FTSE 350: Energy giants' cash flow explodes

In fairness, many investors were clamouring for higher-margin portfolios, and weak oil and gas prices had left many projects unprofitable or barely able to reach break-even – which meant they were better off removed from the balance sheets of BP (BP.) and Shell (SHEL) et al. And the combination of better margins and stronger oil and gas prices has led to massively improved cash flow: RBC Capital Markets forecasts March-quarter aggregate cash flow from operations for the sector of $80bn (£61bn), up from $48bn a year ago. 

But the worm has turned such that further dividends and buyback programmes may be held back because boards don’t want to deal with the backlash from handing out masses of cash while the populace struggles with exorbitant energy and petrol prices. There will be some paper hits from the war in Ukraine as Shell and BP pull out of joint ventures and equity tie-ups, but the biggest impact will be courtesy of higher prices. 

Further out, the question is whether these dynamics will jolt the sector back into its previous habit of constantly ploughing billions into new production. 

“Given a supportive macro backdrop and headwinds to other sectors, we believe focus could shift away from the majors’ energy transition plans, and back to core businesses,” said RBC analyst Biraj Borkhataria.  On the other hand, energy experts see falling demand as the next stage in the transition, so oversupply could become an issue within a few years. 

Borkhataria said the US majors – previously seen as laggards compared with the European energy giants – would reap rewards for their steady-as-she-goes strategies when it comes to their core businesses. “In a sustained high commodity price environment, we think the focus may shift from near-term free cash flow strength to longer-term portfolio longevity,” he said. The majors are unlikely to slam the brakes on energy transition plans, but a slight shift in capital allocation could easily take place and bring on more supply. 

Shell has already loosened its approach to greenfield projects, in this case specifically liquefied natural gas (LNG): “When it comes to new LNG opportunities, we will go selectively after those,” said Shell integrated gas director Wael Sawan. This is a shift from previous plans – Jefferies analyst Giacomo Romeo said in the same February briefing that Shell had previously planned to stop greenfield LNG spending once a major Canadian project was done. 

The forecast for capital expenditure at Shell is $23bn-$25bn a year out to 2026, while analysts see BP staying similarly disciplined, at $14bn-$15bn a year in the period. This will be a drop in real terms (capex in 2019 was over $15bn for BP) and constitutes a clear commitment to scaling back, helped along by asset sales. Whether this will bear fruit for shareholders will depend on oil and gas prices, however – as well as whether or not green investments can produce positive returns. One test of investors' current appetites will come in May, when Shell shareholders vote on a resolution put forward by activist group Follow This calling for Paris Agreement-aligned climate targets. A similar resolution received 30 per cent support last year.