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As Prices Slide, Exxon, Shell, BP, Chevron and ConocoPhillips Make Tough Calls and Conserve Cash

THE WALL STREET JOURNAL

NOVEMBER 26, 2008

Tough choices are looming for the global oil industry as sinking energy prices force companies to reconsider how they spend their money. The new priority: Conserve cash.

Just a few months ago, major oil and natural-gas companies were minting record profits as global energy demand boomed and crude-oil prices climbed to $145 a barrel in July. Oil companies didn’t have to choose between paying down debt, raising stock dividends, increasing their cash balances or expanding capital budgets. They could afford to do it all simultaneously.

Now the world-wide economic downturn is drying up demand for oil and natural gas, dropping the benchmark price for a barrel of oil to below $50 last week for the first time since 2005. On Tuesday, oil prices fell $3.73, or 6.8%, to settle at $50.77 a barrel on the New York Mercantile Exchange.

If oil prices don’t rebound significantly in the next few weeks, industry experts expect oil companies, as a first step, will take a scalpel to generous share-repurchase programs that have helped cushion falling stock prices in recent months.

Further cuts may be necessary. Predicting oil prices in such a volatile market is a perilous pastime, but industry analysts have been slashing price forecasts recently and some believe oil won’t rebound anytime soon. Calgary-based energy investment bank Tristone Capital on Tuesday forecast oil prices would average $50 next year.

At that level, oil giants such as Exxon Mobil Corp., Chevron Corp. and ConocoPhillips will need to add debt, spend their substantial cash balances or cut other costs in order to fully fund capital budgets and maintain their dividends, according to a cash-flow analysis by credit analysts at Barclays Capital, the investment-banking arm of British bank Barclays PLC.

With plunging oil prices and a global credit crisis, there is “no question in our minds that [a] noticeable slowdown will happen in [the] worldwide energy biz,” wrote Houston-based investment boutique TPH Energy in a note to investors. “Fear + less cash flow = retrenchment.”

Even at $70 oil, Chevron and some midsize companies such as Marathon Oil Corp. and Suncor Energy Inc. will need to make strategic decisions about what to cut and what to fund. In a recent research note, Sanford C. Bernstein said that, at $70 oil in 2009, “it is obvious” that companies such as BP PLC, ENI SpA, Royal Dutch Shell PLC and ConocoPhillips “could struggle to maintain the dividend and buy-back levels,” while Exxon and StatoilHydro ASA would face similar problems in 2010.

To manage their cash, some midsize energy companies have begun trimming their capital-spending plans. So far, the large global companies are maintaining planned spending, though they are delaying certain projects in the hope that construction and engineering costs — which have soared in recent years — will come down as the industry expansion slows.

Energy companies already have been pummeled by the broader stock-market selloff and concerns about falling oil prices. Shares of Exxon and Chevron, the two largest U.S.-based oil companies, are down 17% and 18%, respectively, this year. This month, J.P. Morgan slashed its projected earnings next year for Exxon by 17% and for Chevron by 26%.

To cope in the downturn without cutting funding for projects expected to deliver future growth, companies are most likely to spend down their large cash reserves and increase debt, said Jason Gammel, an energy analyst with Macquarie Securities. He noted that Exxon could fund its capital spending for 1½ years with the $37 billion in cash it reported at the end of September.

And while the credit crisis has locked up debt markets for most industries, the strong balance sheets forged in recent years by high oil prices means “there would be plenty of market appetite for integrated oil debt if things got bad,” he said.

Of course, if oil prices were to spike upward again, as some analysts continue to predict, oil companies will be able to ride out the current downturn with little fuss. Price forecasts at Barclays see demand growth returning to push prices back up to $100 a barrel. Others, such as Tristone Capital and Deutsche Bank, are more bearish.

If the bearish forecasts are correct, oil companies will be forced to act. There are a number of potential barriers to higher oil prices: a deep global recession; an inability of the Organization of Petroleum Exporting Countries to cooperate in production cuts; and political developments in the U.S. to promote investment in renewable energy, which would put a damper on long-term fossil-fuel prices.

Still, oil supply remains constrained and, if demand returns, prices could head back up quickly. If there is a broad move to defer projects in coming months, concern about the impact on future energy supplies would grow. “At the end of the day, this creates a potential for serious price spikes when we come out of the trough of the economic cycle,” said Macquarie’s Mr. Gammel.

The steep drop in oil and natural-gas prices already has had a dramatic effect on companies that are smaller and have a weaker financial position than the global oil titans. These smaller companies, mainly producers focused on natural gas or high-cost production projects such as Canada’s oil sands, already have slashed capital spending to make sure they aren’t spending more than operations bring in. That is a departure from recent years, when many of the companies spent heavily and relied on debt and equity markets to provide additional cash.

—Ben Casselman contributed to this article.Write to Russell Gold at [email protected]

WALL STREET JOURNAL ARTICLE

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