As oil markets are slowly recovering from the oil price bust in April, big oil is facing a set of new challenges in the next couple of years. The Covid-19 pandemic has simply magnified what was already plaguing the industry before the downturn. Eyeing the future, the oil majors have made bets on other sectors, such as petrochemicals, but even a long-term bet on plastic is not looking quite as good as it once did.
For years, the largest integrated oil companies soothed shareholders with hefty dividend payouts. But they have had to pile on debt in order to afford those payments to shareholders. It’s a funny arrangement – borrowing to pay investors; the money comes in the door and then immediately turns around and goes right out.
Now, the oil majors are writing down tens of billions of dollars’ worth of assets. While the finances were problematic beforehand, the massive impairments reveal a troubling future – one after another, the majors are lowering their long-term oil price assumptions, which directly reduces the assumed value of their assets. Put another way, the companies are admitting that some oil and gas may never be produced.
Of course, some of them have been preparing for a rockier future for quite some time. Shell, for instance, made a massive bet on natural gas when it purchased BG Group five years ago, a bet that gas would fare well in a low-carbon future. Shell is now the largest LNG exporter in the world.
However, that bet is not looking quite as solid as it did at the time. The Anglo-Dutch oil major recently announced a $15 to $22 billion writedown, with a large portion of that concentrated on the company’s gas and LNG assets in Australia.
Another bet the majors have made is on plastics. Seeing the writing on the wall in terms of crude oil demand in transportation, plastic looked like a more durable growth industry. Half of the growth of crude demand in the coming decades is expected to be concentrated in plastics and petrochemicals, according to the IEA.
But the market for petrochemicals is also souring. The price of polyethylene, the building block of plastic, was declining before the pandemic, due to an overbuild in capacity. The pandemic has hit the market when it was already down. Petrochemicals now look like a much riskier bet. “The plastic market is saturated, and a short-term uptick in demand for personal protective equipment will not change the long-term downward trajectory of plastic use,” the Center for International Environmental Law (CIEL) wrote in a new report.
“[T]he combination of a demand shock, increasing regulation of plastic, low resin prices, and decreased capital spending pose a combined significant threat to the petrochemical industry,” the report concluded.
The majors have yet to write down their petrochemical assets – although BP just agreed to sell off its entire petrochemical unit – but they are writing down billions of dollars’ worth of other assets. And in the case of Shell and Eni, at least, they are also beginning to cut dividends.
These developments should raise alarm bells for investors, CIEL argued in its report. Cutting dividends and writing down the value of assets “should alert investment managers and policymakers who are accountable to beneficiaries and taxpayers, respectively, to the perils of funneling more cash into oil and gas companies,” the CIEL report said.
“Dwindling dividends, deepening debt, and decreasing assets are just the latest evidence that the industry is in its endgame,” CIEL added.
Shell and BP, at least rhetorically, have announced that they will undergo dramatic transformations in an effort to reach net-zero emissions in the next few decades, although they do not plan on halting oil and gas production anytime soon.
ExxonMobil and Chevron, on the other hand, are not even feigning such a transition. They may be eyeing a potential upswing in oil prices after a period of underinvestment – there is broad speculation that they will consolidate their respective positions in the Permian and grow an even larger unconventional footprint.
The problem with that is the poor track record of shale finances more generally, and the very risky bet that there will indeed be another boom cycle. Sure, the shortfall in upstream capex today could sow the seeds of another upswing in prices, but as the FT points out, the boom could be brief.
Oil companies clearly need higher prices to make money. But a surge in prices will hasten the energy transition.