For much of the past three years, the oil majors have struggled to adapt to the new reality of low oil prices, while at the same time, their smaller and nimbler rivals deftly pivoted to the ebbs and flows of oil price movements. Big Oil, it has been said, was ill-equipped to deal with $50 oil, dragged down by the enormous expenses on their billion-dollar megaprojects. Shale, on the other hand, was the future, and production surged in places like the Permian Basin. The oil majors finally saw the writing on the wall, and followed their smaller competitors by pouring money into the shale patch.
But, ironically, the outlook for the oil majors looks better – at least in the short run – than it does for some shale drillers. The recently released second quarter numbers were relatively strong for the largest oil companies, most of which emerged from the red and posted strong profits. Even at $50 oil and below, the lumbering oil giants can apparently make money.
That has dispelled fears that they would not be able to pay their dividends. Proving that they can adapt, the oil majors look nothing like they did a few years ago. The largest European oil companies “generated in 1H 2017 higher free cash flow at US$52/bl Brent than in 1H 2014 at US$109/bl Brent,” Goldman Sachs wrote in a recent research note. That is a staggering improvement in just three years.
The better financial position could allow the oil majors to return to fully funding cash dividends, rather than issuing scrip. “We believe the industry has the ability and the willingness to retire/neutralize scrip dividends in the next six months in a US$45-55/bl Brent oil price environment. This could be an important positive catalyst for the sector,” Goldman concluded. “We think risk-reward for the sector is tilted to the upside in the near term,” the investment bank wrote, citing strong production and cash flow growth and more spending cuts. Goldman singled out Shell, Eni and Total as particularly attractive.
Meanwhile, the shale industry has seen its momentum slowed recently. In a world of $50 oil, shale has been assumed to be the place to be, for a variety of reasons. Shale companies can drill dozens of wells on short notice, which bring in cash very quickly. That means that they are relatively low risk in a volatile market.
But the recent financials from the shale industry has raised some concern. A few top shale names have underperformed, including Pioneer Natural Resources and EOG Resources. The disappointing second quarter results from these two shale companies – who have been darlings of Wall Street – “triggered questions on positioning across well-owned, perceived high-quality Energy companies,” Goldman wrote in a report on August 2.
Pioneer, the second largest producer in the Permian Basin, posted earnings that beat expectations and reported production figures that were at the upper end of its guidance. However, the company said that drilling delays will force it to push off 30 well completions until next year, which means it had to lower spending for this year and also tamp down production expectations. Moreover, the company is seeing a higher gas-to-oil ratio from its output, a potential red flag for the hottest shale basin in the country. The disappointing results led to a 13 percent decline in Pioneer’s stock price.
Goldman Sachs says that it has “fielded questions on where to reallocate capital within [the energy sector,” a sign that shareholders are starting to sour on even the strongest shale players. Goldman says investors could start to shift their sights to other stocks that offer better returns, higher free cash flow, etc.
Ultimately, that might make the oil majors relatively more attractive, with significantly improved financials and fat dividend payouts. It’s an odd development, given the assumption that the medium-sized shale companies were much more agile and able to adapt to this new low and volatile price environment. After all, that is why the oil majors have increasingly pivoted to focus on shale.
By Nick Cunningham of Oilprice.com
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