ExxonMobil saw its share price nosedive by roughly 15 percent in the past week, one in a series of oil companies that finds itself in a freefall.
Four other oil majors – Chevron, BP, Shell and Total – also declined sharply, dragged down by the worst weekly loss for oil prices in more than four years.
But the problems for the oil majors run much deeper than the coronavirus, and their share price declines have been underway for quite some time.
The majors find themselves facing a complex set of problems, with no clear way out. Oil demand growth in the short run has vanished, but in the long run peak demand looms. Prices have been stuck at low levels, but returns for the majors were disappointing even prior to the 2014 meltdown. Many of them have bet big on U.S. shale, even as the business model remains unproven. A decade of negative cash flow on shale drilling raises serious red flags about the financial viability of the entire fracking enterprise.
In the past, continuous growth was the business model. More spending and more exploration in order to find more reserves, which translated into a larger production portfolio. Investors have completely soured on this strategy, and companies are increasingly hiking dividends and share buybacks to keep shareholders from abandoning them. ExxonMobil finds itself somewhat alone in sticking with the old strategy of aggressive growth.
But dishing out more money to shareholders and forgoing growth presents a new set of challenges for an industry premised on endless growth. The dramatic decline in energy share prices likely reflects a growing belief from Wall Street that oil and gas companies are going to struggle with a low-carbon transition. Related: The Complete Guide To FID’s
The European majors are trying to make the pivot, with BP, Shell and Total announcing varying degrees of climate targets. Eni just announced that its oil and gas production would peak in 2025.
None of the strategies seem to be working and all of the oil majors are struggling. Collectively, they are now spending much less than in the past, but that too is a sign of decline, according to a new report.
“In 2019, the five largest integrated oil and gas companies—ExxonMobil, Shell, Chevron, Total and BP—spent a total of $88.7 billion on capital projects, down nearly 50 percent from the $165.9 billion they spent in 2013,” a report from the Institute for Energy Economics and Financial Analysis said. “Not since 2007 have the capital expenditures, or capex, among the five companies been so low.”
The majors have slashed spending in order to limit the damage to their balance sheets, but low capex is a “warning to a mature industry with declining prospects in its traditional businesses – oil and gas exploration and production, refining and petrochemicals,” the report said.
Capex is a “crucial gauge” for how companies view their future growth prospects, the analysts wrote. But a “convergence of trends” has squeezed them. Related: U.S. Gasoline Prices Jump On Outages At Major Oil Refineries
These trends include weaker growth prospects, including the “elusive” belief that petrochemicals offer the next big growth sector. They have less cash than they used to, due to lower oil and gas prices.
Replacing reserves is no longer the preferred metric by Wall Street. Instead, investors want cash flow, something that the majors are also struggling with.
Meanwhile, the majors collectively rewarded shareholders with $536 billion in dividends and share buybacks over the past decade, while only generating $329 billion in free cash flow. They have had to sell assets and take on debt to make up for the shortfall.
In addition, the energy sector is declining more broadly in importance, representing a much smaller slice of the S&P 500 than it used to. “Simply put, a declining industry requires less capex,” the IEEFA analysts wrote.
The oil and gas industry “has reached a mature and declining phase, with a weak financial outlook,” IEEFA concluded.
By Nick Cunningham of Oilprice.com
More Top Reads From Oilprice.com:
- Is Tesla Really The Emerging ‘Energy King’?
- UAE’s Latest Natural Gas Discovery Is A Gamechanger
- Two Abundant Elements That Could Create A Superbattery
Those writing about oil majors and the global energy transition should always remember the following mantras. There will neither be a post-oil era nor a peak oil demand throughout the 21st century and probably far beyond. An imminent global energy transition is an illusion and oil and gas will continue to be the core business of the global oil industry as long as there is demand for both oil and gas.
Low oil prices since the 2014 oil price crash have no doubt affected the revenues of the major oil companies even before the onset of the coronavirus outbreak. Since 2014 oil prices have been facing a glut in the global oil market. This glut has been augmented by almost two years of trade war between the United States and China from 1.0-1.5 million barrels a day (mbd) to an estimated 4.0-5.0 mbd. However, neither the glut nor the coronavirus outbreak will be with us forever. A good business sense dictated that the oil majors cut their capex so as to avoid augmenting the glut further.
Another measure the majors should take is to balance their dividend payments with their earnings. It is illogical to pay $536 bn in dividends while generating only $329 bn in free cash flow during the same period.
The fact that the global oil and gas industry managed to raise $617.4 bn in capital in 2019 speaks volumes about the indispensability and profitability of this industry. After all the oil and gas business is the world’s biggest and most profitable business. Oil and gas will continue to be the fulcrum of the global economy well into the future.
Yet, Big Business is investing heavily in energy transition because of genuine interest in being part of the clean energy solutions.
International oil companies (IOCs) with declining proven reserves of crude oil have no alternative in the long term but to adopt a business model whereby income from renewables would eventually overtake fossil fuels. This, however, is not the case with national oil companies (NOCs) with huge reserves. For NOCs, their future strategies are to continue to maximize revenues from their plentiful oil and gas wealth.
For now, we’re in an era of energy diversification where alternative sources to fossil fuels, notably renewables, are growing alongside—not at the expense of—the incumbents.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London