Repost from The Wall Street Journal
Big Oil Feels the Need to Get Smaller
Exxon, Shell, Chevron Pare Back as Rising Production Costs Squeeze Earnings
By Daniel Gilbert and Justin Scheck, Nov. 2, 2014
Extracting oil from Western Canada’s oil sands, such as at this Shell facility near Fort McMurray, Alberta, is a particularly expensive proposition. Bloomberg News
As crude prices tumble, big oil companies are confronting what once would have been heresy: They need to shrink.
Even before U.S. oil prices began their summer drop toward $80 a barrel, the three biggest Western oil companies had lower profit margins than a decade ago, when they sold oil and gas for half the price, according to a Wall Street Journal analysis.
Despite collectively earning $18.9 billion in the third quarter, the three companies— Exxon Mobil Corp. , Royal Dutch Shell PLC and Chevron Corp. —are now shelving expansion plans and shedding operations with particularly tight profit margins.
The reason for the shift lies in the rising cost of extracting oil and gas. Exxon, Chevron, Shell, as well as BP PLC, each make less money tapping fuels than they did 10 years ago. Combined, the four companies averaged a 26% profit margin on their oil and gas sales in the past 12 months, compared with 35% a decade ago, according to the analysis.
Shell last week reported that its oil-and-gas production was lower than it was a decade ago and warned it is likely to keep falling for the next two years. Exxon’s output sank to a five-year low after the company disposed of less-profitable barrels in the Middle East. U.S.-based Chevron, for which production has been flat for the past year, is delaying major investments because of cost concerns.
BP has pared back the most sharply, selling $40 billion in assets since 2010, largely to pay for legal and cleanup costs stemming from the Deepwater Horizon oil spill in the Gulf of Mexico that year.
To be sure, the companies, at least eventually, aim to pump more oil and gas. Exxon and Chevron last week reaffirmed plans to boost output by 2017.
“If we went back a decade ago, the thought of curtailing spending because crude was $80 a barrel would blow people’s minds,” said Dan Pickering, co-president of investment bank Tudor, Pickering, Holt & Co. “The inherent profitability of the business has come down.”
It isn’t only major oil companies that are pulling back. Oil companies world-wide have canceled or delayed more than $200 billion in projects since the start of last year, according to an estimate by research firm Sanford C. Bernstein.
In the past, the priority for big oil companies was to find and develop new oil and gas fields as fast as possible, partly to replace exhausted reserves and partly to show investors that the companies still could grow.
But the companies’ sheer size has meant that only huge, complex—and expensive—projects are big enough to make a difference to the companies’ reserves and revenues.
As a result, Exxon, Shell and Chevron have chased large energy deposits from the oil sands of Western Canada to the frigid Central Asian steppes. They also are drilling to greater depths in the Gulf of Mexico and building plants to liquefy natural gas on a remote Australian island. The three companies shelled out a combined $500 billion between 2009 and last year. They also spend three times more per barrel than smaller rivals that focus on U.S. shale, which is easier to extract.
The production from some of the largest endeavors has yet to materialize. While investment on projects to tap oil and gas rose by 80% from 2007 to 2013 for the six biggest oil companies, according to JBC Energy Markets, their collective oil and gas output fell 6.5%.
Several major ventures are scheduled to begin operations within a year, however, which some analysts have said could improve cash flow and earnings.
For decades, the oil industry relied on what Shell Chief Financial Officer Simon Henry calls its “colonial past” to gain access to low-cost, high-volume oil reserves in places such as the Middle East. In the 1970s, though, governments began driving harder bargains with companies.
Oil companies still kept trying to produce more oil, however. In the late 1990s, “it would have been unacceptable to say the production will go down,” Mr. Henry said.
Oil companies were trying to appease investors by promising to boost production and cut investment.
“We promised everything,” Mr. Henry said. Now, “those chickens did come home to roost.”
Shell has “about a third of our balance sheet in these assets making a return of 0%,” Shell Chief Executive Ben van Beurden said in a recent interview. Shell projects should have a profit margin of at least 10%, he said. “If that means a significantly smaller business, then I’m prepared to do that.”
Shell late last year canceled a $20 billion project to convert natural gas to diesel in Louisiana and this year halted a Saudi gas project where the company had spent millions of dollars.
The Anglo-Dutch company also has dialed back on shale drilling in the U.S. and Canada and abandoned its production targets.
U.S.-based Exxon earlier this year allowed a license to expire in Abu Dhabi, where the company had pumped oil for 75 years, and sold a stake in an oil field in southern Iraq because they didn’t offer sufficiently high returns.
Exxon is investing “not for the sake of growing volume but for the sake of capturing value,” Jeff Woodbury, the head of investor relations, said Friday.
Even Chevron, which said it planned to increase output by 2017, has lowered its projections. The company has postponed plans to develop a large gas field in the U.K. to help bring down costs. The company also recently delayed an offshore drilling project in Indonesia.
The re-evaluation has also come because the companies have been spending more than the cash they bring in. In nine of the past 10 quarters, Exxon, for example, has spent more on dividends, share buybacks and capital and exploration costs than it has generated from operations and by selling assets.
Though refining operations have cushioned the blow of lower oil prices, the companies indicated that they might take on more debt if crude gets even cheaper. U.S. crude closed Friday at $80.54 a barrel.
Chevron finance chief Patricia Yarrington said the company planned to move forward with its marquee projects and is willing to draw on its $14.2 billion in cash to pay dividends and repurchase shares.
“We are not bothered in a temporary sense,” she said. “We obviously can’t do that for a long period of time.”