The effect of the oil price decline on international oil companies and their business strategies

Abstract

In light of the oil price fall that began in June 2014, this master’s thesis assesses the resulting impacts on the top six international oil companies (IOCs): ExxonMobil, Chevron, ConocoPhillips, Shell, BP and Total. The report presents the key drivers and the role of the oil price decline in the business strategies of the IOCs from the economic, environmental and regulatory perspective and how they affect their position in the global energy landscape. Within each segment the thesis evaluates the comprising indicators to answer key questions related to: market power, business models, portfolios, reserves and environmental and regulatory policies. First, the report reviews the literature on the fundamental concepts of the petroleum industry. It then goes on to analyze the available financial and operational data of the companies and identifies the trends in the key financial indicators in the historical oil price cycles. Lastly, it demonstrates the subsequent actions taken by the companies. Through a qualitative and quantitative analysis of the available literature on the IOCs, the study concludes that the downturn in the price of oil has financially weakened the IOCs and created the following domino effect: with a negative impact on the income, lower revenues resulted in market devaluations, decreasing the operating cash flow, thus reducing the funds needed to cover dividends and capital expenditures (capex), ultimately limiting the long-term investment. To optimize their financial resources, the IOCs cut capex but continued to distribute dividends to maintain shareholder value. However, to fund current operations, they issued extensive amount of debt and began divesting downstream assets. Comparable to previous oil price decline environments, divestment activity increased coupled with a fast trend of mergers and acquisitions. Moreover, despite record capital spending, their reserves and production levels are decreasing overtime. Consequently, the pressure to improve their resource base has shifted their strategies by developing a competitive advantage in large scale and capital intensive projects like LNG, the Arctic, and Deepwater. In a world increasingly concerned with climate change, the IOCs’ high dependence on oil exposes their current assets to development risk. One way forward is a large shift towards natural gas production. Increasing production of gas has also become part of the IOCs’ role in the fight against climate change, as evidenced by the recent announcement of EU companies (Shell, Total, BP) in support of a global carbon pricing system. However, there is a rift between the six majors, as the US companies (ExxonMobil, Chevron, ConocoPhillips) hold the opposing view, which can be explained by examining their production portfolios. Their EU counterparts produce more gas than crude oil; meanwhile, the portfolios of the US companies show a predominant production of crude. From regulatory perspective, deteriorating contract formulas reflect the weakened negotiating power of the IOCs with the producing countries, as the “government take” has increased over the years. However, the fluctuation in government take policies follows the trend of oil prices. In a downturn, governments are prompted to reduce requirements to attract more investment, and for the majors, this presents an opportunity to secure future reserves consistent with their newly reduced budgets. Furthermore, a lift on the ban of US oil and gas exports would close the gap between the WTI and the Brent, and increase the profitability of the IOCs with operations in the US, but the current status only deepens the effect of low oil prices. In sum, this thesis exposes the vulnerability of the six major oil companies and recommends a more conservative risk assessment approach for investment decisions involving the IOCs. A weak financial and operational performance, increasing environmental and regulatory risks coupled with depressed oil prices with weak prospects of rapid recovery question the future sustainability of the IOCs.