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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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BP Spells Out What’s Wrong With Big Oil In One Chart

 The trouble in the oil industry may have started with a supply glut, but the problems are rapidly spreading across all facets of the industry. BP recently included the chart below in one of their investor presentations.

BPChart

(Click Image To Enlarge) Related: Africa Banking On Nuclear Power

The chart shows that compared with the first half of 2014, the first six months of 2015 have seen the company fail to generate enough cash flow via asset disposals and cash flow to pay for its dividend and capex. Despite cutting share buybacks and inorganic capex dramatically, BP still finds itself in need of more cash. That result is largely a byproduct of the collapse in oil prices which BP of course has no control over. Thanks to that lack of cash, the company is going to have to sell even more assets and further cut its capex expenditures.

These asset sales come in an environment where BP is not alone – it’s likely that virtually all oil majors will be following the British giant in trying to sell more assets into an already depressed market. The result is that asset prices will likely continue to remain low and firms will have to rely on capex cuts, dividend cuts, raising new capital, or some combination of the three. Related: Clinton A Continuation Of Obama On Energy

For now BP seems to be focusing on capex cuts, but those cuts also eventually must reduce the level of production that BP and other firms can bring to market. For now, most majors from Statoil to BP seem to be trying to pump as much out of their fields as fast as they can. Investors seem to be succumbing to the reality that the industry’s mess will take a while to work itself out. Even super majors like BP have seen their stock prices crater in the last three months. This marks a dramatic turn-about from the end of 2014 and the first half of the year when the majors had seen their stock suffer much less than smaller independent E&P firms, even as the price of oil languished near current lows.

If something major doesn’t change soon, asset sales and capex cuts may not be enough for many firms. The oil industry needs a strong economic rebound to help boost demand both in the U.S. and abroad. That scenario does not seem to be on the cards. U.S. jobs growth and economic growth in general are reasonable but not particularly robust. Yet by contrast, the U.S. performance is exceptional in comparison to the truly anemic growth in Europe and the rapid slowdown in China. Related: Can Economies Of Scale Rescue TSLA?

In the absence of a growing economy and faced with a glut that is only disappearing slowly, there is a good chance many oil majors will be forced to cut their dividends in the next six to twelve months. Analysts are starting to come to this realization, and while BP is among the safest of the oil majors, all of them are actually at risk of having to cut dividends.

The industry’s free cash flow shortage trouble is on the order of tens of billions of dollars. Moody’s estimates that, despite capex cuts and other internal measures, the industry will still have a negative free cash flow position of nearly $80 billion in 2015. Given that, investors in the oil sector need to be prepared to hold stocks for the medium term or longer rather than looking for a quick rebound.

By Michael McDonald of Oilprice.com

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