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Big Oil’s Dilemma: Cut Dividends Or Cut Operations

The oil majors are facing a financial vice like they never have before. With oil prices hovering around $20 per barrel and no end in sight for the global pandemic, the financial pain has only just begun. Norway’s Equinor became the first large oil company to cut its dividend, slashing it by 67 percent. It may not be the last.

On Friday, Italy’s Eni reported a 94 percent decline in profit in the first quarter, a period that did not capture the full brunt of the current slump. Eni cut spending by 30 percent and lowered its production guidance for this year by 100,000-125,000 bpd. “The period since March has been the most complex period the global economy has seen for more than 70 years,” Eni CEO Claudio Descalzi said. “Like everyone, we expect a complicated 2020.”

When asked whether or not the company would cut its dividend, Descalzi demurred. “We’ll see how COVID-19 evolves in the next few months... In July, we can update on the dividend front,” he said, according to Reuters.

The largest U.S. and European oil companies are in danger of burning through $175 billion in cash if Brent averages $38 per barrel over the next two years, according to the FT and Wood Mackenzie.

The majors have typically guarded dividends at almost all costs. When unable to cover capex and also shareholder payouts – as has consistently been the case over the past decade – the majors have resorted to some combination of spending cuts, asset sales and taking on new debt.

Related: Rig Count Collapse Continues Despite Jump In Oil PricesThat formula becomes more challenged in today’s crisis environment. With a massive surplus of oil and the prospect of a persistent slump in demand, selling off assets isn’t really a strategy they can rely on. For one, there are going to be very few buyers for anything, at least not at prices the majors would want. Also, would-be buyers are probably in worse financial shape and don’t have billions of dollars lying around that they can throw at the majors for their unwanted projects.

That leaves spending cuts and debt as the main instruments the majors will use. ExxonMobil has already taken on an additional $18 billion in debt in March and April alone, after $7 billion in bonds issued in all of last year. Shell has taken out $20 billion in new debt in the past few weeks.

It’s unclear how long that strategy can last. ExxonMobil has already seen its credit downgraded by two different ratings agencies since March. Exxon's cash flow trajectory was “already relatively weak entering 2020, as very high growth capital investment combined with muted oil and gas prices and low [earnings in its downstream and chemicals segments] resulted in substantial negative free cash flow and rising debt in 2019,” Moody’s analysts wrote in early April.

Royal Dutch Shell has postponed two large oil and gas projects in the Gulf of Mexico and the North Sea because of the unfolding downturn. Many more projects will be delayed or cancelled altogether.

Independent U.S. shale companies are in even worse shape. An estimated 2,500 oil and gas workers lost their jobs in Texas in a 10-day span. Continental Resources has shut in most of its production in North Dakota because of low prices. In March, Occidental Petroleum cut its dividend by 86 percent. Occidental is in a much more serious financial predicament than the oil majors, largely unable to take on new debt after its unfortunately timed takeover of Anadarko Petroleum last year.

The oil majors have a much better ability to survive the crisis than independent shale drillers, but they may survive in a smaller, more indebted form compared to before the pandemic.

The effects of the current crisis will be felt over the long-term. According to Rystad Energy, global oil supply will be 6 percent lower in 2030 than it otherwise would have been due to the current cutbacks in spending. Roughly $195 billion in non-shale projects have been delayed, Rystad said.

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The majors have the great advantage of liquidity while their smaller rivals, particularly the shale boys, do not. The result is that while the majors will, for a while, suffer they will pick up the best shards left from the collapse of their weaker competitors who cannot survive the severe conditions that are upon us all. The majors will not only survive but with their intiment knowledge of where the best &quot;shards&quot; are to be found thay will prosper when this too all passes.
The passing may be quicker than we think though the downturn is servere as deep cuts in production ALWAYS overshoot and sure as day follows night shortages are not far from the depths of gluts.
In 2 years those who do not own shares in these companies will wish they had. Just my humble opinion.

Mamdouh Salameh on April 27 2020 said:

Big oil should learn from history. They should look no further than the adverse impact that the collapse of oil prices in July 2014 had on them.

The seven major oil companies in the world – Royal Dutch Shell, BP, Exxon Mobil, Chevron, Total, ENI and Equinor - sold then many of their production assets and cancelled more than $200 bn in oil & gas investments. Moreover, oil production by Exxon Mobil, Shell, Chevron and ENI declined then from 11.5 million barrels a day (mbd) in 2003 to 9.5 mbd in 2015. Nevertheless, they never wavered on the payment of their dividends.

In a global oil market sagging under a glut estimated at 1.8 billion barrels between globally-stored oil and excess oil in the market and a global oil demand declining by 30 mbd with half of the world’s population in lockdown, major oil companies don’t have the luxury of cutting their production and selling some of their assets as they did in 2014. Oil production cuts are forced upon them by the exceptional circumstance in the market. Furthermore, there are hardly any buyers for their devalued assets.

They have no alternative but to cut dividends drastically. Unusual times require unusual decisions if they are to survive rather than sink under the weight of their outstanding debts. The choice is therefore between survival or upsetting their shareholders. I certainly know what decision I would take.

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