By Giles Parkinson, reneweconomy.com.au
Just how much trouble is Big Oil in? The biggest, richest and most ruthless industry sector ever to strut the global economic stage is facing an existential crisis thanks to plunging oil prices. And according to the latest analysis, it has no Plan B.
A new report by global investment bank Citigroup highlights the problem. As its analysts note, the oil industry is spending hundreds of billions of dollars on investments that do not make sense.
The industry is trying to cover its dividend promises, but is relying on a rebound in oil prices to do that. For an industry that is largely funded by dividend-hungry investors, it’s a high-risk strategy that may just blow up in its face.
Even the Citigroup analysts infer that this strategy is not so bright, but is typical of of an industry that is convinced of its own absolute primacy in the corporate world.
Big Oil’s Plan A revolves riding out the storm through some cuts in capital expenditure. Citi suggests that a better and more prudent Plan B might be to reconfigure the industry on lower cost production, but only two or three companies that rank among the Pantheon of Big Oil companies appear capable, or willing to do it.
The evidence against Big Oil has been mounting quickly. Already, $170 billion of oil and gas capital expenditure has been cut or deferred, the rig count in the US shale industry is falling dramatically as drillers exit the industry.
Add to this, the big push by the US, the EU, with the apparent support of China and India, for a binding climate deal in Paris this year, would mean that vast reserves could not be exploited even if the price recovered.
And then there is the plunging cost of renewables which is causing some to re-assess the fate of the industry, and wonder whether it is destined for an extended period of price deflation. Simply relying on a 1980s style recovery of the oil price no longer seems credible. And as we pointed out last year, the falling price of oil is likely to benefit renewables rather than the other way around.
A few weeks ago, former industry advisor and now solar entrepreneur Jeremy Leggett predicted in the Guardian that one Big Oil company this year would turn its back on fossil fuels, in much the same way that Europe’s biggest utility, E.ON, late last year turned its back on conventional fossil fuel generation.
Just who that might be is not clear, although Leggett pointed to French group Total as a likely candidate. It has a majority stake in SunPower, one of the most successful solar companies in the market, and one that is becoming increasingly vertically integrated as it focuses on the distributed generation market, storage, and smart software.
The Citigroup say here are several things that are different now to the last time the industry experienced an oil price crash in the mid 1980s.
Last time round, they note, Big Oil survived on its earnings power and because it was largely in control of the cycle. That is no longer the case, because the extra supply – that targeted by the OPEC Nations – is coming from US shale.
And while many shale companies are also at risk, particularly those at the top end of the cost curve and with high debt levels – most of Big Oil’s untapped reserves are even more expensive. Nearly 80 per cent of these assets don’t work as investments at current prices and 30 per cent still don’t work even at $US70/barrel.
Added to this is the rabbit-in-the-headlight response of Big Oil management. ‘Perhaps understandable in the context of the brisk sell-off in oil is the seeming inertia from Big Oil company managements to respond,’ the Citigroup analysts note.
This anecdote from the Citigroup analysts provides a striking example.
‘In December the attitude that pervaded the industry was largely one that the downturn would be short-lived and that strong balance sheets offer all the necessary protection. One CEO said to us ‘we have been here before… the supply overhang is not that big’ en route to a discussion that was largely business as usual. The industry’s Plan A was that oil prices would rebound.
‘We sense that Plan A has evolved over the last month, to a genesis that we call Plan A-star. At its heart is still a belief that oil prices will rebound, but that capex cuts and some cost-control are needed to help cash management and protect profitability. This is largely the plan that we expect to be laid out over the coming weeks by the industry.’
But Citigroup says this is only a short-term fix. In the interests of shareholders, it says, Plan B should start with the underlying principle that oil prices may not recover any time soon, and that the companies need to adjust their cost base to this new paradigm.
But it sees only three companies likely to live up to these expectations:
One is Total,where new management is undertaking a broad repositioning of the company; BP, which recognised as the recent Davos conference that it was planning for a world of $50/barrel oil for the next few years; and Conoco Phillips , the first Big Oil company to make steep cuts in investment,.
It expects the likes of Exxon, Chevron and Royal Dutch Shell will be slower to act, preferring to emphasise the use of balance-sheet strength to weather the cycle.