By Sarah McFarlane 

Oil companies are expected to slash investments and cut shareholder returns after crude prices sank to their lowest level in four years.

The Saudi Arabian Oil Co. this past weekend decided to discount oil prices after the Organization of the Petroleum Exporting Countries and Russia failed to agree to a production cut in response to the coronavirus epidemic. The move, along with the kingdom's plan to increase production starting in April, threatens to exacerbate a glut in oil supply. And publicly traded oil companies -- including Aramco, as the Saudi state-run oil giant is known -- are collateral damage in the conflict.

BP PLC's shares fell by more than 20% on Monday, while Royal Dutch Shell PLC was down 14%, France's Total SA off 12%, and Exxon Mobil Corp. down 9%. On Sunday, Aramco's shares fell below their December listing price, in what was the world's largest initial public offering.

Oil companies were already the laggards of equity markets. Shareholders are questioning their long-term future in a lower carbon world where oil demand is expected to decline. At the same time, companies' earnings are eroding due to lower energy prices in 2019 compared with the previous year.

The latest price slide will mean they will be hard pressed to meet hefty shareholder returns and maintain investments, all the while paying down debt.

"The first thing to go will probably be the share buybacks," said Santander analyst Jason Kenney. "Then there will be an assessment of absolute capital expenditure needs. Maintenance capex levels are somewhere in the 30-40% range of annual spend, so there's a lot of money that can be flexed."

Shell already sounded a warning on the sustainability of its $25 billion share-buyback plan in January, when Chief Executive Ben Van Beurden said the program's pace was "subject to macro conditions and further debt reduction." With $15 billion in buybacks completed by January, the company was due to conclude the program by the end of this year, having launched it in mid-2018.

Total was due to buy back $2 billion in shares this year, but its plan assumes an oil price of $60 a barrel. Brent oil prices -- the global benchmark -- have almost halved since the start of the year to around $35 a barrel. According to estimates from consultancy WoodMackenzie, a $10 a barrel move in oil price has a $40 billion impact on global cash flow per quarter for the oil sector.

If companies rein in spending, the belt-tightening is likely to hasten a peak in oil supply which Christyan Malek, JP Morgan's head of oil research for Europe and the Middle East, forecasts was already due in 2022. "All you are doing now is accelerating it."

The sharp drop in oil prices will hit companies' debt positions at a time when many balance sheets were already stretched.

In the fouth quarter, BP's gearing -- the ratio of net debt to the total of net debt and equity -- was 35% including leases, down from 36% in the third quarter but above the company's long-term target of between 20% and 30%.

"Considering both the financial framework and balance sheet position, we see BP as in the most-stressed position, largely due to the starting point on gearing, which is the highest in the sector, followed by ENI and Exxon," said Biraj Borkhataria, co-head of European energy research at RBC Capital Markets.

Shell said in January that its gearing was likely to remain above its target of 25% this year.

Dividends are expected to remain sacrosanct, analysts said. Exxon has increased its dividend annually for 37 years and Shell hasn't cut its since World War II.

"I think there's going to be every effort to cover dividends... it's a red line really," said Santander's Mr. Kenney.

Cheaper oil could also slow the energy transition to the lower carbon future that investors and policymakers are increasingly demanding. The move toward electric vehicles and renewable energy has threatened business models and deterred some investors from holding oil stocks due to the growing risks around their future.

"The worst thing that those people need is a low oil price, as that will certainly discourage substitution away from oil," said Mr. Kenney, referring to climate activists.

Write to Sarah McFarlane at sarah.mcfarlane@wsj.com

 

(END) Dow Jones Newswires

March 09, 2020 13:09 ET (17:09 GMT)

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