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Oil major quarterly results: a recovery mirage?

Oil major quarterly results: a recovery mirage?

Shares in London's oil majors, BP (BP.) and Royal Dutch Shell (RDSB), both ticked up on the publication of first-quarter results last week. The filings were also accompanied by glowing news headlines focusing on the "surge" in profits. This was understandable. BP's replacement cost profit - its preferred measure of profitability - hit $1.4bn (£1.1bn), against a loss of $485m in the first quarter of 2016. Two days later, Shell posted an even better profit leap, with the $3.4bn in earnings in the first three months of 2017 more than four times the comparative figure a year ago, and triple the final quarter of 2016.

But in the fast-moving and unpredictable world of commodities, those headlines looked somewhat incongruous. The majors' earnings came just as the price of Brent crude, the international benchmark for oil and gas prices, slipped towards levels not seen since Opec members struck a deal to curb supplies in late November.

When we last wrote about the oil price - prompted by the International Energy Agency’s (IEA) suggestion that the market was "very close to balance" - it was clear that summer pricing would be dictated by demand growth, the scale of US tight oil's resurgence and the ability of the parties to the Opec agreements to make good on their promises. Since then, the oil price has faltered on the latter two factors, principally the belief that a further extension to the Opec deal will not be sufficient - or sufficiently adhered to - to offset US shale production.

Against these movements, the relatively positive oil prices enjoyed by the likes of BP and Shell in the first three months could be seen as a neatly segmented mirage. Since the end of March, the oil price has traded $2 lower than the first-quarter average. Comparisons with the start of 2016, when operators were impairing balance sheets and Brent dipped below $30 a barrel, are also flattering.

 

Six months in the balance

 

And while shareholders will be encouraged by the duo's consensus-beating return to profitability, the figures were replete with caveats. To take two examples, BP was greatly helped by a lower-than-expected tax charge, while Shell's $4.3bn capital expenditure in the quarter was well below the amount needed to maintain medium-term production goals.

As many investors hold the stocks for income, the cash flow statement is arguably the most important indicator of financial health. On this count, Shell outperformed BP, with first-quarter free cash flow of $5.2bn more than enough to cover the $3.9bn total dividend. The Anglo-Dutch group also managed to reduce its gearing to 27 per cent despite higher interest charges. Its rival's borrowing leverage edged up to 28 per cent, partly because BP is investing at a proportionally higher clip. But negative cash flows are still a concern: even excluding Gulf of Mexico payments of $2.3bn, operating cash flows would not have covered BP's $1.3bn cash dividend, let alone the scrip component.

IC VIEW

If reassurance is what you're after - and let's face it, shareholders of either oil major should still see a 7 per cent dividend yield as a reason for concern - these quarterly figures provided some solace. After all, there is cash to be made at under $60 a barrel. Furthermore, for all the bearish sentiment currently enveloping the oil market, crude oil inventories have been falling (albeit by not as much as bulls had hoped) and there will be increased pressure on Opec members to reassert their relevance when they meet to renew cuts at the end of this month. Still, things are very finely balanced for operators; particularly in the case of BP, whose cash generation looks less adept to handle another slump to $40.

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By Alex Newman,
09 May 2017

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