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 1 1/2 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.
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