing its capital spending by 7 percent to $24 billion this year.

"BP moved first out of necessity post-Macondo; Shell's growth objective led to too much capital employed in unproductive areas," said Ivor Pether, a fund manager at Royal London Asset Management, which owns BP and Shell shares.

"For very big companies, it's not just a question of investing in larger projects to maintain a competitive growth rate, the quality of the appraisal process is critical. Often the board got involved too late in the process to change the outcome."

American Exceptions
U.S. majors, with historically better returns than European rivals, have also not embraced the shrinking strategy to the same extent as BP.

For example, Chevron Corp's shares fell 3.5 percent on Jan. 31 when the company said it planned to keep spending roughly $40 billion a year for the next several years.

Exxon, the sector's largest company and its star performer in terms of returns, in 2014 plans to trim capital spending by 6 percent to $39.8 billion.

Addressing past growth failures earlier this year, chief executive Rex Tillerson acknowledged it was a "valid question" as to whether supermajors are too big to grow their production.

Fund manager Ivor Pether said, "The majors know they are not earning a high enough return on their capital employed - they are making lower returns with oil at $100 than they did when it was $30 or $40.

"That's hardly been a productive return on all that investment."

For Statoil CEO Helge Lund, however, the key to improving returns is less about a cycle of growth and contraction but in simplifying supply chains and saving on materials and taxation: "We need to challenge ... the cost of development," he said.

"We cannot use the old recipes."

(By Alex Lawler and Dmitry Zhdannikov; Additional reporting by Peg Mackey in London and Gwladys Fouche in Oslo; Editing by Alastair Macdonald)