Editorial: Damned if you do… [NGW Magazine]

Oil has seen a limited recovery, based on some modest re-opening for business. Prompt Brent has been trading in the high $20s-low $30s, after plunging to a near two-decade low of under $20 in April.

By most accounts, Russia and its Opec+ allies are closing in on their targets for supply cutbacks in May. Norway has also imposed its own unilateral cut to production. Private companies have had to take their own more drastic measures in their attempt to survive.

Still the recovery has so far been driven largely by sentiment rather than fundamentals. The world is still producing far more oil than it needs, with the glut estimated by Rystad Energy at 13.6mn b/d this month. Opec+ participants could struggle or even flout their commitments, as has happened in the past; and Norway’s contribution to the cuts of only 250,000 b/d has more symbolic than material value. Other, larger non-Opec+ producers have not followed its example, instead banking on organic cuts to rebalance the market.

Meanwhile, spot prices for gas continue to decline, sinking to a historic low of under $2/mn Btu – half their value in early April and lower than the cost of liquefying and shipping gas to Europe from the US. Worse is still to come, once low oil prices feed into long-term LNG supply contracts.

Oil and gas companies across the world have responded by slashing their dividend payments or cancelling them altogether. But the majors have prioritised short-term rewards for shareholders.

BP, Chevron, ConocoPhillips, ExxonMobil and Total have all said they will maintain their dividends. This is despite several of them booking net losses in the first quarter on impairments and other charges relating to the price collapse.

Shell has broken rank, though, announcing a two-thirds cut to shareholder returns – its first in 80 years. Italy’s Eni may well follow the same course but has deferred the decision until July.

Unsurprisingly, investors were disappointed with Shell’s decision and its share price suffered the consequences. Yet the move has also won some praise.

The cut is “sensible and prudent,” Wood Mackenzie’s Tom Ellacott says, freeing up $10bn in cash and lowering the Anglo-Dutch firm’s breakeven price from $51/b to $36/b. Meanwhile BP, Chevron, ExxonMobil and Total are due to fork out a combined $41bn in dividends in 2020. Were they all to take Shell’s lead with a two-thirds cut, they would have generated an extra $27bn in cash to build up their reserves and invest in future growth ready for the rebound in demand later this decade.

But with the salaries of many company CEOs tied to share price performance, others have understandably refrained from adjusting dividends, even as the industry faces its biggest challenge in 100 years. Stock has already plunged, not only because of low prices but also because of the suspension of buyback schemes. Even so, companies that bite the bullet and cut returns now may capitalise on the market recovery. Those that do not could find their role in the global energy sector diminished.

While Shell’s cut was “very unwelcome news for income investors ... it may be better news for the long-term health of the business,” Hargreaves Lansdown analyst Nicholas Hyett believes.

“The need to service a cash-hungry dividend has seen future investment sacrificed and assets sold,” he explains. “Essentially both Shell and BP have been slowly digesting themselves to keep the dividend ticking over. Removing that pressure allows the group to focus on the future and also secures the future of recently announced renewables energy investments.”

In late 2019 and early 2020, a number of oil companies announced ambitious targets for lowering their carbon emissions over the coming decades. But now the sector will have far less spare cash to invest in clean technologies. Yet Europe’s majors say they are as committed as ever to delivering on these goals.

And even where they are not so committed, the upstream regulators may leave them no choice: the UK Oil & Gas Authority for example is to juggle the UK government’s twin imperatives of net-zero carbon with maximising the economic recovery of the UK continental shelf. Clearly these objectives are incompatible. Decarbonising production is likely to make already marginal fields too expensive. The alternative, says OGA, is that companies may lose their “social licence” to operate.

Despite cutting its capital spending plan by a quarter this year, BP ringfenced the $500mn it intends to invest in low-carbon activities. Total likewise said it would still plough $1.5-2.0bn into low-carbon electricity despite the market’s collapse. On the same day it reported a 35% drop in net profits, the French major announced its aim to achieve net zero for its scope 1 and 2 emissions worldwide by 2050 or sooner, and net zero for scope 1, 2 and 3 emissions across all its production and energy products in Europe by that point.

Though companies are cash-strapped, they may, paradoxically, have greater incentive to invest in renewables. Given the bearish market outlook, oil and gas projects will be seen as offering a smaller rate of return than they once did, while the importance of the social licence to enable those activities will swell. Companies will have to buy back more shares as more investors sell.

But governments are in an even worse position: the pot of other people’s money available to subsidise renewables is shrinking fast. They have to choose between the cheapest energy to restore the economy, or the greenest energy to achieve purely political goals that are 30 years away. Either approach seems likely to anger half their population.