Major oil producers’ buybacks and dividends have grown to represent 98% of their capex in the past three years, according to an analysis by credit-rating firm Fitch Ratings. The rate is up from 59% in 2002.

“As a group, majors have nearly tripled shareholder-friendly activity from $34 billion in 2002 to $93 billion for the 12-month period ending September 30, 2007. Of the two components of shareholder-friendly activity, buybacks have accelerated much faster than dividends, with dividends up a cumulative 44% and buybacks up over 500% in the period.”

This may result in M&A, and independent oils are among potential targets, report Fitch Ratings analysts Mark Sadeghian, Sean Sexton, Adam Miller and Andrew Steel in “Will Higher Share Buybacks by Oil Majors Lead to Greater M&A Risk Down the Road?”

Independent producers have reinvested a greater percentage of profits into growing reserves and production growth than major oils have.

“…The effect of majors’ increasing cash flows to shareholder-friendly activity has been to lower cumulative reserve growth, all else being equal. We believe lower reserve growth may increase future pressure on majors to do upstream M&A deals,” the team reports.

The study group of major oils consists of ExxonMobil, Chevron, ConocoPhillips, Marathon Oil, BP, Royal Dutch Shell and Total SA.

“While independents face some of the same constraints as majors—namely, higher service and finding, development and acquisition (FD&A) costs—as a group they appear to be undeterred by the current investment environment and are targeting reserve and production growth to a much greater degree than the majors.”

FD&A costs for the group of major producers grew to $15 per barrel of oil equivalent in 2006, from $11.32 in 2005 and $8.02 in 2004. “Given the strong outlook for the drilling and services sector, cost pressures are not expected to abate any time soon.”

The majors’ buybacks alone have grown from 16% of capex in 2002 to 60% for the 12 months ending September 30. Meanwhile, independent producers’ buybacks have been negative, net of their equity issuances in that time period, the analysts report. The analysts’ study group of independents consists of Apache Corp., Anadarko Petroleum, Devon Energy, Chesapeake Energy, Hess Corp., Newfield Exploration and Pioneer Natural Resources.

While using surplus cash flow for stock buybacks is viewed as favoring shareholders over bondholders, the activity may be serving to help protect debt-owners in the current energy-industry environment, “albeit indirectly, by preventing companies from locking into expensive and potentially value-destroying long-lived assets…at inflated levels.”

And, it may prevent the need for a facelift—recapitalization—later in life.

Of course, major oil producers’ strong cash flows and low—or no—debt leverage mean there is little concern with their credit quality in the near future. “However, rerouting cash into shareholder-friendly activities now raises the risk that companies may need to look to larger upstream deals down the road to make up for lost ground.”

Comments