If there has been one common theme among the Big Oil stocks this earnings season, cutting capital expenditures is it.
As oil prices have plunged, spending on new projects has fallen by the wayside, and Big Oil spending has tempered even more than originally planned.
That’s seemingly awesome news for investors in this market — especially investors drawn to oil stocks’ hefty dividends and buyback programs. Lowered capex spending means Big Oil has more cash to keep those payouts coming.
Longer-term, however, these major capex cuts could come back and bite oil stocks in the proverbial behind.
Big Oil Cuts $200 Billion
You can’t keep Big Oil down … unless you have a strong dollar and dwindling global demand, of course. Prices for oil aren’t jumping higher, so it’s easy to see why energy firms wouldn’t continue spending ungodly amounts of moola developing new projects.
In some cases, deepwater drilling in the Canadian oilsands, or certain shale formations, simply isn’t profitable. As they say, “all the easy oil has been found.” The problem is, all the non-easy oil is very expensive to drill and obtain, so capex is cut instead.
Already, Big Oil has dropped its capex spending by an average 14% and operating costs by 18% during the first half of the year. And others have cut costs even more. ConocoPhillips (COP) has reduced its spending by over 20%, Royal Dutch Shell’s (RDS.A, RDS.B) acquisition target BG Group cut by more than 30%.
Last summer paints an even grimmer picture: According to analysts at Wood Mackenzie, Big Oil has deferred or canceled 46 major oil and natural gas projects worth about 20 billion barrels of oil equivalent. That is nearly $200 billion worth of capex spending gone.
In the latest round of Big Oil earnings, capital spending plans have been revised to reflect the current and extended low oil-price environment. Integrated giant Chevron (CVX) announced that it was cutting an additional $5 billion in projects and cutting 1,500 jobs. During its conference call, CVX management also announced that further spending cuts would occur next year and well into 2017. Major rival Exxon Mobil (XOM) made similar statements about its plans to readjust its spending on new projects.
Investors have mostly lauded these moves. The reason why is simple: There’s now more money in the kitty for keeping Big Oil flushed with large dividends and buybacks. Almost all oil firms– sans Italy’s Eni (E) — have pledged to keep the spigot of dividends flowing no matter the price of oil. With oil low, the profits and cash flows aren’t there.
Cutting capex spending is quickest way to raise more cash for dividends.
Big-Time Oil Production Declines
The problem is, Big Oil may not be cutting just spending — it could be cutting future production as well.
This round of capex cuts — the largest since 1986 — has the potential to derail any production gains made over the last year or so.
It’s no secret that all the major oil stocks have experienced dwindling production as their mega-legacy fields have begun to dry up. Generally speaking, when exploration and production firms can’t find oil quickly enough, they’re stuck with aging fields with declining output.
That’s a bad thing when it comes to paying out those rich dividends and buybacks over the longer term. For a company like XOM, it takes some massive projects to move the needle and significantly ramp up production. Big projects need big capex.
With that capex spending gone, production drops hard.
When oil cratered down to about $10 per barrel during the dot-com bust, CVX, XOM and RDS cut spending drastically. Overall production dropped significantly over the next four years, and Chevron alone saw its production sink to about 290,000 barrels per day.
Likewise, spending cuts during the Great Recession, as well as the oil bust of 1986, saw similar patterns of production declines, all of which took years to rebuild. The real saving grace at Big Oil was that prices for crude kept moving higher after dropping. That helped them realize higher revenues and profits.
The issue now is that oil is expected to be very range-bound for what seems like an eternity. Oil should go up, but we aren’t looking at $100 or even $75 per barrel anytime soon. Analysts expect that oil should trade in this $40 to $60 range for next few years as supplies continue to outweigh demands.
Lower production, and less income from that production, isn’t the ideal environment for investors — especially those looking for dividend income for the long haul.
While Big Oil does have some flexibility with regards to raising debt to pay for dividends in the near term, that’s still not a viable solution over the long haul. Higher debt loads exacerbate the problem, and analysts now postulate that if production doesn’t soon rise to counteract the effects of lower oil, dividends at a few of the majors — Chevron or BP (BP), for example — could be cut in the next year.
And that won’t make investors very happy at all.
As of this writing, did not hold a position in any of the aforementioned securities.
