Talk of Shell BP tie-up to create £200bn world leader
After a solid 10 hours locked in secret briefings at the Langham Hotel in London this week, 100 of BP’s top investors emerged into the crisp winter evening air to the grim news that oil prices had sunk to a new five-year low.
From an article in The Sunday Telegraph 14 December 2014 by Andrew Critchlow
UK oil giants fight for control in a current of falling prices
Investors in BP and Royal Dutch Shell – Britain’s biggest international oil companies – now find themselves caught in the crossfire of a much bigger game
After a solid 10 hours locked in secret briefings at the Langham Hotel in London this week, 100 of BP’s top investors emerged into the crisp winter evening air to the grim news that oil prices had sunk to a new five-year low.
Given the challenges facing big oil producers, the mood at the briefing, led by BP’s upstream chief executive Lamar McKay, was described as being “serious” by those present. However, the thought of US crude crashing below $60 (£38) per barrel, a baseline level that most oil majors use to stress test the profitability of their future projects, will have pushed sentiment to a new low.
Investors in BP and Royal Dutch Shell – Britain’s biggest international oil companies – now find themselves caught in the crossfire of a much bigger game that is being played out by the world’s most powerful petroleum producing countries for control of the market.
Shares in these giants may have lagged behind a 44pc decline in Brent crude since June but now, along with most of their peers,they are in a frantic rush to cut capital expenditure and costs in line with the new constrained realities of the global oil market.The gap must start to narrow quickly.
“Every oil producer is hurting a lot,” Qatar’s former energy minister and Opec president Abdullah bin Hamad al-Attiyah told The Telegraph. He has argued that the entire industry, including producers outside the Organisation of Petroleum Exporting Countries (Opec) where international oil companies are prevalent, must prepare to make big cuts.
Given the significant challenge that falling oil prices will continue to present for the likes of BP, the company may have been expected to have revealed even deeper restructuring cuts than the $1bn (£637m) it unveiled for next year. This will mean significant job losses are inevitable. More pessimistic investors would have expected even deeper cutbacks were possible to protect the bottom line.
Part of the challenge for BP’s upstream management team will be working out which projects it must fight to hold on to in the face of investor pressure.
“We expect to see growth from our conventional and deepwater assets and an increasing contribution from gas. And we also have a quality pipeline of opportunities that we believe are capable of extending underlying growth well beyond 2020,” said Mr McKay.
These schemes combined could produce an additional 900,000 barrels per day (bpd) of oil equivalent by the end of the decade, boosting the company’s all important cash flow, which Deutsche Bank expects to grow by 5.3pc through to the end of 2017.
“The falling oil price is clearly a drag on sector cash flow and BP is no exception but we see the underlying operational momentum, flexibility on the capex base, commitment to simplify the business and low gearing levels that will support dividend payouts as enough for the next 12 months to outweigh our concerns over both the Macondo overhang and Rosneft,” said Barclays after the investor gathering.
BP and Shell are not the only global oil majors making hard choices over whether to invest into developing fields and exploring for new resources. Chevron, the second-largest oil company in the US, has delayed its drilling budget for next year and ConocoPhillips has said it would cut capital spending by 20pc to $13.5bn next year.
From the perspective of investors the current fall in oil price will see more emphasis placed on holding shares in the so-called “super majors” instead of higher risk smaller operators such as Cairn Energy and Premier Oil.
“Despite the large falls in oil prices we retain exposure to the highest quality exploration and production companies around the world,” said Neil Gregson, fund manager at JP Morgan Natural Resources Fund.
This flight to quality could trigger a surge in merger and acquisitions in the sector, which hasn’t seen a major deal since the big deals that followed BP’s takeover of Amoco in 1998, when oil prices were also in the doldrums.
Talk of a Shell tie-up with BP to create a £200bn world leader has excited the imagination of the City recently, but insiders in both companies see the deal as unlikely while the financial fallout from the Gulf of Mexico disaster remains unresolved.
“We expect the whole industry to be cutting costs aggressively in the present environment,” said Mr Gregson, who doesn’t hold BP in his portfolio. “There is potential also for M&A activity in the sector.”
Other analysts also expect that the downturn in oil prices will encourage majors to shun expensive and risky acquisitions to instead focus more ruthlessly on pruning their upstream project portfolios, to help reduce demand in the industry, which has pushed up the cost of drilling and constructing large engineering schemes. According to research by IHS the average cost for companies to produce oil and gas after drilling was completed had quadrupled to more than $21 per barrel in 2013.
“Downturns can be used to build and strengthen businesses; falling prices and activity levels allow companies to lock in lower costs from contractors and to access resources in the right postcodes on more favourable terms,” said analysts at Credit Suisse in a note to investors last week.
Next year companies are expected to make the final decision on around 800 oil and gas projects worth about $500bn, which will unlock an estimated 60bn barrels of oil equivalent to meet world demand. However, analysts at Rystad Energy say $150bn worth of these schemes may not happen with prices firmly rooted below $70 per barrel.
This cut in project spending by the oil majors has started to weigh heavily on Britain’s oil and gas engineering sector. Shares in companies such as Weir Group, Petrofac and Wood Group have all come under pressure since the current slide in oil prices started to take hold.
This cut in project spending by the oil majors has started to weigh heavily on Britain’s oil and gas engineering sector. Shares in companies such as Weir Group, Petrofac and Wood Group have all come under pressure since the current slide in oil prices started to take hold.
“Operator focus on efficiency and the recent reduction in the price of oil is leading operators to reconsider their spending plans for 2015 with a consequential impact on service company activity,” said Wood Group in an update to investors last week.
The North Sea, which has high production costs, could be especially hard hit by oil majors making significant cuts to their operating costs. Industry body Oil & Gas UK has forecasted that 35,000 jobs could be lost in Britain’s offshore oil and gas industry in the current environment.
“The recent fall in oil prices has brought home the challenges ahead, but now more than ever the industry needs to stay the course and continue to invest in developing its own – not repeating the mistakes from the 1980s and 1990s,” said the group in a recent report.
The industry employs about 400,000 people across the complete supply chain in the UK and cutbacks by the big oil majors will hit areas such as Aberdeen hard.
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