With lower costs of production and diversified, counter cyclical businesses, oil giants are typically a safe haven for energy investors during turbulent commodity markets. This time around, however, mega producers have felt their fair share of pain.
Sharp declines have erased capital returns over the past decade for reputable names such as ExxonMobil (XOM, Financial), Chevron (CVX, Financial), Royal Dutch Shell (RDS.A, Financial)(RDS.B, Financial), ConocoPhillips (COP, Financial) and BP (BP, Financial). What’s different this time around?
The era of cheap oil finds is over
In that past, huge oil companies were able to capitalize on their scale by entering huge projects that require significant upfront capital. With oil discovery nearing century lows and on a clear, secular decline, replacing lost reserves has gotten incredibly pricy.
This works against big oil companies the most. With a huge amount of reserves to replace, it’s forced to go to incredibly expensive lengths to acquire additional volumes. Every single company shown in the chart above has seen its cost of production explode over the past decade.
Reliable cash flows are also in the past
Expectations are for integrated oil companies to see a huge collective negative cash flow position for this year as well as 2016. With capex already slashed 20% to 30% for the majors, expect spending to be cut even more. As companies focus primarily on low-cost projects, replacing its reserves every year with new discoveries is certainty a thing of the past.
Despite the gigantic investments in the last five years, each of the top four oil majors saw a significant decrease in production volumes during that period. Over the long term, this can do nothing but pressure fundamentals.
For example, despite cost cuts, Moody’s (MCO, Financial) still expects the industry to face a 20% contraction in 2015 free cash flows to a negative position of nearly $80 billion in 2015. Moody’s also expects the industry’s total debt load will increase, with cash balances declining as companies sell assets to cover dividends and capital spending.
Investing in majors not as lucrative as many think
With rising costs of production and continually lower volumes to show for it, oil majors are not immune to falling oil prices anymore. Even with their downstream businesses offsetting some of the decline, most appear to be in big trouble. Either spend big when cash flow is pressured, taking on debt to fund expensive exploration, or cut capital expenditures and exacerbate production declines.
In all, investing in the majors might not be as obvious of a long-term investment as many investors think.
