Double trouble

Double-digit oil forces majors into more self-help

The big listed oil companies had enough trouble with profitability when the price of crude was above $100 a barrel. A sustained fall into double-digit territory will force majors to step up their self-help programmes.

National oil companies control so many of the most attractive fields that the traditional majors tend to end up with expensive projects. Costly investments led global oil and gas companies to spend more money than they made in the year to March, according to the US Energy Information Administration. To fill the gap, they borrowed $106 billion and sold $73 billion worth of assets. Among the big companies, only Exxon and Shell will cover their dividend from free cashflow this year, according to Citi estimates.

Majors were already scrapping expensive projects and trying to sell assets. Shell plans $15 billion of sales by 2015 and BP is targeting $10 billion. But weakening oil prices may make it harder to reach those targets.

The next challenge is to cut labour and capital costs, which have doubled in the last decade. The push into more technologically challenging projects has increased the oil price needed to earn a decent return: "$100 a barrel is becoming the new $20 in our business," as Chevron's chief executive mused in March.

If costs prove sticky, the sector has a problem. A strengthening dollar helps non-U.S. companies. But even for the European majors, every $10 fall in prices reduces earnings by about 12 percent, Morgan Stanley estimates.

For now, dividends look safe, thanks to strong balance sheets. Even assuming a $90 a barrel price, gearing would rise next year only to between 21 and 22 per cent for Eni and Total, reckon analysts at Morgan Stanley. At Shell, the increase would be to 12 per cent. But if the oil price stays low and the majors cut back hard on capex, they could end up shrinking. They will hope that sub-$100 oil also leads to enough production cuts at the national companies to create a shortage, pushing prices up again. The OPEC cartel seems pretty relaxed for now. If that changes, the majors would breathe a sign of relief.