Rivals Loath to Copy BP's 'Cash Back' Strategy

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The leading integrated majors have spent massively in recent years without delivering commensurate increases in cash flow, production or returns. They have failed despite assistance from $100 oil, and as a result investors are now officially fed up -- they are not only demanding strict capital discipline from the majors, but also want more cash back in the form of higher dividends and buybacks. Analysis by PIW sister publication EI Finance shows that while the average annual Brent oil price rose some by 70% from 2006 to 2012, the majors' operating cash flows rose by just 27% on average. Capital expenditure meanwhile climbed 72% over the period. Of the group, only Royal Dutch Shell grew its operating cash flows more than its spending, with both around 40% higher last year than in 2006. Even so, Shell acknowledges that its return on capital employed (ROCE), the holy grail of financial benchmarks for the majors, is lower today than a decade ago, when oil prices were around $30/bbl (PIW Aug.12'13). The restive mood among investors has prompted BP to announce a new strategy based on capital discipline, growing cash flow, selling more assets and returning as much cash to shareholders as possible. An equity market laggard since the 2010 Macondo disaster, BP has long been seeking a way to close the gap with its peers while legal uncertainties linger in the US. And investors have rewarded the UK major with an 8% share price gain since its Oct. 29 shift in strategy. BP vowed to keep annual capex flat at $24 billion-$27 billion between 2013 and 2020, sell an additional $10 billion in assets by end-2015 -- with proceeds returned directly to shareholders, mainly via $5 billion-$6 billion a year in buybacks -- and hike its quarterly dividend by 5.6%. BP's move put pressure on its rivals, but they have not, generally speaking, followed its lead. Most noted existing dividend or buyback programs and said 2013 would likely be the peak year for investment, with the implication that BP was responding to short-term market whims and risked destroying value further down the road. Shell, Exxon Mobil and Chevron suggested they weren't about to disrupt long-term spending plans for the sake of a quick share price bump, and insisted the payoff from massive mega-project investment was imminent. Investor pressure on the majors will mount if the status quo persists, but BP's new strategy is also fraught with risk. The company has sold $66 billion in assets since Macondo, including its 50% share in TNK-BP, and surely cannot sell much more before it starts cutting into the muscle. Letting investors, often focused on the short term, dictate company strategy can be dangerous, as ConocoPhillips can testify. Previous management at Conoco deferred to investor pressure in selling off massive chunks of the business to increase the amount of cash it returned to shareholders. Conoco's new bosses, however, have had to halt the biggest piece of that program -- buybacks -- and pursue yet more sales just to raise cash to cover capex and dividends. The result has been a further shrinking of production, with a free cash flow deficit expected through to 2016 despite high oil prices. In BP's case, there's also the question of possibly higher Macondo penalties and lower oil and gas prices (PIW Jul.22'13). Chief Financial Officer Brian Gilvary warns that the UK major's $30 billion-$31 billion 2014 cash flow target is not "in the bank," while RBC believes BP will be dependent on divestments to cover its full dividend next year.

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