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After OPEC - What’s Next For Oil Prices?

Crude oil prices surged Wednesday…

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U.S. Shale Set To Kill Oil Price Rally

The EIA expects oil prices…

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Goldman Sachs Turns Bullish On Oil

Known for its extreme calls…

Next Few Weeks Will Reveal Full Extent Of Oil Industry Suffering

Next Few Weeks Will Reveal Full Extent Of Oil Industry Suffering

Get ready for some bad news and red ink.

With the bulk of quarterly earnings reports in the energy industry yet to be announced, there are already $6.5 billion worth of asset write-downs, according to Bloomberg. And that could be just the tip of the iceberg. A Barclays’ assessment last week predicted $20 billion in impairment charges from just six companies.

Write-downs occur when the expected future cash flow from an asset falls sufficiently that a company has to report that the asset has lost some of its value. With oil prices half of what they were from mid-2014, oil and gas fields around the world are no longer worth what they used to be. Some oil fields that were previously expected to produce in the future may no longer even make sense to develop given current oil prices. As a result, investors should expect billions of dollars in further write-downs in the coming weeks. Related: Banks Give A Stay Of Execution On Oil And Gas Sector

Persistently low oil prices are putting a lot of pressure on the dividend policies of oil and gas producers. The Wall Street Journal reported that four oil majors – BP, Royal Dutch Shell, ExxonMobil, and Chevron – have a combined cash flow deficit of $20 billion for the first half of 2015. In other words, these big players are not earning enough revenues to cover expenditures, share buybacks, and dividends. With such a large cash flow deficit, something has to give. All four are focusing on slashing spending in order to preserve their promises to shareholders, with dividends especially seen as untouchable.

However, it could take several years to bring spending into alignment so that cash flows breakeven. The problem for these companies is that they were also cash flow negative even when oil prices were above $100 per barrel in the years preceding the bust in 2014. Over the past decade, costs at all of these companies have all been heading in the wrong direction – higher spending on new projects, dividend payouts, and share buybacks have all driven costs dramatically higher. The WSJ notes that Chevron’s dividend bill doubled since 2004, for example, and its capital spending increased by six fold. Higher oil prices over that timeframe allowed for this cost inflation, but the oil majors were still cash flow negative. Now that oil prices have crashed, the deficit has ballooned, forcing painful cuts to payroll and spending for new oil projects. Related: Stop Blaming OPEC For Low Prices

While erasing the cash flow deficit will make sense in the short-run, the oil majors have a tricky balancing act on where to cut. Cutting spending on finding and developing new sources of oil will lead to lower production in the years ahead. Preserving dividends only to sacrifice oil production could keep share prices aloft for now, but will raise red flags for the companies over the long run.

Meanwhile, smaller companies don’t have the luxury of time that the oil majors have, particularly those in the oilfield service sector where demand for rigs has all but disappeared.

The latest casualty of low oil prices was the dividend for Noble Corp., an offshore driller, which cut its dividend by more than half from 37.5 cents per share to just 15 cents per share. “We believe the revised dividend appropriately addresses the prevailing industry uncertainty,” said Noble’s CEO David Williams. “The decision to adjust the dividend and preserve liquidity in an uncertain market is not reflective of our current financial performance,” he added. Related: Pain For Oilfield Services Will Continue Even If Oil Prices Rebound

Offshore rig suppliers have been hit even harder than E&P companies. The lack of drilling activity has gutted earnings across the entire sector. Some of Noble’s competitors, such as Transocean and Seadrill, have also moved to cut their dividends over the past year. Even if oil prices rebound – and there are few signs that an increase is imminent – there will be a lag between a price rise and an actual uptick in drilling. That suggests that the offshore oilfield service sector will continue to remain in the doldrums. The current oil price slump “is shaping up to be the most severe downturn in the industry for decades,” Schlumberger CEO Paal Kibsgaard said last week.

A few companies may not survive today’s depressed market, but a lot more details will be revealed in the coming weeks as earnings season unfolds.

By Nick Cunningham of Oilprice.com

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