Price Fall Hastens Western Oil Majors Retreat

Seven oil majors ran annual cash deficit of $55 bln; falling oil price to force new wave of asset sales. Repeat of M&A boom as response to low oil prices seen unlikely

This year's fall in energy prices is hastening the decline of big oil, as the seven Western majors sell-off assets, cut investment, return money to shareholders and shrink in size, leaving ever more output to small producers and state firms.

Companies that were already deep in the red when the price of Brent was at $109 a barrel last year are having to redraw business plans for prices as low as $90.

With promised shareholder dividends probably untouchable for now, they will have to divest, cut costs and borrow more against a smaller business just to make ends meet. And unlike in previous downturns, they are no longer big enough to ensure that their own cutbacks will drive prices and profits back up.

According to Morgan Stanley (MS) analysts, the seven majors - Royal Dutch Shell (RYDAF), BP, Exxon Mobil (XOM), Chevron (CVX), Total <TOTF.PA, ENI and Statoil (STO) - ran a collective deficit of $55 billion last year.

They generated $207 billion of operating cash flow but invested $209 billion in capital expenditure and returned $53 billion to shareholders in dividends.

All have promised investors to do better this year by cutting their capital investment and operating expenses - which mushroomed in recent years on the back of cost overruns and delays at projects such as Kashagan in Kazakhstan or Gordon in Australia - both estimated to cost over $50 billion.

But the latest drop in oil prices to a two-year low leaves few options other than to continue shrinking by selling projects, oil fields and refineries.

And given that the seven majors have already sold assets worth $150 billion in the past four years, they are gradually turning from super-majors into mini-majors: still among the biggest companies in the world but no longer with the size to bend prices to fit their investment cycle.

"Oil companies are in a period of circumspection, which will only be prolonged with the oil price pullback... It is quite clear the business cannot sustain itself with Brent below $100," said Charles Whall, fund manager at London-based Investec Asset Management, which invests in Shell, Total, Chevron, Exxon and Statoil.

Last year, most majors would have needed a price of $120-130 per barrel to balance their budgets without borrowing, selling assets or cutting payments to shareholders in the form of dividends and share buybacks.

With promised spending cuts, financials were expected to be back in balance by 2016 based on average oil prices of $110 a barrel, according to Morgan Stanley, which also estimates that every $10 per barrel fall in oil prices translates into a 12 percent decline in earnings.

No Oil Price Help
An old mantra in oil markets says that when prices fall too sharply, companies respond by cutting investment, which in turn leads to an oil shortage several years down the road, helping to propel prices so companies can start a new investment cycle.

That theory may simply no longer work for oil majors.

In 2003, Exxon, Shell, BP, Total, Chevron and Eni produced 11.5 million barrels of oil liquids per day, or 14.5 percent of global output of 79.6 million bpd. Fast forward 10 years and their smaller output of 9.5 million bpd is equivalent to only 10.4 percent of larger global production of 91.6 million bpd.

"Oil majors have very little leverage over actual oil prices today," said Jason Gammel, analyst at Jefferies.

Meanwhile the engine of today's growth in oil output - the U.S. shale oil boom - is driven mainly by mid-sized and small producers such as Anadarko, Apache, Occidental and Devon, rather than the majors.

And technology improves so fast on U.S. fields that what looked uneconomical two years ago looks economical today, even with lower prices.

According to an analysis from Barclays (BCS), 90 percent of production from the U.S. Bakken province will still be profitable even if oil prices fall to $60 per barrel.

Eating Itself
For now, the one form of expenditure that many analysts believe the majors cannot cut is dividends to shareholders, who might revolt if they no longer get their expected payouts.

"Prices will have to go below $90 for companies to start putting projects on the back burner. But dividends is the last thing they will want to cut," said Iain Reid, analyst at investment bank BMO.

According to BMO, Exxon and Eni are effectively trading today as if oil prices were at $102 a barrel, partly thanks to dividend payments that keep the share prices up. For some of the majors, dividend yields are as high as 6 percent.

To keep up such payments, majors are effectively eating into themselves and will have to sell tens of billions of dollars worth of additional assets in the next years, according to banking and oil industry sources.

In recent years they have been able to borrow cheaply - all of the majors but Exxon are paying out dividends at a higher yield than their cost of borrowing. But if historically low interest rates go up they will no longer be able to fund their dividend payouts with ever more debt.

One way to maintain their stature might be to merge. The last collapse in oil prices at the end of the 1990s triggered the wave of oil mega-mergers that produced the present big seven, when BP bought Amoco and Arco, Exxon bought Mobil and Total bought Elf and Fina.

That seems unlikely to be repeated.

"I think most easy mega-mergers have been already done. It is difficult to see French Total and Anglo-American BP opting to merge," said a senior mergers and acquisitions banker at a top Wall Street bank, who asked not to be named.

Reid from BMO agreed: "Majors' strategies today are all about capital discipline and free cash flow, not mega mergers".

By Ron Bousso and Dmitry Zhdannikov