Oil majors must long for the halcyon days when a sustained period of low crude prices could be expected to send OPEC riding to the rescue with sweeping production cuts and a promise to boost global prices. Now, two years into a global supply glut that shows few signs of lifting, do oil majors need an OPEC to finally take action?
BP (LSE: BP) wouldn’t say no to the help. Interim results released last month saw underlying replacement cost profits, its preferred metric of profitability, slump 67% year-on-year. Add in a $2bn statutory loss for the period and net debt leaping to $30.9bn and worries have rightly begun to proliferate that dividends will be slashed sooner rather than later.
Unsurprisingly, management has publicly maintained that there’s little risk to shareholder returns. The company says that it can balance capital expenditure, operating costs and shareholder returns with crude in the $50-$55/bbl range.
The good news is that prices aren’t far off this mark, with Brent crude currently trading at around $47/bbl. And the company’s gearing ratio at 24.7% is within the safe range of 20%-30%, although it’s rising quickly.
However, in a worst case scenario where prices remain at current levels for a sustained period of time, the company would need to lower the $2.2bn it returned to shareholders over the past six months alone. If management is to be relieved of making this tough decision, oil prices will need to rise, whether that comes from OPEC, other major suppliers or a miraculous jump in global demand.
Betting on gas
While BP has been treading water for five years by selling assets and slashing capex to pay out over $43bn for costs related to the 2010 Gulf of Mexico spill, rivals such as Shell (LSE: RDSB) have been planning for a future where OPEC has less sway and prices remain far below $100/bbl.
Shell believes the decades to come will mark the rise of natural gas as a cleaner, cheaper fossil fuel. To this end it took advantage of slumping valuations across the industry last year to snap up rival BG for £35bn. This acquisition, while pricey, has made the combined group the world’s largest supplier of liquefied natural gas (LNG).
Although LNG prices have been battered as badly as crude oil prices, the deal shows that Shell’s management is taking seriously the prospect of a future where oil is no longer the cash cow it has long been.
In the short term though, the BG deal and low fuel prices have presented Shell’s management with the same dilemma their counterparts at BP face. Gearing at the end of June had risen to a dangerously high 28.1% on the back of lower earnings and the BG acquisition, while dividend payouts remained untouched.
In the past quarter alone these shareholder returns totalled a whopping $3.7bn, a large expense for Shell when constant cost of supplies earnings collapsed 87% to $1bn over the same period year-on-year.
With dividends on the line, both BP and Shell will be watching closely next month’s informal OPEC meeting in Algeria. Of course, with American shale producers and lower global demand. even an OPEC cut may not be enough to send prices soaring. The oil majors will muddle through either way thanks to strong downstream assets and price cuts, but investors shouldn’t expect dividends to be sacrosanct forever.