Analysis: Big Oil's resistance to coronavirus-led price drop set to be tested

Oil majors are likely to keep investment plans intact in the coming months but could have to reassess should oil prices drop well below $50/b for a sustained length of time, according to analysts.

Dated Brent as assessed by S&P Global Platts has already seen more than 25% of its value wiped out since early January as the coronavirus outbreak pulls the rug from under global oil demand growth forecasts.

"We are at the cash flow neutrality level," said Jefferies analyst Jason Gammel, adding that while big oil companies will be cautious due to the coronavirus-induced drop in prices, they won't be changing plans.

"That's unless we see prolonged multi-month price falls below $50/b," he added, noting projects which require large-scale capital investments aren't as flexible as those with a short cycle, and in particular shale. While a lot of investment has gone into short-cycle projects since 2015, those which need a longer-term investment will have been penciled in ahead of time.

S&P Global Platts Analytics shares a similar view. "The decrease in oil demand caused by the coronavirus is thought to be unlikely to have a major impact on global E&P spending in 2020 on non-OPEC crude production over the next few months. Activity in US shale production (the largest component of 2020 crude and condensate growth) is not likely to be reduced since most operators base their forecast using an average price of $50/b WTI in 2020," it noted.

"Activity in offshore areas (Gulf of Mexico, Brazil, Guyana, and in the North Sea) is also unlikely to be affected due to the long-lead time nature of such projects," it added.

Last month, the International Energy Agency slashed its 2020 oil demand growth forecast by 365,000 b/d to 825,000 b/d, the lowest since 2011. All eyes are now on OPEC's meeting with Russia and other allies on March 5-6 to see whether they will do enough to put a floor under oil prices, with the Brent and WTI benchmarks currently hovering either side of the $50/b mark.

GOOD SHAPE

BP is one oil major that appears to be able to handle a sharper price fall. Like many of its peers, BP has "high-graded" its upstream operations since the 2014 oil price slump, boosting the resilience of its balance sheet to lower prices.

"BP is in excellent shape. We have invested a lot of money over the last several years in 35 major projects," the company's new CEO, Bernard Looney, said in February, adding that 23 of these were now online.

"We have major 2021 free cash flow targets, which drives the breakeven of this company down to around $40/b. This is a very resilient business. We will run that business resiliently," he said.

BP CFO Brian Gilvary said for 2020 "we'll be somewhere around mid-$50s breakeven for the corporation."

Oil companies such as BP have been on a mission to squeeze out returns and improve efficiencies ever since oil prices fell below $30/b in early 2016. Many of the oil majors are basing their budgets close to $50/b, factoring in not just the cost of supply but also at what level they can make returns to shareholders.

Shell has based its future earnings targets on a Brent oil price of $60/b, underpinned by new, lower-cost upstream oil and gas projects set to take its average upstream breakeven to $30/b from about $40/b currently.

Total CEO Patrick Pouyanne has maintained that the priority is "not volume growth but value growth," an industry mantra now more prescient than ever given looming uncertainties over long-term oil demand.

ExxonMobil has said it's sticking to its plans to spend between $33 billion and $35 billion this year, as the US oil giant appears less cautious over the prospect of lower-for-longer oil prices. It has repeatedly expressed its intention to invest counter-cyclically to lock in lower value assets, and analysts don't see coronavirus shaking this strategy, with cash flow breakevens seen close to $50/b.

CASH FLOW CRASH

Norwegian consultancy Rystad Energy is a little more downbeat on upstream oil and gas producers. It said US shale drillers would be hardest hit, noting that decisions taken in Vienna in the coming week by OPEC and its non-OPEC partners would be critical.

"Lower oil prices will result in oil and gas companies scaling down their flexible investment budgets, especially shale operators in the US as well as some offshore exploration and production players," Rystad said.

"Our current assessment forecasts that COVID-19 could result in global Exploration & Production investments falling by around $30 billion in 2020, a significant hit to the industry," the consultancy added.

Rival energy consultancy Wood Mackenzie believes that the greatest threat to oil majors from the spread of coronavirus is prevailing oil and gas prices rather than potential supply chain hiccups. A $10/b change in oil prices has a $40 billion impact on global cash flow per quarter for the sector, according to Wood Mac.

"For some companies, this could make the difference between increasing shareholder distributions or another year of negative cash flow," Wood Mac said.

Amid the vast uncertainties right now, "all that we do know is that WTI below $47 is a dangerous place to be... as that's the average price where most E&Ps would reduce their budgets," analyst James West of Evercore ISI said in an investor note Monday.

West noted Evercore's annual 2020 E&P upstream spending survey released in December found most upstream operators budgeted at $58/b Brent, which he called "disconcerting."

Low-cost producers could use this time to gain some market share and produce a bit more, while companies 50% or more hedged and with some debt might stick with their plans, said Rob Thummel, managing director of Tortoise Capital Advisors.

"But operators with a lot of debt and no hedges are in the camp of significantly reducing capital to preserve as much cash as they can to potentially lower debt," Thummel said.

With a renewed focus by oil majors on shareholder returns as cash flows recover--BP, Total and Equinor recently hiked their dividends pledges--the price collapse from coronavirus epidemic comes as a bitter reminder of both market uncertainty and the world's reliance on oil. That's still both a blessing and a curse for the companies most exposed to it.