Oil and gas: returns to sender Every so often, the hoary question arises of whether the integrated oil and gas company model has had its day. This year is one such moment. For the second year running, oil and gas shares are limping home behind nearly every other industry. A combination of outsized capital expenditure - $550bn in 2012 across the sector - and a mixed acquisition record has led to a paralysing lack of operational momentum. There are signs that this year might mark the lowest point in the cycle. But the integrated model has rarely been under such pressure. Why own shares of Big Oil? One reason is that the integrated model generates enormous amounts of cash. Royal Dutch Shell generated $47bn of cash (including disposals) in the four quarters to September 2013, for example. But the sector as a whole may have generated just $12bn in free cash flow this year, according to Macquarie research. That represents a return of 0.8 per cent from a sector with a market capitalisation of over $1.5tn. If the integrated model is not generating organic returns, surely it can do so through M&A? The problem is that oil companies have made big bets in the wrong areas. ExxonMobil paid $40bn for XTO Energy at the end of 2009 to get a foothold in supposedly higher-return gas assets that are failing to deliver those returns. The US natural gas price has collapsed. This has been a boon for consumers, but terrible for producers and their investors. Exxon's shares have risen just a third since the XTO deal; US oil companies lag the S&P 500 by a distance over two and five years. What matters now is to rein in capex and start focusing on returns. This will happen in two ways. One is by asset disposals - 2014 could see a flood of oil and gas assets come on the market. The other is through a clampdown on capex and greater control of costs. The French company Total says its capex will start to fall from 2014. BG Group is also reining in capex. There are good reasons to do so. Production costs are rising, and production is at best staying flat; it is falling at many producers. BP's shares have had their best year since the Gulf of Mexico accident in April 2010. Repsol of Spain has risen 19 per cent as it rebalances after the loss of YPF in Argentina. But these are special situations, where once-unthinkable change became essential. Each is a smaller company now than it used to be. Perhaps that is the answer. Only radical thinking can remake Big Oil's investment case.