XOM Exxon Mobil Corp

By Sarah Kent 

Years of painful restructuring have left big oil companies better positioned to handle the recent decline in oil prices, but another prolonged downturn could reinforce newfound financial discipline that has already led to concerns about underinvestment.

Oil giants like Exxon Mobil Corp., Chevron Corp. and Royal Dutch Shell PLC have slashed costs and cut spending in recent years in an effort to convince investors they can be resilient--and profitable--even when oil prices are volatile.

Those efforts have paid off. The industry's biggest players are churning out cash this year and improving returns to shareholders. The average Brent oil price that the world's biggest western oil companies need to break even, has fallen from more than $100 a barrel before the price crash in 2014 to less than $50 a barrel this year, according to Edinburgh-based consulting firm Wood Mackenzie.

As prices have tumbled, that has left executives feeling vindicated for remaining cautious, and well prepared for the prospect of fresh pain ahead.

"We're very confident in the outlook for the company, not so much in the outlook for the oil market," BP PLC chief financial officer Brian Gilvary said.

BP has said it would be able to cover its capital budget and shareholder payouts with cash from operations with oil at $50 a barrel this year, and is working to bring that number down to between $35 and $40 a barrel by 2021.

While the recent fall in oil prices is likely to reinforce the industry's financial discipline, a harsher test could be ahead should prices decline further. The price of international benchmark Brent crude has plunged around 30% since its October peak, when it reached a four-year high of more than $85 a barrel. American benchmark West Texas Intermediate has also plummeted, falling below $50 a barrel this week.

Big international companies generally use the Brent crude price as a marker for strategic planning. At around $60 a barrel, it is still at levels where the companies have shown they can comfortably make healthy profits and it is unlikely to cause any major changes to strategic thinking.

But if the slide continues below the $60 a barrel marker, the broader industry could struggle to generate enough cash to fully cover financial commitments. "$55 a barrel and below is when a lot of companies start going cash-flow negative. Clearly if we go back down to $30 a barrel, it's a very challenging environment," said Wood Mackenzie's senior vice president for corporate research Tom Ellacott.

Even if prices remain around $60 a barrel, executives face a pressing dilemma: To maintain and grow production, they need to keep investing in new projects, but price volatility is likely to feed extreme caution around sanctioning large and costly developments.

Historically, companies have ratcheted up spending in the aftermath of an oil price decline, taking advantage of a healthier investment environment. Not this time. Even when prices were rising through most of 2018, big oil executives repeatedly reiterated their mantra of disciplined spending.

"I think people--they're thinking the history is going to color our future, and that's really not the case," Chevron Chief Financial Officer Patricia Yarrington told analysts earlier this month. "We have growth potential, but it's going to be at a much lower capital rate."

Chevron is spending about half what it was in 2014 on finding and developing new projects. Both Shell and BP have set clear limits around their spending through the end of the decade. Exxon stands out as an exception for laying out plans to substantially increase capital expenditures in the coming years.

The companies say they can now do more for less and are still growing production. On top of reigning in spending, they've redesigned and simplified new projects and renegotiated expensive contracts--moves they say have helped to permanently lower costs.

Where companies have returned to drilling, they are doing it within a strict budget. Shell, for instance, spent three years looking at ways to make its Vito project in the Gulf of Mexico more economic before greenlighting the development earlier this year. By simplifying the original design and working more closely with its contractors, the company was able to reduce costs by more than 70% and bring the project's break-even oil price down below $35 a barrel. Once it is up and running in 2021, Vito is expected to produce up to 100,000 barrels of oil equivalent a day.

But some analysts and executives have raised concerns that the industry still needs to start investing more to avoid a supply crunch that could send prices spiking higher within the next few years.

"Overall in the industry, the current level of investment is probably not enough to support demand," Equinor CEO Eldar Saetre said. "You've seen three or four years now with low investment levels and few FIDs, and that needs to come up."

Write to Sarah Kent at sarah.kent@wsj.com

(END) Dow Jones Newswires

November 29, 2018 07:21 ET (12:21 GMT)

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