Oil Majors Are Preparing For A Difficult Period

• The oil majors have been making record-high profits, but that hasn’t altered their capital discipline as they prepare for the next oil price rout.
• The energy segment of the S&P 500 has shed 5% since the start of the year, reflecting a fear that a recession will drive oil prices lower.
• The combination of higher operating costs, increased interest rates, and a drop in both oil and gas prices suggests the good times may soon be at an end.

The piles of cash Big Oil made from last year's energy crunch have become the stuff of legend. They have also become a weapon in the hands of governments that like to have a scapegoat handy.

The weapon hasn't been particularly effective, whether used to threaten the oil industry with windfall profit taxes or deployed by activists to add more detail to the already demonized image of the industry.

The industry, meanwhile, has kept its head down and its capital spending lower. The capital discipline trend appears to have become entrenched in oil and gas as companies seek to be prepared for the next price rout.

The Wall Street Journal reported this week that the seven largest oil and gas companies on the S&P 500 have accumulated a combined cash amount topping $80 billion. Exxon alone has a cash stash of close to $30 billion. Chevron has over $15.6 billion. EOG, the smallest among the big, has over $5 billion. And they are keeping it.

"They've paid dividends forever. That's been a hallmark," Rob Thummel, managing director at energy investment firm Tortoise, told the WSJ. "But now there's excess cash beyond dividends to do buybacks."

That's what's helped keep energy stocks high in the past couple of years and especially last year. Investors may be getting more climate-conscious, but they can still recognize a return when they see it. And they see it in energy stocks. Related: Oil Prices Dip As Traders Brace For U.S. Inflation Data

The issuers of those energy stocks, on the other hand, know that, as Chevron's CFO Pierre Breber put it, "good times don't last" and are conserving cash for when the current crop of good times ends. Which might be sooner than expected.

The energy segment of the S&P 500 has shed 5% since the start of the year while the broader index has added 8%, the Financial Times noted in a recent report. Oil prices have dropped by some $10 per barrel over a month. Fear of recession is running high and hurting energy stocks—those same stocks that carry with them the promise of certain returns, even in bad times.

In a way, the situation is kind of absurd, as described by PetroNerds' chief executive Trisha Curtis: "These companies had high share prices when they were losing money," Curtis told the FT. "Now they are making money hand over fist and not being rewarded."

According to some, there is concern that with lower oil prices, energy companies will start cutting their dividend—those of them that have made said dividend variable. It seems not all investors are happy about it. But there is a bigger factor for the energy stock skepticism that is emerging at a time when Big Oil and smaller operators too are flush with cash.

"An estimated 30–40 percent cost increase in field operations, increased interest charges on borrowed money, a drastic collapse in natural gas prices combined with lower crude oil prices produced a noticeable lower cash flow," one respondent to the Q1 Dallas Fed Energy Survey said in the comments section.

"Outside investors seem to be losing interest in hydrocarbons," the same respondent said, also noting the uncertain outlook on the global economy and geopolitics. "We expect another "muddle through" period in a cyclical business where more players will be winnowed out."

Besides cost inflation and lower well productivity, according to EIA data cited by the FT, the reputational factor appears to be stronger than ever. According to that Dallas Fed Survey respondent, outside investors are losing interest in oil and gas. According to PetroNerds's Curtis, "The market and investors are still uncomfortable with oil and gas. The companies are not being valued to their assets or what they're producing."

In a context like this, there is little that makes as much sense as keeping your dividends close and your cash pile closer, at least until some more clarity emerges about the future of the U.S. economy and the wider world.

By Irina Slav for Oilprice.com

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