Oil loses its lustre on pyre of price volatility

The 2010 Deepwater Horizon inferno marked another industry crisis. Picture: US Coastguard
The 2010 Deepwater Horizon inferno marked another industry crisis. Picture: US Coastguard
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There are no slick solutions to the crisis for the oil industry, says Martin Flanagan

OIL major BP’s annual results this week will bear the scars of the plummeting oil price as the group is also expected to unveil sharp cuts in its investment plans. Chief executive Bob Dudley will be taking on the spluttering profits torch and cost-cutting narrative from arch-rival Shell, which reported a slide in underlying fourth-quarter earnings to $3.26 billion (£2.45bn) last Thursday – about 20 per cent below analysts’ expectations.

BP’s turn in what has become the harsh energy spotlight on Tuesday will come 24 hours after American oil major Exxon is set to tell a similar story. Dudley is expected to say BP took a similar big Q4 hit as the tailspin in the oil price since last summer has been exacerbated by the fall in the Russian rouble against the US dollar after western sanctions on the Kremlin because of the Ukraine crisis.

The City consensus is that it will mean the British group, which has a 20 per cent stake in Russian oil producer Rosneft, will post annual profits down by more than 25 per cent to $9.9bn. On a more favourable note, analysts say the slump in the price of oil should have assisted BP’s downstream operations – refining, minerals and marketing.

The pivotal factor in the decline, however, is the oil price. It is trading at less than $50 a barrel, more than halved from $116 last summer and down from about $87 in autumn. Black gold has lost its glitter.

The rattled energy industry has reacted in a herd to shelve or bin investment projects in response to their reduced cashflows. BP has already said it will cut 300 staff and contractor jobs from its 3,500-strong North Sea business and freeze salaries. The oil and gas industry is worth some £35bn annually to the UK economy, but a recent Holyrood ­report suggested the current crisis could see 15,000 jobs axed out of the 200,000 posts based in Scotland.

BP has also sold down its equity interest in two Gulf of Mexico oilfields, where it has so far paid out $40bn for the Deepwater Horizon oil disaster in 2010. Last month the group warned that plans to streamline its business would cost it $1bn over the next year. City analysts say it is possible Dudley may have more to say on additional cost-cutting this week so fast is sentiment moving in the sector. Shell said it would rein in its capital spending by $15bn, or 14 per cent, over the next three years, even though in 2015 it will spend nearly as much as the $35bn it invested in 2014. That represents 40 (unnamed) projects that will be delayed or cancelled.

Patrick Pouyanne, chief executive of French giant Total, a North Sea operator like Shell and BP, said his company would cut investment by 30 per cent this year in an interview with Le Monde on Friday.

It is the same story with the American energy heavyweights. ExxonMobil will put flesh on the bones tomorrow of its already announced $9bn of cutbacks over the next three years. ConocoPhillips, the biggest US exploration and production company, says it is to slash its capex in 2015 by 33 per cent to $11.5bn. That is a $2bn deeper cut than guided the market only two months ago. Things are moving fast in the industry as companies decide that a price of under $50 will not cover the cost of capital on many projects.

Nobody really knows where it will stop, with an extraordinarily wide range of forecasts embracing everything from jeremiad pessimism to panglossian optimism. Projections for the medium term go from $10 a barrel to well over $100, even up to $200.

Ian McLelland, oil specialist at broker Edison, is in line with a lot of City thinking when he says a period of “inertia” in the price is likely following the race to the bottom over the past six months or so. “While a price correction is likely in the medium term, we forecast crude prices to remain subdued at current levels for the remainder of 2015, for which we estimate an average crude price of $52.50 for the year,” he says. McLelland reckons the price should recover to an average $72 in 2016 – not brilliant by some past peaks, but a price that the beleaguered industry would bite your hand off for now.

However, others think the price may have farther to fall. Tony Shepard, oil analyst at broker Charles Stanley, said: “There’s nothing to put a floor under the oil price yet. The imbalance in the market, the glut, is still there. It could go lower. America is producing record amounts of oil, with US inventories at 80-year highs.

“Russia is pumping out record levels. The Middle East is going strong, with Opec more concerned about losing market share than reducing production to get balance back into the market. In the longer term the industry will readjust, but who is to say how long term that will be?”

The party line of the oil and gas industry is that energy projects are long term by nature, and that eventually supply and demand will balance out and prices will perk up. Executives cheer themselves up by saying privately that taking the axe to major projects will help realise this scenario by reducing the supply of oil. The sector sceptics claim this is largely whistling in the dark.

But the dilemma is clear. If the cuts are too deep the majors will lose out when the oil price comes back; not deep enough, they will be throwing good money after bad down the well. “Slash and burn is out, but moderate scaling back will not be enough,” is how one analyst describes the quandary the sector is in.

IN FIGURES: THE SHIFTING BILLIONS

Shell’s annual profit: Up 16 per cent at $19bn.

Capital expenditure cutbacks:

BP: To be announced on Tuesday with annual results. At Q3, estimated spend in 2014 was $23bn.

Shell: $15bn over next three years.

Exxon: $9bn over next three years.

ConocoPhillips: Cut by one third to $11.5bn in 2015.

Oil price decline:

Now under $50 a barrel. Was at $116 last summer.