Royal Dutch Shell’s wave of transformative takeovers Royal Dutch Shell’s £55bn swoop for rival BG, you will struggle to find an oil chief executive predicting a wave of transformative takeovers. Yet the response of the world’s biggest energy companies to the crude price collapse has been no less dramatic.
Almost without exception the “supermajors” that bestride the industry believe a sustained period of sharply lower oil prices lies ahead. Swiftly and without fanfare, they have torn up spending budgets and imposed stringent cost-cutting, demanding savings from contractors and shedding labour.
They have also changed the way they plan for the future. The bar for approving new production plans — the multibillion-dollar projects that are their bread and butter — has been raised. So a $90 a barrel “break-even” price, the level at which expected revenues match costs, has been jettisoned as a hurdle for success. So has $80 a barrel.
In fact, the debate over what goes ahead now centres on projects in a $60-$70 range. If Brent, the international price benchmark, fails to recover from $55 a barrel, even that may not be low enough.
A new study by Wood Mackenzie, the energy consultancy, shows the scale of the response. Companies have deferred some $200bn of capital spending on 46 major oil and gas projects — enough to build a fleet of state of the art US aircraft carriers — as a result of the plunge in crude prices since last summer, it says.
The effect has been to blow a hole in the industry’s investment pipeline, its store of resources that need developing to meet demand years from now. Some 20bn barrels of oil equivalent in reserves, more than Mexico’s proven holdings, have been pushed further into the future.
Deferring costlier projects — or postponing “final investment decisions” — is one of the first buttons to push in response to falling oil prices. This frees up capital that can be deployed elsewhere and pushes back expenditure, making it easier to absorb the hit to revenues from crude’s plunge.
Importantly, such action boosts free cash flow, which should help the majors cover dividend payouts. And that is what investors want to hear right now. The reason that dividend yields for oil groups have risen versus those of the wider market is fear that payouts to shareholders will be cut.
The majors, moreover, can now wait for their suppliers’ costs to fall. For technically challenging projects, these can be substantial. Ultra-deepwater drilling rigs cost hundreds of thousands of dollars a day and rates have fallen by more than a third since October. The global rig count has declined by more than 1,100. Waiting a year could lead to tens of millions in savings for such developments.
Little surprise, then, that more than half the reserves identified by Wood Mac are deepwater projects.
These include BP’s Mad Dog extension in the US Gulf of Mexico, ExxonMobil’s Domino project off Romania and Woodside Petroleum’s giant Browse floating liquefied natural gas development in Australia. Canada’s oil sands, with big upfront costs, have fallen victim to the cull too, accounting for almost 30 per cent of deferred reserves.
For Morgan Stanley analyst Martijn Rats, the industry reaction resembles what happened in the slump of 1986, almost 30 years ago, when Saudi Arabia triggered an oil price slide by making a bid for market share.
Then, like now, as the oil groups cut spending, the wider workforce shrank and costs in the supply chain tumbled. The majors shored up cash flow and, in time, investors reacquired faith in their dividends, he says. Oil demand picked up and non-Opec supply growth slowed, rebalancing the market.
So will this downturn be a repeat of that one? In a sense, yes. Capital spending is falling, while demand for oil products has started to pick up. The supply side, though, is where the parallel becomes flawed.
While US output, the target of Saudi action this time round, has plateaued, America’s shale producers have proved nimbler and more resilient than many had expected. Opec output has since risen strongly, too, but this may owe much to higher domestic Saudi consumption.
Shale’s resilience, rising US stocks and the prospect of Iran’s return to the oil market explains why prices, having rallied towards $70 in May, have slipped back again. With futures pointing to a slow recovery towards $60, the cost-cutting has further to run. For some projects, this will mean a return to the drawing board. Expect to see billions of dollars more investment shelved.
Another resource stock enjoying a spell in the sun was Tomco Energy, as investors clambered on board following the grant of a ground water discharge permit and a construction permit at its Holliday Block shale oil project in Utah; the company has already secured a large mining operation permit for the block.
As a result it now has all necessary permits to take Holliday Block into production and development.
That is the good news.
Ostensibly the bad news, or not so good news, is that TomCo has taken what it calls a strategic decision to wait for a nearby project to prove key extraction technology at a separate shale oil project, and this project is being put back by two years.
If you are a Tomco shareholder, the other company you should be keeping an eye on is Canadian outfit Red Leaf Resources, which is effectively acting as a trail blazer for the technology Tomco wants to use.
Still in U.S.A, U.S-based oil and gas exploration firm, ERHC Energy, it has retained the services of Deloitte Corporate Finance (DCF) to advise on the company’s oil assets in Kenya and Chad for possible joint ventures amid drop in global oil prices.
One deal on the table apparently is a $5m joint venture with Mercom Oil a London listed investment company with assets in Chad.
The deal rumoured to be a 50/50 split in a new venture sold by Chevron a 25 percent non-operated interest in a producing oil concession in southern Chad and the related export pipeline interests to the Republic of Chad for approximately $5 million.
Closer to home, Cluff Natural Resources said significant progress has been made to accelerate the development of its underground coal gasification (UCG) assets in the Southern North Sea.
Support services giant Halliburton is currently working with Cluff to facilitate and accelerate the drilling of one or more wells.
Together they are carrying out technical and geological work for the Southern North Sea and the Kincardine UCG project, in the Firth of Forth, which is the initial focus for Cluff.
The company has nine UCG licences across Scotland, England and Wales and its shares took a bit of a hit at the end of June after sector peer Cuadrilla's fracking plans were rejected by Lancashire council; the only problem being, that the shale gas extraction that Cluff is proposing does not use the controversial technique of high-pressure multi-stage fracking.
The shares were up by almost a quarter this week.