This leaves the industry with an unknown conundrum: What to do with all the cash? First world problem, perhaps, but right now a potential problem nonetheless.
The last decade, which saw a boom in shale production but a drop in oil stocks, has refocused attention on the main thing executives are supposed to do well: allocate capital. This year, it looks like there will be few hard choices. For the Big Six, in round numbers, nearly $50 billion would go to dividends. Assuming the buyback targets are front-loaded, they could require another $50-55 billion, which could push total shareholder payouts to over $100 billion for the first time (2008 payouts were just shy of of that level). Even then, roughly $50 billion of excess cash flow would be on balance sheets, reducing collective net debt from 0.9 times earnings before interest, taxes, depreciation, and amortization to less than 0.5 times on an annual basis. proforma basis.
For energy investors, this combination of a 7% payout yield plus ongoing deleveraging — the polar opposite of what they’ve gotten for much of recent history — is as good as it gets. With consensus estimates pointing to free cash flow of almost $140 billion in 2023, the industry could repeat the trick next year.
However, when the oil companies are getting into this, the first order of business in Washington is to accuse them of speculation. Especially when there is a (proxy) war on:
We’re here today to get answers from Big Oil about why they’re ripping off the American people. At a time of record profits, Big Oil is refusing to increase production to provide the American people with much-needed relief at the gas pump.
That was Rep. Frank Pallone of New Jersey opening a House Energy and Commerce Committee hearing earlier this month. Democrats are well aware of the dangers posed by rising gasoline prices, amid broader inflation, ahead of the midterm elections. While Russian President Vladimir Putin is one of the targets of the blame, and rightly so, the instinct to criticize oil companies for cheating drivers at the pump is never entirely dormant, even though the accusation is false.
It is also important to emphasize a big difference between 2008 and now. Back then, the boom in oil prices was about to crash and large companies were still earning high returns on capital (for more details, see this excellent blog post by Arjun Murti, the former Goldman Sachs analyst who described the “super peak” oil). then and now is part of the ConocoPhillips board). Today, we are just emerging from an oil meltdown of generational proportions and years of low yields. Also, while peak oil supply was the big fear in 2008, climate change is now changing the approach to predicting peak oil demand. Free cash flow is high not only because of rising oil and gas prices, but because oil companies acted rationally and repressed their long-standing urge to immediately spend most of every dollar that comes in.
Still, the industry’s sudden liquidity seems to make her nervous. This year’s calls for President Joe Biden to grant effective permission to drill — odd when federal land onshore accounts for only about a tenth of U.S. production — can be interpreted as an attempt to deflect anger. from Main Street. The ritual bombing of the Capitol was an attempt by the Democrats to reverse it.
If oil prices increase further, things can get very complicated. Russia’s apparent war crimes in Ukraine, coupled with expectations of a new offensive, suggest that European Union sanctions on Moscow’s energy exports have become a question of when rather than if, although how and the moment remain debatable. The disruption involved could well trigger an incredible spike in energy prices and updates to those cash flow forecasts.
Recent history suggests that high pump prices have a way of pushing Congress, including its Republican members, toward higher taxes on oil producers. In 2006, when Republicans controlled both chambers and had a former oilman in the White House, they eliminated a tax break for several oil majors related to writing off exploration expenses when gasoline rose above $3 a gallon. Two years later, that same ex-tanker, though by then a lame duck, enacted new changes for oil producers that effectively increased their taxes. History lesson: He points out that the 2008 tax changes appear again in the House-approved version of Biden’s stalled Build Back Better package.
In addition to showing that high pump prices can temper Republicans’ traditional aversion to windfall taxes on oil producers, these examples also show that there are ways to extract money without calling it a windfall tax. Biden’s call for fees on idle wells can be viewed this way. Clearly, for now, Republicans are focused on linking high bomb prices to Biden’s green agenda, and Build Back Better is all but buried.
However, if oil rises to $150 or higher, Big Oil may want to look over its shoulder. Despite the premise of that ridiculous recent hearing, they don’t control oil prices. However, they control spending and communication. It will be interesting, for example, to hear the messages about dividends and buybacks on impending quarterly earnings calls; one suspects that it may have a sotto voce quality. Large budget increases to take advantage of higher oil prices, and join the “war effort,” are unlikely for now, given the reasons discussed above plus the growing risk that a recession could undermine demand.
What other options do they have? In another of her blog posts, Murti discusses the volatility that portends the energy transition and urges oil companies, as insurance against that, to simply save more cash on their balance sheets. Quietly leaving money in the bank might also offer some insurance against a potentially hot and unpredictable summer.
More from Bloomberg’s opinion:
• This back door maintains the flow of Russian oil to Europe: Javier Blas
• Russia’s war draws governments into energy markets: Liam Denning
• Germany will have a hard time moving away from Russian oil: Julian Lee
(1) Traditionally, ConocoPhillips is evaluated separately from the other five, as it is a purely upstream company rather than an integrated one. However, the sheer size of Conoco (its market capitalization is larger than BP’s) and the fact that it was an integrated company in 2008 means I include it here.
(2) The aggregate oil and gas production of the six companies in 2008 was 17.67 million barrels of oil equivalent per day. Consensus forecasts for this year put it at 17.37 million barrels per day, about 2% lower (source: Bloomberg).
(3) The tax exemption eliminated in 2006 dated from the Energy Policy Act of 2005, which allowed the amortization of two years of “geological and geophysical expenses”. This was extended to seven years for five major oil companies. In 2008, President George W. Bush signed into law amendments to the Foreign Oil and Gas Extraction Revenue and Foreign Oil-Related Revenue Act. In addition, the (then) Section 199 corporate tax deduction, which increased to 9% for most manufacturing sectors, was frozen at 6% for oil and gas producers and refiners.
This column does not necessarily reflect the opinion of the editorial board or of Bloomberg LP and its owners.
Liam Denning is a columnist for Bloomberg Opinion covering energy, mining, and commodities. He was previously the editor of the Wall Street Journal’s Heard on the Street column and wrote for the Financial Times’ Lex column. He was also an investment banker.
More stories like this are available at bloomberg.com/opinion