European oil majors seen resilient to downturn as capex cuts begin

London — Italy's Eni became the first European major to bow to the oil price route by flagging heavy spending cuts this week, leaving the sector guessing how the region's top producers will respond to collapsing cash flows.

But with balance sheets less stretched than in 2014 and a much leaner suite of upstream projects in tow, it remains unclear how damaging the expected spending curbs will be on planned FIDs and scheduled start-ups.

Rivals BP and Total have both said they could reduce capital spending by a fifth this year as part of self-help moves to weather the storm as oil prices plummet close to 20-year lows. None have yet said where the cuts will fall.

With European majors less exposed to shorter-cycle, higher-breakeven shale than their US peers, upstream spending levels have been more resilient to cheaper oil.

During the last oil price downturn of 2014-17, European oil majors reduced their capex by 35% on average while US Big Oil cut spending by about 50% during the same period, according to Goldman Sachs.

With capital expenditure by Big Oil at about half the levels it was in 2014, Goldman said it sees capex remaining flexible for oil majors and can be cut by 20% if required from 2021 onwards.

"We view that the industry is in a very different place today than it was during the previous downcycle," Goldman said in a note. "We highlight the flexibility and optionally that this offers for Big Oil if the current commodity price environment is to persist for longer periods of time."

Longer investment horizon

In the case of Eni, the company has yet to lay out where its "strong" spending cuts will land compared to previous capex guidance of around Eur8 billion/year ($8.64 billion). The Rome-based major is planning three oil and gas field start ups this year along with seven FIDs, four of which are in the UAE. Mozambique's giant Rovuma LNG development is also on the cards. The company could also pare back drilling on the 2.5 billion boe of resources it is targeting with exploration wells over the next three years and slow its downstream projects. Halting share buybacks --which Eni has announced-- and cutting dividends are other key levers.

Outside the US, the need to trigger spending cuts may be mitigated by the longer investment cycles for conventional oil and gas fields. Eni said it still expects Brent to average $40-45/b this year, for example, well above the near 17-year low of $24.52/b seen this week.

"This is a reminder that the integrateds are long-cycle businesses, and will not necessarily be willing or able to adjust to spot commodity prices," Royal Bank of Canada said in a note. "Plans are generally made on multi-year horizons, and sometimes even decades."

Historically, Eni, Equinor, Repsol, and OMV have been the responsive European players to oil price downturns with capex cuts, according to Goldman.

Toxic debt

Others believe the industry shakeout in the wake of the 2014 price crash, gives oil majors less running room for a new round of cost-cutting. Less low hanging fruit, they argue, could raise the chance that producers accelerate their transition to clean, low-carbon fuels by spending less on oil and gas.

Across the industry, spending cuts of 40% may be needed, including dividends, for the average producer to be cash flow neutral at $35/b, consultant Wood Mackenzie estimates. Cash flow breakevens for European majors average around $50/b.

With European majors more resilient to cheaper oil, their levels of debt and the length of the current oil price downturn will both be key to how they respond, according to Jefferies.

"The duration of the price downturn is a key risk," Jefferies said. "Debt is toxic at this oil price...a prolonged price downturn will limit the strategic options of all but the strongest companies."

On this metric, spending or dividends at BP, Equinor and Repsol may be more vulnerable than others given their higher debt ratios. BP's gearing of 31% at the end of last year means the major may need to return to scrip dividends at current oil prices if it plans to stand by its current dividend policy, according to Royal Bank of Canada's Biraj Borkhataria.

Rebound hopes

On average though, radical downsizing and cutbacks after 2014 means European integrated majors now have their gearing in the middle of the historical range. Net debt to capital employed for the sector is currently around 25%, according to Goldman, leaving them headroom for new debt if required.

"The results indicate that even in a $30/b Brent environment, gearing for the group would be maintained below the 30% level for 2020," Goldman said citing a sensitivity analysis of oil majors' cash flow generation.

Further out, breakevens for upstream projects targeted by the majors are coming down. Eni has said it expects to produce 85% of its existing 3P reserves by 2035 as its oil and gas assets have an average $20/b break-even.

Wood Mackenzie is less optimistic over the broader response of upstream investment in the sector. Cuts to discretionary investment will be "immediate and deep", the consultant believes, with spending falling by well over 25% year-on-year in 2020.

"In the short term, companies, governments and other stakeholders are likely to continue producing assets at a loss, as they have in the past, in the hope the price will rebound quickly," according to Wood Mac. "If prices don't rebound, the taps will inevitably be turned off."