Majors Stare Down Looming Limits of Cash Flow Bonanza

The Issue

Gone are the days when investors see higher capital expenditure as an inherently value-accretive way to spend robust free cash flows. Management teams at the Western integrated majors face intense pressure to deliver promised returns and avoid a repeat of the "lost decades" that started this century. But share buybacks and debt repayment have their limitations, and companies are loath to raise dividends too aggressively, at the risk of future cuts.

Swimming in Cash

Last year was more than just an oil and gas price recovery. It was a free cash flow bonanza unlike anything the current industry has seen. The majors pulled in nearly $62.4 billion in free cash flow in 2021, Energy Intelligence analysis has found — their strongest performance of the post-megamerger era.

The tremendous bounty in part reflects strict capital discipline. The majors invested nearly $128 billion less in 2021 than they did at their peak in 2013, a staggering 65% decline. Trimmed dividend payments also pad free cash flow figures, reflecting dividend cuts at BP and Shell in 2020.

But it would be incorrect to conclude that fuzzy math is in play. The majors made the most of oil’s faster-than-anticipated price recovery and record gas prices in Europe and Asia, demonstrating what value-over-volume strategies can start to deliver following more than a decade of persistent outspending.

Energy Intelligence breaks down each major’s capital priorities and positioning:

Chevron

Chevron was the only major to raise its dividend through the downturn, and it announced another 6% increase in January. Investors have applauded that dividend streak by sending Chevron’s shares to all-time highs.

But its record equity price also makes Chevron’s new buyback push a bit awkward. Retiring shares has the lasting benefit of easing the absolute cost of dividends since payouts are made across a fewer number of shares. Over time, this could potentially allow for higher dividends for remaining shareholders than would otherwise be feasible. Yet repurchases generally provide greater value when shares are heavily undervalued.

Here, Chevron’s shares are just 2% below the median target price held by analysts, according to data from Refinitiv. What's more, Chevron’s peers still trade around 20% (Exxon Mobil) to 60% (BP) below their respective records (Shell and TotalEnergies are around 35%).

The dilemma for Chevron is that it is already ticking all of its capital priority boxes, so there isn’t an obvious other place to park the excess cash. It already had the lowest debt profile of its peers heading into 2021, and further debt reductions have its net debt ratio “comfortably” below its 20% target. Its annual dividend increases already outpace its peers. And higher capital spending would be challenged for now since Chevron is already funding modest oil and gas output growth over the next few years — in contrast to its peers — and its new energies ventures are early stage, limiting the pace it can invest without acquisitions first beefing up its base.

So Chevron has settled on raising annual buybacks to $3 billion-$5 billion, up from $2 billion-$3 billion announced in mid-2021. It will spend at the high end of its new range this year, and management has emphasized that the program is meant to extend for “multiple years” and through the business cycle.

Exxon Mobil

Exxon’s primary focus is to get its business back in order to deliver sizable annual increases on what is the largest absolute dividend payout of the majors.

Exxon was able to avoid a dividend cut in 2020, but severe balance sheet pressures forced it to skip raising its dividend for 11 quarters — its longest stretch since the early 1980s. Bumper cash flows last year have helped turn the course, and the board approved a 1¢ per share (1.1%) increase in October. But management is looking to avoid a repeat squeeze during the next downturn.

Exxon will therefore pay down further debt this year, despite already reversing its $20 billion borrowing frenzy taken during 2020. It aims to reduce its gross debt-to-capital ratio from 22% at end-2021 to the bottom of its 20%-25% target range this year.

In the meantime, Exxon hopes to placate investors with buybacks. Robust oil and gas prices are allowing it to bias its $10 billion, 12-24 month program toward the shorter end of its timeline. Exxon is also raising its capex the most of its peers, with the midpoint of its $21 billion-$24 billion range implying a near-$6 billion hike. About $1 billion (4%) is earmarked for low-carbon ventures.

BP

Having reached its net debt target of $35 billion far ahead of schedule, BP has been buying back shares at a steadily higher clip as part of its 60% “surplus” cash flow buyback program. In fact, the UK major is tacking on another $1.25 billion in repurchases this quarter funded by last year’s excess cash.

BP expects to repurchase an average $4 billion worth of shares annually through 2025 assuming $60 Brent. At $90 Brent, there is certainly upside. Still, BP has earmarked the other 40% of its “surplus” cash to debt repayment for at least this year, despite net debt already approaching sub-$30 billion. The ongoing work, as CEO Bernard Looney put it, has left BP in “a much better place with our ratings agencies.”

Indeed, ratings aside, added balance sheet resiliency is not unwarranted. BP had to half its dividend in April 2020 as oil prices collapsed — its second cut in a decade. But the company insists today that the dividend is its first call on capital and it is confident that it can deliver 4% annual dividend increases through at least 2025 if $60-plus Brent can hold. BP already recorded its first such hike last August.

Shell

Shell is also looking to placate investors stung by the sharp cut to its dividend in 2020, the company’s first dividend reset since World War II.

Like BP, Shell is promising 4% annual dividend increases from its lower base, if oil prices can oblige. Those payouts are part of a wider program to deliver 20%-30% of its cash flow from operations to shareholder distributions via dividends and buybacks.

In the meantime, Shell’s distributions are far exceeding that guidance. The company will spend a healthy clip more than the $19.7 billion it reinvested last year, but wants to stick to the lower end of its $23 billion-$27 billion medium-term capex range. Management believes a “measured” spending increase is prudent to avoid introducing cost and operational inefficiencies by running too far, too fast. That’s especially true in renewable energy, where supply-chain cost inflation is particularly acute.

That means even more money to buybacks and dividends. Shell hiked its much-lower dividend by 38% last summer in a one-off additional increase and is repurchasing $7 billion worth of shares beyond its ongoing buyback program with proceeds from its recent Permian Basin exit. Its underlying buyback program has meanwhile been upsized to $3 billion in the first half of 2022.

In total, Shell’s ongoing plus Permian buybacks and 4% dividend increase this quarter should bring its total shareholder distribution spend to around half of its cash flows from operations over the previous two quarters. "I still believe that our shares are undervalued, and therefore, it does make sense to return in the form of buybacks," CEO Ben van Beurden said this month. "That may, of course, change over time, but not at this point in time."

TotalEnergies

The French major is back on track to deliver 5%-6% annual dividend growth, having suspended those plans in 2020 and 2021. In fact, Total partially stepped back the 5% annual increase it put in place in 2019 as it reduced its quarterly payouts from €0.68 per share to €0.66/share — a level held for the past eight quarters.

Now, the major says “structural growth” in cash flows from its LNG and electricity businesses can support record payouts, implied at €0.69/share. Its LNG business alone is set to deliver $1 billion in incremental cash flows this year from higher volumes and greater arbitrage capabilities — the first tranche of $5 billion of higher underlying cash flows Total expects to deliver company-wide by 2026.

Like its peers, Total is augmenting higher dividends with buybacks, with an eye toward returning roughly 35%-40% of its cash flows from operations to shareholders. Unlike its peers, it is only discussing repurchases through the first half of 2022, at $2 billion.

That’s because the board of directors wants to see how Total’s shares are performing before committing to more. “We will not buy if the shares continue to grow — there’s a certain point [where we’ll reconsider],” CEO Patrick Pouyanne said this month. Total’s shares are up nearly 17% so far this year, although that lags Shell (plus-20%), BP (plus-22%) and Exxon (plus-29%).