The largest oil companies are struggling to balance competing objectives with dramatically lower revenues compared to previous years.
Nearly all have taken the axe to their spending levels, although to varying degrees. New exploration projects have been scrapped, suppliers have been squeezed, and workers have been laid off. But the top tier companies are fighting to protect their dividend policies above all else, an increasingly expensive priority that is forcing deeper cuts to spending.
But the strategies differ depending on the company. Chevron, for example, continues to cut spending in order to keep its dividend. The California-based multinational just announced that it would cut its capex in 2017 and 2018 by another 36 percent, bringing annual spending down to between $17 and $22 billion. That is down from an October 2015 estimate, when Chevron said that it expected to spend $20 to $24 billion each year in 2017 and 2018. It is also sharply lower than the $26.6 billion Chevron is spending this year, which itself is a 25 percent reduction from last year’s levels.
The severe cuts come as Chevron has had to take on debt in order to afford shareholder dividends, as the company has not generated enough cash flow to cover the payouts with oil prices as low as they are. Dividends cost the company $8 billion in 2015 alone. Chevron would need oil trading at $50 in order to cover the dividend with cash flow.
This week is also notable for Chevron because the giant Gorgon LNG project in Australia is finally beginning operations. The $54 billion export facility has absorbed much of Chevron’s capital and attention, a project that has suffered from repeated delays and cost inflation. The total price tag is 45 percent higher than the original estimate.
The bad news for Chevron is that the facility is set to export LNG into a market that is already oversupplied. Spot LNG cargoes have plunged by two-thirds over the past two years. For April delivery, LNG cargoes in East Asia have dropped to just $4.25 per million Btu (MMBtu). In early 2014, the same cargoes sold for over $17/MMBtu. Chevron will be insulated somewhat from these forces with contracts lined up for delivery under fixed prices. The long-term picture, the company believes, still looks strong. LNG export terminals can operate for decades. Nevertheless, the massive project is squeezing Chevron in the short-term, a time when it can least afford it. And with dividends untouchable, spending on exploration and production must be cut deeper.
Meanwhile, other companies have instead opted to cut their dividends so as not to hollow out spending too much. They lack the financial heft of ExxonMobil, Shell, or Chevron. Companies like ConocoPhillips, Noble Energy, Anadarko, and Eni have trimmed shareholder payouts over the past year.
Eni, in particular, offers an interesting window into the downturn. Eni is a large oil company, but smaller than Chevron. Eni decided to cut its dividend once oil prices collapsed, and announced a cut to the payout one year ago. That helped provide some breathing room. Although it wasn’t enough for Eni to cover its spending obligations with cash flow – the company needs $50 oil to do that – it still allowed the Italian oil company to cut 2016 spending by a lower proportion than its larger competitors. While Chevron cut spending by a third, Eni is only cutting spending by 20 percent.
With that said, Eni’s oil and gas production will remain flat this year after seeing gains in 2015. New fields starting up in Norway, Egypt, Angola, and Kazakhstan won’t be enough to offset its decline rate from mature fields. On the plus side for Eni though is the fact that last year it announced the largest natural gas discovery ever recorded in the Eastern Mediterranean. Eni is already working to develop the natural gas field off the coast of Egypt. Eni was able to replace more than 148 percent of the reserves it produced in 2015, a metric known as reserve-replacement ratio.
The supermajors might be protecting their dividends, but they are also risking lower long-term oil production. For now, that is a problem for another day. Referring to his company’s first negative reserve-replacement ratio in 12 years, Shell’s CFO said in February: "While we're not entirely comfortable with a negative number, it's not the most important thing today.”
By Nick Cunningham of Oilprice.com
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