Majors Within Sight of Zero Net Debt

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  • Western majors are within striking distance of zero net debt in a rapid turnaround from peak gearing levels just a couple years ago.

  • Lower debt levels and higher cash reserves provide a strong financial cushion in an era of higher volatility in energy markets — and new understandings of downside risk.

  • The reversal sits as part of a wider industry shift toward a self-funding model that could help insulate companies from higher future capital costs.

The Issue

The five leading Western majors have used bumper cash flows from higher-than-expected oil and gas prices to cut their combined net debt by more than half over the past two years. The trend is set to continue to the point where BP, Chevron, Exxon Mobil, Shell and TotalEnergies could this year be within reach of achieving zero net debt — an unprecedented position that should provide greater financial resiliency for a sector that is expected to face rising capital costs over time, while also supporting near-term M&A.

The Other Net Zero

The opportunity to get down to zero net debt was “something that we did not anticipate,” Total CEO Patrick Pouyanne admitted during an investor day last fall. But the faster-than-expected recovery in oil and gas prices out of the Covid-19-led 2020 downturn coupled with last year's disruptive effects of the Russia-Ukraine crisis to leave the majors — and the oil and gas industry at large — flush with cash. Rigorous demands for "capital discipline" meant that cash could not be used for reinvestment alone, leaving aggressive debt repayment and expansive shareholder returns to fill the gap.

“It's now within our reach to achieve zero gearing or zero net debt, which makes us obviously stronger, more resilient, and gives us a lot of flexibility to implement our transition strategy: to invest, to execute and to deliver it,” Pouyanne said. “I think it is giving a huge flexibility to the way we think about the future, because we know there will be a volatile environment.”

Indeed, debt repayment has gone far beyond reversing the sky-high debt levels taken on during the 2020 downturn that no doubt left majors’ CFOs with many sleepless nights. That extra financial stress saw the group’s net debt hit a peak of around $274 billion in 2020, and there were concerns energy companies would face a years-long struggle to repay loans if oil and gas demand — and therefore prices — remained slow to recover out of the world's pandemic lockdowns. For some of them, gearing — or net debt to shareholder equity — topped out at over 40%. For BP, the figure reached an eye-watering 60%, according to Energy Intelligence calculations.

Combined net debt was cut to around $108 billion at the end of the third quarter of 2022, and is expected to continue falling fast across 2023. Already BP has been able to pay down debt for 10 quarters in a row, bringing its gearing back to around 35% as of end-September. Chevron had about $6 billion less debt than Total, and a peer-leading gear ratio of just 5%. That sits well below Chevron's long-term target of 20%-25%. “That’s just a function of cash coming in and our just commitment to not be procyclical,” CFO Pierre Breber said on an earnings call. Morgan Stanley expects both US majors to hit zero net debt in 2023, despite rising shareholder returns via dividends and buybacks. Exxon's gearing stood around 8% after the third quarter.

Improved Outlook

The retirement of so much debt brings clear benefits. For one, it has come at a very opportune time, with the decision to retire rather than refinance debt insulating the companies from rising interest rates that would increase borrowing costs. In turn, a lack of debt and interest repayments will make a company’s capex and all-important shareholder distribution plans more resilient, even if there is a sharp drop in oil prices.

“We know that even if tomorrow's price goes down to $50, or if there is a huge financial crisis on the markets, which is possible, we are in a strong situation and we can use the balance sheet to go through the storm — which was not really the case in 2015 when we had quite a pile of debt," Pouyanne acknowledged. For Chevron's part, it says it is perfectly comfortable bringing its gearing up to that 20%-25% range during the downcycle to maintain growing dividends and recurring share buybacks.

The robust debt retirement has also improved the credit outlooks for the group. After negative outlooks were slapped on their ratings in 2020, all majors now boast stable or positive credit outlooks and retain solid investment-grade ratings. Even Shell, whose net debt briefly bucked the trend by rising more than $1.2 billion in the third quarter partly on its acquisition of Indian renewables firm Sprng Energy, was given a clean bill of health by Fitch in December. The ratings agency forecasts the UK supermajor will continue to generate positive free cash flow and noted its liquidity profile would be further supported by its divestment program.

Reduced leverage could also advance the majors' ability to carry out strategic M&A, with headroom to layer on some debt without compromising their deleveraged positions and/or tap robust pools of cash. Shell's purchase of Sprng is a case in point; so, too, is BP's recent $4.1 billion purchase of US biogas producer Archaea Energy, which included absorbing $800 million of debt.

Material Change

While the majors' balance sheets are clearly in much better shape than they were two years ago, the sector still faces plenty of financial risk in the years ahead. Everything from windfall taxes to elevated price volatility to an expected rise in capital costs for high emissions industries like fossil fuels longer term all support the decision to adopt a more conservative financial framework that uses debt as backstop to preserve strategic priorities.

The majors indeed sit at the top of the industry pecking order, meaning they are likely to maintain advantaged access to capital and lower capital costs relative to other peer groups. But they are still participants in a sector facing rising scrutiny from major financial institutions that increasingly see climate risk and financial risk as part and parcel of risk management. Moving toward a more self-reliant financial model built around lower gearing levels and a higher percentage of capex and opex covered by cash flows could help insulate the majors from these longer-term capital markets pressures.

At the same time, balance sheet conservatism makes sense against the backdrop of major transformations to corporate business models, with investments in renewable electricity, carbon capture and hydrogen forcing the group to navigate new returns models and execution risk. In a note on the European majors, for example, ratings agency Moody’s said growing low-carbon operations was “vital” to their future. “However, if diversification comes with weaker profitability and cash flow generating capabilities or significant debt financing, the credit implications could also be negative,” it added.

Equity and Debt Markets, Corporate Strategy , Capital Spending, Majors
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