Investors in energy companies aren’t happy. While they see that the major players are in an excellent financial position and the price of oil remains attractive (over $ 100 per barrel), production is not growing and there are few attractive projects left. As a consequence, investors want big dividends. Oil and gas companies may be spending in 2014, but are making few efforts to increase their dividends. Companies that are doing worse, have to play along with investors’ demands.

Low production – high price 

Last year, even a behemoth like Apple couldn’t resist the pressure from activist investors. The company with the world’s highest market capitalization was forced to make concessions that included increasing dividends and initiating a share buyback program. Investors also conducted a series of successful attacks on energy companies including Occidental Petroleum, Hess, Transocean, and Chesapeake Energy. And now the five largest oil and gas companies, Exxon Mobil, Chevron, Shell, BP, and Total, are being held at gunpoint. Investors are insisting on higher dividends and as quickly as possible. The current environment, in which production is declining as fears that high prices, won’t last, explains the anxiety

Big Five have shown no increase in production since 2006.  

The share of natural gas in total production has gradually increased (Fig. 1).  For the first time in history, gas accounts for half of Shell’s production, while Exxon Mobil and Total are close to this figure. At BP, natural gas accounts for 39% of production. Only Chevron has seen the share of natural gas in output remain stable, at around 30% of production.

  Fig. 1 Oil and gas production

 

Source: companies’ data, Bloomberg, Arbat Capital

Few attractive oil projects remain

And what are the outflows? In general, the industry requires more capital spending (upstream projects are more expensive); production performance is disappointing, operating costs are rising, and there’s no money to increase dividends. Dividends and capital expenditures relative to operating cash flow do little to inspire investors (Fig. 2).

 Fig.2 Dividends and Capital Expenditures relative to Cash Flow

Source: companies’ data, Bloomberg, Arbat Capital

The price of oil is still attractive – not less than $100 per barrel 

For six years - from the crisis year of 2008 to 2013 - oil prices have doubled although the cumulative dividend yield hasn’t exceeded 35% (Fig. 3).

 Fig.3 Oil prices and investors’ total return

Source: companies’ data, Bloomberg, Arbat Capital

But the market has serious concerns regarding the sustainability of this price. Analysts at Deutsche Bank and Citi posit the following:

1) Developed countries find it hard to digest high oil prices while sponsoring politically hostile oil exporters. Therefore, efforts to replace oil with other fuel alternatives remain a point of emphasis.

2) A geopolitical factor is the weakening potential for a diplomatic solution regarding Iran’s nuclear program following the change in government (the possibility that the Strait of Hormuz could be closed in the event of military action against Iran is a key geopolitical risk for the market).

3) Over the long term, there could be further technological breakthroughs in shale oil  and deep water production, which would remove nationalism and geopolitics as factors affecting the market. Due to the growth of shale drilling in North America, the price of oil has remained at $110 for some time despite the high volume of supply disruption (3-4% of global demand.)

In the wake of investors

In order to support stock prices, the Big 5 companies have no other option than to restrain capital spending and increase dividends. Investors are particularly wary of large and expensive projects. But what are the companies ready to do? For a start, we have to try to understand their businesses. In 2013, compared to 2008, only Chevron and Shell saw their market cap increase, by 33% and 2% respectively. The remaining three all experienced a decline.

However, all of the companies saw capital spending increase. BP saw expenditures rise by 8% while Exxon Mobil experienced a 74% increase. Dividends per share increased by 59% at Exxon Mobil an 54% at Chevron, but at BP the dividend was down by 13%. Exxon Mobil was able to show such high growth predominantly by repurchasing their own stock. Shell paid out the highest proportion of net income in dividends, or 69%, while Total paid out 64% (Figure 4).

Chevron is in the most advantageous situation, but BP is less fortunate. Chevron rose from fifth to second place in terms of market cap, while BP fell from second place to fourth.

Fig.4 «The Big Five»

2008 vs 2013

Source: companies’ data, Bloomberg, Arbat Capital

Each company is choosing its own tactics.  Shell showed resilience in the face of unhappy shareholders following weak stock performance since the beginning of 2013, and increased investment spending to $5 billion by the end of the year. Cuts in capex to facilitate high dividends would undermine the long-term interests of investors and provoke an explosive rise in oil prices, as at the beginning of this century, recently emphasized Shell CEO Simon Henry. The market reacted to the announcement with a 4.5% drop in Shell’s stock price.

Exxon Mobil is keen to buy back its own stock. Since 2006, the company has devoted $186 billion to this goal and the number of outstanding shares has fallen by 1.7 billion (about 28%). The fact that the company has spent twice as much on share buybacks as dividends is only slightly encouraging to shareholders. It wasn’t until 2012, yielding to shareholder entreaties, that Exxon increased its dividend payment by 12% (the average increase in previous years was 4.5%). Investors were unhappy, and Exxon stock lagged nearest competitor Chevron by an average of 7% last year. Chevron is spending half again as much on dividends as stock repurchases, while oil production is up (by 3.3% over 2008).

Now Total and BP are making every effort to please their shareholders. Last summer the French company promised to reduce capex and increase dividends, leading the stock to lead the sector (with outperformance of approximately 20%). BP’s announced growth in dividends on plans to double asset sales to almost $10 billion. The stock jumped by 6%.

But what about Russia?

Russian producer LUKOIL is the most likely contender to heed the request of investors to increase their capitalization. Given the limited access to reserves in Russia and the lack of success in its overseas strategy, containing capex and increasing dividends appears logical. Management (together with the controlling shareholder) is interested in boosting the share price, and not in need of dividend yield.  

Surgutneftegaz has significant experience in battling shareholder activism. There is the fact that although the company produces financial statements in accordance with IFRS, they still manage to avoid disclosing the ownership structure. Investors remain content with the designated level of dividends on preferred shares.

TNK-BP Holding, met market expectations that it would be absorbed by Rosneft (big dividends, cost control, positive production dynamics). Rosneft continues to invest big. The only question is where? Management of state companies are more inclined to increase the magnitude of cash flows under their control than increase capitalization. Over ten years, Rosneft has become the largest Russian oil company, absorbing two industry leaders (Yukos and TNK-BP). With new long-term contracts with the Chinese, Rosneft is capable of absorbing any other competitor in Russia.

At Gazprom, reform is necessary to curb the management’s appetite for increasing capex. The company paid out 25% of IFRS net profit in dividends, which is a step in the right direction.

 Fig. 5 Russian Oil Companies

2008 vs 2013

 

Source: companies’ data, Bloomberg, Arbat Capital

Potential drivers for stock price growth include:

1) World leaders — BP (desire to please shareholders and expectations that the trial in the US following the oil spill in the Gulf of Mexico will come to an end).

2) Russia — LUKOIL (likely increase in dividend payout) and Gazprom (possibility of share buyback and change in board).

17 March 2014, Vedomosti

oil, investment, dividends

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