Investors in the world’s largest oil and gas companies are eyeing a windfall from rising crude prices as the sector heads towards its strongest financial performance in a decade while keeping a tight rein on spending.

Companies including Total SA (NYSE: TOT) and BP Plc (NYSE: BP) have already launched share buyback programs, and Royal Dutch Shell Plc (NYSE: RDS.A) is preparing to follow suit in a sign of the industry pushing to improve investor returns as it bounces back from a long downturn.

“The oil market is tightening and we now see it as appropriate to factor in at least some of the windfall profitability that higher prices are generating,” said Lydia Rainforth, analyst at Barclays, in a report that said Europe’s integrated oil and gas groups were on course to deliver excess free cash flow for the first time since 2008.

U.S. groups, such as Exxon Mobil Corp. (NYSE: XOM) and Chevron Corp. (NYSE: CVX), are also benefiting from this year’s faster-than-expected upturn in oil prices because of rising global demand, supply disruptions in Venezuela and political tensions in the Middle East.

Brent crude, the international benchmark, hit $80 per barrel last week for the first time since 2014.

Many oil producers are generating more free cash at current prices than they did at $100 per barrel before the market crashed four years ago.

This is because of deep cost cuts during the downturn, with average operating expenses per barrel down a third and development costs halved by the same measure since 2014.

Most oil majors can now cover dividends and capex at prices around $50 per barrel, meaning that, at $80, they make a healthy surplus.

Having spent the downturn battling to balance the books, oil executives are adjusting to a new environment in which they face choices over how to use spare cash.

The message from most has been consistent: there will be no return to the runaway spending of the $100 oil era. Instead, companies are focusing on debt reduction and shareholder returns.

Debts rose sharply during the downturn as companies borrowed to avoid cutting dividends and leverage remains high. Shell, for example, has trimmed net debt by $10 billion in the past year but still owes $66 billion, a debt-to-capital ratio of 25%.

Jessica Uhl, Shell CFO, indicated last month that she wanted gearing closer to 20% before launching a promised $25 billion share buyback program.

The recent surge in oil prices has increased investor expectations that this will happen in the second half of this year.

BP said this month that it, too, was prioritizing debt reduction after announcing a 71% increase in first-quarter earnings.

But Brian Gilvary, CFO, said the group would start looking at options for further share buybacks or a dividend increase as the balance sheet improved in the second half.

Gilvary said that BP remained intent on reducing its break-even point further to below $40 per barrel by 2021. Equinor ASA (NYSE: EQNR), the Norwegian group previously known as Statoil, gave a similar commitment.

“Costs are coming down and efficiency is going up in all parts of our business and we have been able to sustain that,” Eldar Saetre, Equinor’s CEO, told the Financial Times.

Increased spending by national oil companies in Asia and the Middle East is forecast to lift industry-wide capex by 11.5% this year, according to BMI Research.

Yet the listed international oil groups (IOCs) such as Shell and BP are on course to buck this trend with a combined 1.1% decrease.

This reflects an increasingly selective approach to new projects, with only the most profitable going ahead and only then after costs have been squeezed.

Shell, for example, halved the budget for its Kaikias development in the Gulf of Mexico before giving it a green light last year, by simplifying designs and haggling with suppliers.

“The industry has gone through a significant mindset shift,” said Andrew Smart, managing director of Accenture’s energy practice.

“During the $100 oil era, nothing was too hard or expensive; every target was worth attacking. Companies are now exposing investments to a lot more commercial rigor.”

After big cost overruns on megaprojects such as Kashagan in Kazakhstan and Gorgon in Australia over the past decade, there has been a shift towards smaller, lower risk projects.

Frontier exploration in undeveloped regions is being shunned in favor of “brownfield” projects—Shell’s Kaikias, for example—near existing fields with proven resources and established infrastructure.

The average budget for new upstream projects approved last year was $2.7 billion, the lowest for a decade and half the $5.5 billion average over that period, according to Wood Mackenzie, the consultancy.

“Companies are signaling to investors that they don’t need to invest more to deliver production growth,” said one fund manager with Shell and BP among his biggest holdings.

The exception to this restraint is Exxon Mobil, which has increased capex by a quarter since 2016 and last year approved the $4.4 billion Liza megaproject in Guyana as part of efforts to improve its sluggish growth outlook.

Investors have so far not rewarded this approach. Shares in Exxon Mobil are down 3% this year, compared with a 10% increase for the S&P global oil index.

Some analysts worry that spending restraint has gone too far. “The big question is whether the industry is actually spending enough,” said Angus Rodger, research director at Wood Mackenzie. “We cannot rely on small projects forever.”

Others argue that tight budgets are here to stay as the oil and gas majors face growing competition from abundant U.S. shale resources, as well as from the long-term shift to cleaner technologies such as renewable power and electric vehicles.

“Companies need to keep maximum flexibility to compete with shale and maximum financial headroom to build new business models,” said Smart. “We’re in a very different paradigm to this stage in previous oil cycles.”

A Costly History Lesson

If oil companies are to make good on their promise to keep down costs as the market recovers, they will have to reverse decades of history.

In this most cyclical of industries, costs have always risen and fallen in parallel with oil prices. Bernard Looney, BP’s head of upstream exploration and production, said this time would be different.

“We are entering a new world of abundant supply and competition from new sources of energy,” he told the Financial Times. “We’re going to have to demonstrate productivity improvements on an ongoing basis.”

Much will depend on containing supply chain costs.

Saetre, Equinor’s CEO, said that costs were rising in the U.S. shale industry but there was “still a lot of capacity” in conventional oilfield services. Equinor aimed to keep costs per barrel at current levels to 2020.

Oil producers are investing in digital technology, such as artificial intelligence and robots, to raise productivity.

Technology helped lift BP’s upstream reliability, a measure of plant availability, from 86% to 96% in the past five years.
Gold-plated engineering from the era of $100 oil has given way to no-frills designs and off-the-shelf procurement, Looney said.

Several new oil and gas fields have been completed by BP ahead of schedule and under budget in the past year, in contrast to the industry’s history of overruns.

“We’ve come a long way but can do a lot more,” said Looney.

Comments