What’s the most un-sustainable part of the global energy complex?
Maybe you would say co-ordinated OPEC production cuts.
Or perhaps you would bring up high growth rates of shale producers.
If you talked about the lack of free cash flow among shale producers you would be getting warm…
But for me, when I went looking through the final 2016 financial statements of the supermajors, their dividends seemed the most un-sustainable part of the industry. That should make shareholders very nervous.
What these year end financials show is that these companies have spent the last two years continually digging a balance sheet hole.
With the commitment that they have to their dividends it doesn’t look like they will be putting their shovels down any time soon.
Law of holes – The first law of holes is an adage which states that “if you find yourself in a hole, stop digging”. Meaning that if in an untenable position, it is best to stop carrying on and exacerbating the situation
Behind The Numbers – Those Dividends Are A Heavy Burden
The largest oil companies and their dividend yields are as follows:
Exxon (XOM: NYSE) – 3.60%
Chevron (CVX: NYSE) – 4.11%
BP (BP: NYSE) – 7.12%
Total SA (TOT: NYSE) – 5.24%
Royal Dutch Shell (RDS-B: NYSE) – 6.97%
These companies have long taken great pride in being able to maintain their dividends through even the worst of oil crashes.
Exxon for example has 34 years of consecutive dividend increases. Chevron has increased its dividend for 29 consecutive years.
That is very impressive to be sure.
However, when I drill into the 2016 financial statements of these companies I don’t find myself wondering if they should continue to increase dividends.
I find myself wondering if they should continue paying dividends.
In the table below I’ve laid out the 2016 cash inflows and outflows for each of these companies.
|Cash Inflow From Operations||$22.1||$12.8||$16.5||$10.7||$20.6||$82.7|
|Cash Outflow For Capital Spending||($16.2)||($18.1)||($18.1)||($16.7)||($22.1)||($91.2)|
|Cash Outflow For Dividends||($12.5)||($8.1)||($2.6)||($4.6)||($9.7)||($37.5)|
|Net Cash Outflow||($6.6)||($13.4)||($4.2)||($10.6)||($11.2)||($46.0)|
I have not given any credit for cash from asset sales since that isn’t a sustainable source of cash and I haven’t deducted any cash for asset purchases either (like the Shell purchase of BG Group).
I’ve tried to present a true picture of what these companies look like on an ongoing, sustained basis.
When I was putting this together I kind of knew what to expect, but I still find the numbers very sobering.
As a group, these companies outspent the cash that they generated by $46 billion. Even if the group paid zero dollars in dividends it would not have lived within cash flow.
And this $46 billion outspend has not generated big production increases. In fact generating production and reserve growth has been a constant struggle for the supermajors.
Admittedly oil and gas prices were low in 2016.
Now, remember my comment earlier about being warm if you were thinking about the lack of free cash flow among shale producers as being un-sustainable?
Behind The Numbers – Consuming Cash, But No Worse Than The Supermajors
The combined supermajor numbers weren’t exactly unexpected, but they are still an eye-opener.
What would a similar group of large independent shale producers look like?
To find out I decided to drill into the 2016 10-ks of the following four:
Continental Resources (CLR: NYSE) – (Bakken and SCOOP/STACK)
EOG Resources (EOG: NYSE) – (Bakken, Permian and Eagle Ford)
Pioneer Resources (PXD: NYSE) – (Permian)
Diamondback Energy (FANG: NYSE) – (Permian)
Again I’ve excluded cash spent on acquisitions and cash received for asset sales. The only one of these companies that pays a dividend of any significance is EOG so I left the dividend numbers off the table.
Here is what I found:
|Cash Inflow From Operations||$1,498.0||$1,125.0||$332.0||$2,359.0||$5,314.0|
|Cash Outflow For Capital Spending||($1,857.0)||($1,154.0)||($362.0)||($2,490.0)||($5,863.0)|
|Net Cash Outflow||($359.0)||($29.0)||($30.0)||($131.0)||($549.0)|
As a group I was surprised by how little they actually outspent cash flow. This is certainly not what we would have seen from these companies in 2014 or 2015.
The oil price crash has forced this industry group to spend more responsibly.
While these companies aren’t close to generating free cash flow, I find it interesting that they are doing a better job of living within cash flow than the supermajors are.
The sustainability of shale production has always been questioned (and rightfully so). When I look at all of this data though, the most unsustainable thing that I see are the dividends that the supermajors are paying.
Would You Run Your Own Business Like This?
If the supermajors are outspending cash inflows by $46 billion to pay their dividends the funding of that cash has to come from somewhere.
The vast majority is from increased balance sheet leverage either through a reduction of cash on hand or increased debt.
That begs the question of whether those dividends are really in the best interests of the shareholders to whom they are being paid. If that cash had been invested in new projects at least cash generating ability would have grown and balance sheet deterioration lessened.
Since the oil crash the industry has canceled $1 trillion of projects and hundreds of thousands of workers fired. While the supermajors have taken a knife to every imaginable expense their dividends have been spared.
At some point one of these companies is going to make an unpopular but sensible decision and do what the shale producers did: start living within cash flow.
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