Big Oil may be flush with cash, but don’t expect growth
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International oil companies could enjoy a much hoped for V-shaped recovery in their free cash flow this year if oil prices average $US55 ($69.84) a barrel or more.
This certainly seems achievable given that both the Brent Crude and West Texas Intermediate benchmarks have been trading above that level since early February.
In fact, oilprice.com quoted the Bank of America as saying that oil prices are expected to rise at the fastest rate since the 1970s over the next three years.
“Savage cost cuts imposed last year as the global economy contracted in the face of the COVID-19 pandemic saw average IOC corporate cash flow breakevens reduced from US$54/bbl pre-crisis to US$38/bbl,” Wood Mackenzie senior vice president corporate analysis Tom Ellacott said.
“The record annual losses being announced in the Q4 earnings season serve as a stark reminder that 2020 was one of the toughest years in the industry’s history. But IOCs emerged from the crisis far more resilient to lower prices.
“The scale of their financial reset has primed the sector for a V-shaped recovery in free cash flow.”
Ellacott noted that at an average oil price of $US55/bbl, the resources consultancy estimated that IOCs will have $US140bn in free cash flow this year before shareholder distributions.
“Our IOC peer group of 40 companies generates over US$115 billion of surplus cash flow over the next three years after shareholder distributions, investment and interest at US$55/bbl prices,” he added.
“At US$70/bbl, cumulative surplus cash flow generation over the next three years would rocket to US$400 billion.”
However, Woodmac believes that capital allocation priorities will be very different to any previous up-cycle with “mending broken balance sheets” expected to be at the top of the list.
Companies are likely to lower their gearing to better weather future price volatility by either cutting debt or redeploying free cash flow.
“We expect companies to continue to plan for the worst, prioritising net debt reduction in redeploying surplus cash flow,” Ellacott noted.
“Some players will also look to speed up debt reduction by selling non-core assets.”
The sector is also expected to focus on restoring investor confidence with share buybacks preferred over dividends and paper preferred over cash for strategic mergers and acquisitions.
However, growth plans are far down the ladder, reinforcing concerns that under-investment could lead to a supply squeeze in the medium-term.
Ellacott added that IOCs must also continue repositioning their portfolios for the energy transition, noting that the richer companies can afford to be more strategic at current prices by allocating more capital to grow and decarbonise their legacy businesses or diversify into low-carbon energy.
“Both M&A and organic-led growth in renewables will be on the strategic agenda. But disciplined screening criteria will have to apply to new energy investment too if oil and gas companies are to profitably diversify their product mix into low-carbon energy,” he explained.
“Strategically, the move away from volume growth and towards harvesting the legacy oil and gas business is part of the energy transition reality – one in which pressure to decarbonise is only heading in one direction.”