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OilmajorsbusinessmodelunderincreasingpressureFT.com

February14,20166:07pm

Oilmajorsbusinessmodelunderincreasing
pressure
EdCrooksinNewYorkandChrisAdamsinLondon

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BP,ChevronandExxonwalkafinelinebetweenpayingdividendsand
investinginoperations

orgon,amassiveliquefiednaturalgasprojectoffthenorthwestcoastofAustralia,isoneofthe
wondersofthemodernage.Its$54bnpricetagmakesitinnominaltermsatleastoneof
themostexpensiveengineeringprojectsevercompleted.
Itcouldalsobeamonumenttoafadingera,thelasthurrahofBigOil.
WithUScrudehitting12yearlowslastweek,someintheindustryare
askingwhetherthebusinessmodeloflargeinternationaloilcompaniessuchasChevron,
ExxonMobilandRoyalDutchShell,thethreeprincipalpartnersinGorgon,isfundamentallyflawed.
DuetodispatchitsfirstLNGcargosoon,Gorgonisthetypeofprojectthatjustifiestheexistenceof
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largeoilcompanies.Chevron,whichisleadingit,isoneofonlyahandfulofbusinessesthathavethe
technicalcapabilitiesandfinancialstrengthtotakeonachallengeofthatscale.
Aftertheplungeincrudeprices,however,suchambitiousinvestmentsinLNG,deepwater
explorationandCanadasoilsandsarebecomingincreasinglyscarce.
MorganStanleyanalystscalculatethatjustninelargeprojects,outofmorethan230awaitinga
greenlightworldwide,arerealisticcandidatesforapprovalthisyear.TheycouldincludeBPs
$10bnMadDog2deepwateroilprojectintheGulfofMexico,andItalybasedEnisoffshoreZohr
gasdiscoveryinEgypt.TotalofFranceplanstoapprovenoprojectsatall.
Acrosstheindustry,some$400bninexpectedinvestmenthasbeencancelledordelayed.
Whenexecutivesfromthelargeoilcompaniestalkabouttheindustrydownturn,theygenerally
frameitasatemporarycondition.Becausecrudeatbelow$30perbarrelismuchtoolowto
incentiviseinvestment,theysay,theoversupplyintheoilmarketwillcorrect,andpriceswill
reboundtolevelsthatwillallowthemtomakerespectablereturnsagain.
ThechiefexecutivesofBPandShellbotharguedattheircompanies2015resultsthismonththat
theoilmarketcouldcomebackintobalancethisyear.AsBobDudleyofBPputit,hisexpectations
aboutpriceswerelowerforlonger,notlowerforever.
Butwhatiftheyarewrong?PhilipVerleger,anenergy
economist,arguesthatnightfalliscomingforbigoil
companies,threatenedononesidebytheriseofrenewable
energyandclimatepoliciesthatwillcurbthegrowthof
fossilfueldemand,andontheotherbythesmaller,nimbler
companiesthatleadtheshaleoilandgasindustry.
Thecompaniesthatareweddedtohighcostprojects,like
deepwaterinBrazil,aregoingtohavetotakesomelarge
writedowns,hesays.Thelikelihoodthatthoseinvestmentsaregoingtopayoffoverthenext20
yearsisextremelylow.
TheGorgonLNGfacilityunderconstructionin2012

Companiesthatputtheirhopesinastrongreboundinoilarentgoingtomakeit,headds.
Whiletheoilpriceislikelytorisesoonerorlater,manyindustryexecutivesandanalystsbelievea
sustainedrecoverywillpromptarapidrevivalinshaledrillingintheUS,bringingonadditional
productionandineffectputtingaceilingonprices.
Inthisviewoftheworld,thepricecrashhasbeenlikeanasteroidstrike:agileshaleproducerscan
survive,butthelumberingdinosaursofbigoilaredoomed.
Certainlythepressureonlargeoilcompaniesisintenseatthemoment.AfterEnicutitsdividend
lastyear,followedbyConocoPhillipsandotherUSproductioncompaniesthisyear,risingyieldson
thelargestcompaniessharessuggestssomeinvestorsareincreasinglyconcernedoverwhethertheir
payoutswillbemaintained.

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Analystsgenerallybelievetheywillbeabletomaintaintheirdividends.UnlikeConoco,whichsplit
offitsrefining,chemicalsandpipelinesbusinessasPhillips66in2012,thelargestcompanieshave
retainedsignificantdownstreamoperations.Theyactasanaturalhedge,usuallymakinghigher
profitswhencrudeandnaturalgaspricesareweak.
Bigoilgroupsalsotendtobebureaucratic,withplentyofscopetobecomeslimmer.Theyare
matureorganisationsthataredeliveringmultibilliondollarprojects,sotherearereasonswhythey
arethewaytheyare,saysRobinWestoftheCenterforStrategicandInternationalStudies.But
theyneedtobecomemoreagile,andtheyneedtogettheircostsdown.
Mostofthelargestoilcompanieshavealreadyannouncedjobcuts.Shellhassaiditplanstocut
about10,000jobs,includingrationalisationfollowingtheimpendingtakeoverofBGGroup
Chevroncutitsheadcountby3,200lastyearandplansafurtherreductionof4,000thisyear,while
BPplanstoshedabout7,000staffin201516.
Thecompanieshavealsobeenreiningincapitalspendingondrillingwells,findingreservesand
developingfields,withreductionsofbetween6percentforShelland25percentforExxonplanned
forthisyear.
Theeffectsofthosecutshavebeenmixed,however.Standard&Poors,thecreditratingagency,
downgradedChevronandShellthismonth.Itsaiditdidnotexpectanyadditionalchangein
Chevronsrating,butShellcouldbedowngradedfurther.ItisalsoconsideringstrippingExxonofits
rareandvaluedAAAstatus.

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Moreover,thoseratingsarebasedonS&Psassumptionsofoilat$40thisyear,$45nextand$50
from2018,whichisapathwellabovetodaysprice.Ifoilstaysbelow$30,companieswouldface
toughdecisionsbetweenabandoningtheircommitmentstotheirdividendsandcuttinginvestment
evenfurther.
Alreadycutsincapitalspendingarebeingreflectedinexpectationsforfutureoutput.Totaland
Chevronhavebothscaledbacktheirproductiontargets,althoughtheyarestillgrowingthanksto
themomentumfrominvestmentprojectsalreadyunderway.
BPisinatrickierposition.Ithascutclosertothebone,havingalreadydisposedofmorethan
$40bnofassetsfollowingthe2010DeepwaterHorizondisaster.MrDudleyisreluctanttotrim
projectedinvestmentevenfurther.
Forshareholders,thispressureonspendingmightbewelcome.LydiaRainforth,analystatBarclays,
arguestheproblemforbigoilhasnotbeenoverdistributionofearningstoinvestorsbut
overspendingonprojects.
Perhapsamorerigorousanddisciplinedapproachimposedbytheneedtopaythedividendcould
drivebetterinvestmentchoices,saysMsRainforth.

PhilGreshofJPMorganagreesthatifbigoilcompaniesfailtogrow,thatisnotnecessarilybadnews
forinvestors,solongastheyarereturningcapitalthroughdividendsandsharerepurchaseswhen
theoilpricepicksup.Buybacksmeanproductionpersharecangrow,eveniftotaloutputdoesnot,
headds.

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Forsomeexecutives,thisroleofmanagingdeclinemightseeminsufficientlyambitious.The
alternativeistofollowShellsexampleandgrowbyacquisition.
EricOudenotoftheBostonConsultingGrouparguesthattheterriblefinancialpositionofthe
independentcompaniesintheUSshaleindustry,withlargedebtsandalmostnowellstodrillthat
areprofitableat$30oil,meansthatifwehaveweakpricesfortwoorthreemoreyears,the
majoritywilleitherfoldorbetakenover.
Thatmeansthatthecrisisforbigoilcouldalsobeatimeofgreatopportunity.Manybillionsof
barrelsofreservesintheshalefieldscouldbecomingontothemarket,pricedtosellsocreditors
cancollecttheircash.

Bigoilcompaniescanabsorbsmallandmidsizedcompaniesassets,saysMrOudenot.Andthen
whenoilpricesrecover,iftheyhavemanagedtoreducetheircosts,theycanbehighlyprofitable.
Thatmightseemanoverambitiousrecommendationforcompaniesthatarecountingthepennies.
Culturally,bigoilhasoftenbeenabadfitwiththeshalebusiness.Still,iflargeoilcompanieswant
tosurvivethispotentiallyextinctionlevelevent,theywillneedtoevolve.Buyinguptheshale
industrymightbejustthewaytodoit.
Oilroutpromptsnewapproachestocostcutting

Whenbigoilcompaniestrytocutcosts,therearegenerallytwowaysofdoingit:forcingdowntherates
theyarechargedbytheirsuppliersandfindingbetterwaysofworking.Thefirstwayisgenerallythe
easiest,butthesecondismorevaluable,becauseitismorelasting.Supplierspriceswillriseagainas
activityintheindustrypicksup.
TotalofFrancelastSeptembergavesomeexamplesofefficiencygains,sayingthatimprovementssuchas
havingoperatorscapableofperformingmultipledifferentrolesmeantthatbetween2014and2017itcould
cutthenumberofpeopleworkingonitsBlock17oildevelopmentinAngolaby30percent,andonits
maturefieldsintheUKby20percent.
Companiesarealsolookingatnewwaysofworkingtogether.LastweekGeneralElectric,theUSindustrial
groupthathasbeenbuildinganoilandgasbusiness,announcedaninnovativedealwithDiamond
Offshore,adrillingcontractor,fortheservicingblowoutpreventersthestacksofvalvesusedatthetopof
awelltoshutoffanyleaks.
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Thetraditionalmodelisthatamanufacturersellsblowoutpreventerstoadrillingcontractor,whotakes
responsibilityforservicingandmaintainingthem,callinginthecompanythatmadethemasneeded.Inthis
deal,GEboughttheequipmentfromfourofDiamondsdrillshipsgivingthecompany$210minnodoubt
welcomecashandagreedatenyeardealtoservicethem.
ThecontractgivesGErewardsforavailability,payingoutmoreiftheblowoutpreventersarewell
maintainedandpassinginspections.Asaresult,saysChuckChauviere,GEspresidentofdrillingsystems,
itsincentivesarecompletelyalignedwiththoseofitscustomers.
Before,themanufacturermighthavebeenlookingforsomenicelucrativemaintenanceworkwhen
somethingwentwrong.Now,everyonewantstheblowoutpreventerstobereadyforuseasmuchas
possible.Themodeliswhenyougetresults,wegetpaid,saidMrChauviere.Thatcompletelychanges
theculture.
RobinWestoftheCenterforStrategicandInternationalStudiesarguesthatoilproducersandservice
companiesneedtobecomingupwithmanysimilarlycreativeideas.
Relationshipsbetweenproductioncompaniesandservicecompanieshavebeenveryadversarial,he
says.
Theservicecompaniesandtheoilproducershavenotfullyrecognisedthedepthoftheircodependency.
Theyneedtofindsolutionstogether.

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