(Reuters) - A prolonged period of heavy planned spending looks to be ending for the big private-sector oil producers, leaving investors to gauge how companies will manage cash thrown off by big projects as they ramp up, and how much will be eaten up by costs.
Due out next week, the third-quarter results for the majors - from Exxon Mobil Corp to BP Plc to Total SA - will be hit by an especially tough quarter for their downstream arms, which refine oil and produce chemicals.
Upstream production from wells, meanwhile, has been flat or declining, though the outlook for next year looks better. So at the top of analysts’ minds this quarter will be how much cash can be returned to shareholders, and how much will remain tied up in capital expenditure to keep the oil and gas flowing.
While higher oil prices boosted cash flow in recent years, cost inflation now threatens to eat away at returns as oil companies push the envelope with deepwater drilling and liquefied natural gas mega-projects.
“Rising capex will quickly undermine the positive arguments that can be made for the sector,” Deutsche Bank analysts wrote.
Deutsche Bank noted the majors were guiding toward modest capex growth after a decade where double-digit annual expansions were the norm. Capital spending by sector leader Exxon even fell last quarter, though that was after a 33 percent year-on-year jump in the first quarter.
“I wouldn’t be surprised to see capex pulled back across the board,” said Mark Coffelt, head portfolio manager at Empiric Funds in Austin, Texas, who felt oil prices were only high at the moment because of Middle East security concerns. He expected some higher-cost oil-drilling projects eventually to be shelved.
After a dip in Exxon’s production growth this year, Wells Fargo analysts expect a 4 percent increase in 2014. Yet, they forecast lower cash flow for the period from 2013 to 2015 than the past three years, and have cut their valuation range for the stock by $3 to $89-$97.
Part of the target reductions were due to delays and start-up challenges at Kashagan in Kazakhstan, the world’s biggest oil find in decades, in which Exxon, Royal Dutch Shell Plc and Total all have a stake.
It took 13 years and some $50 billion before output at Kashagan was started in September, and output had been expected to grow dramatically next year and in 2015.
Concerns about spending more to get less prevail among those following the sector. Nomura Equity Research, while cutting 2014 earnings estimates for European majors, noted increased spending on asset integrity and security for projects due to both BP’s Macondo spill and the Arab Spring uprisings. They also pointed to longer planning times due to the greater complexity of the work.
“Lastly, perhaps one of the greatest factors is exploration expense,” Nomura said. “The market has been slow to increase the run-rate despite increased spend in drill-bit activity, something that has increasingly placed downward pressure on profitability in recent quarters.”
The comments followed an announcement by Chevron Corp, ranked second by market value among the majors, of third-quarter write-offs for exploration wells of between $100 million and $200 million - along with a warning about the impact of refining on its quarterly results.
Investors in oil majors may have to grow more familiar with such costly “dry holes,” given that just one deepwater well can cost in the range of $100 million, and Deutsche Bank expects the share of Big Oil spending on deepwater to double by 2016.
According to Barclays Equity Research, it was a doubling by BP of its exploration spending in the past three years that helped reverse its underperformance in that area - part of a yet-to-be-completed strategic turnaround program.
While Barclays acknowledged 2014 would see improved production and cash flow for BP, the analysts saw little to differentiate the company and stuck with an “underweight” rating on the shares and a target price of 485 pence.
Reporting by Braden Reddall in San Francisco; Editing by Terry Wade and Marguerita Choy