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Reserves dilemma for oil majors

As the oil majors churn out their first-quarter numbers, expectations of relative price stability could give way to further industry consolidation
April 30, 2015

Most of the world's listed oil majors have now updated on their first-quarter performance. Expectations were subdued - and with good reason. Energy companies have reported the sharpest contraction in first-quarter earnings among the S&P 500 sectors; a two-thirds drop from the corresponding period in 2014, according to US researcher FactSheet Insight.

At the beginning of the week, BP (BP.) offered an early glimpse of how the sector is faring with crude oil prices at half their average rate from a year ago. On balance, a 20 per cent fall in replacement cost profits wasn't the worst outcome imaginable, but cash-flow generation was particularly weak - a worrying sign for income investors.

The group's downstream refining segment profited from the increased differential between crude prices and finished products, but BP's upstream business delivered profits of just $604m, down significantly from $4.4bn recorded in the first quarter of 2014. That implies a profit rate of just $2.91 a barrel - not a great deal of headroom, and way short of the $22.95 per barrel achieved a year earlier. The disparity underlines how the industry cost base simply isn't geared to a $50-$60 a barrel Brent crude price.

It was a similar story at rival Royal Dutch Shell (RDSB) which today announced a 56 per cent reversal in first quarter earnings on a current cost of supply basis to $3.2bn. This actually came in ahead of expectations, with the slide in profits cushioned somewhat by improved profitability in downstream operations.

 

True-blue interventionism

Meanwhile, in the wake of Shell's (RDSB) move for BG (BG.), the UK government stepped in earlier this week to discourage any approaches for BP from rival majors. A cursory glance at the BP share register would immediately cast doubt on the group's 'British champion' credentials, but it is election year, after all. It is true, however, that the lion's share of industry mergers are announced around the time earnings are reported.

If the likes of ExxonMobil, Chevron, or even one of the national oil companies, did decide to throw their hats in the ring, it could also signal that they expect a period of relative stability in crude oil prices. It's obviously more difficult for buyers and sellers to come together when valuations are constantly in flux due to underlying price volatility.