Are Majors Serious About Capital Discipline?

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Major oil companies on both sides of the pond have sworn to capital discipline following a "lost decade" during which massive spending failed to deliver growth or -- recently -- adequate returns (related). All majors now talk a big game about capital efficiency, but are they just paying lip service to frustrated investors? A look at the organic capital budgets -- which exclude impacts for acquisitions -- of the seven top Western majors shows that they plan to reduce spending by 1% this year to $202.6 billion. Considering 2013 was a record year for capex, should investors consider this strict capital discipline? The sector has promised further spending cuts beyond 2014, but even these don't look very deep. Some analysts worry that the era of capital spending growth is not behind the majors, suggesting they must keep investing aggressively to ensure that oil and gas production doesn't fall even more rapidly than it has over the last ten years (EIF Feb.26'14). Exxon Mobil's strategy session with analysts last week was particularly eye-opening. The US supermajor said its organic capex would actually rise by 4% this year to $39.8 billion but forecast flat production of some 4 million barrels of oil equivalent per day in 2014 on an "underlying" basis. On an actual basis, output of 4 million boe/d would mark a 4% decrease from 4.175 million boe/d in 2013 -- which was a 1.5% drop from the previous year. The Mar. 5 news resulted in a one-day drop of 3% for Exxon's stock, as investors struggled to come to grips with the company's strategy. Exxon continues to cling to growth targets, but its longer-term guidance of 4.3 million boe/d by 2017 is 500,000 boe/d lower than its initial guidance of 4.8 million boe/d and came in below most analysts' expectations. Exxon Chief Executive Rex Tillerson confounded by saying that Exxon does not "take these outlooks lightly," but that company is not "bound to them" in its investment decision-making process. Tillerson then mused that Exxon could live without volume targets, which have never been "key objectives" at Exxon. So why not kill them altogether as European rivals BP and Royal Dutch Shell have done? "I could do that," Tillerson said -- after his management team explained to analysts exactly how Exxon would reach 4.3 million boe/d by 2017. Exxon's US rival Chevron sounded like a broken record on Tuesday, slashing its 2017 production forecast by 200,000 boe/d to 3.1 million boe/d. "Our growth strategy remains intact, though some things have changed," Chief Executive John Watson said at the company's analyst day in New York. What is not changing much is the company's spending level. Underlying capex will rise 8% to $39.8 billion this year before "flattening" in 2015-16. This has emerged as a trend across the integrated peer group. Budgets remain huge. Exxon will spend up to $37 billion between 2015-17, BP will spend between $24 billion and $27 billion through 2020, and Total will spend between $24 billion and $25 billion in 2015. Further down in the sector, Eni has dropped its capex plan for 2013-17 by a modest 5% to €53.8 billion ($74.6 billion), while Statoil may be the most realistic. The Norwegian major has pledged to invest around $20 billion per year -- an 8% drop from 2013 levels -- between 2014-16 while pushing back its production goal of 2.5 million boe/d by a couple years. Even these modest cuts to capex are being viewed warily by investors. Replacing existing exploration and production infrastructure requires far greater expenditure than it did in the past, says Oppenheimer & Co. analyst Fadel Gheit. "Oil companies are spending more capital now than at any time in history and this is not likely to come down significantly at any time soon. Most likely, it will continue to climb," Gheit said. Barclays analyst Paul Cheng is particularly circumspect of Exxon's vow to spend no more than $37 billion annually in 2015-17. "We think actual spending will likely be higher than guidance and that the burden of proof is on management," said Cheng. "The combination of the lower production growth outlook and higher capital expenditures compared to our estimates reinforces our initial belief that the market will need to reassess Exxon's base earnings power." Gheit notes that BP was forced to move from "volume to value" growth sooner than the rest of the group because of the 2010 Macondo spill and the portfolio restructuring it necessitated. The $38 billion in post-Macondo divestments, combined with another $10 billion pledged over the next two years, may have given the UK major a head start in removing "low margin barrels" from its portfolio and investing only in projects that deliver higher margin output. This remains to be seen, with investors watching closely to see if BP can hit its operating cash-flow target of $30 billion to $31 billion this year (EIF Feb.5'14). What's clear is that BP and the rest of majors will continue to spend robustly to combat the decline rates that have taken a toll on their production in recent years. Majors' Organic Capital Expenditures (US$ billion) 2013 2014E %Chg. Royal Dutch Shell 38.0 35.0 -8% Exxon Mobil 38.2 39.8 4 Chevron 36.7 39.8 8 BP 24.6 24.5 0 Total 28.0 26.0 -7 Statoil 21.7 20.0 -8 Eni 17.5 17.5 0 Total 204.7 202.6 -1% Notes: BP's 2014E figure is midpoint of company's guided range of $24 billion to $25 billion.

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