Will Statoil's New Strategy Pay Off?

On Friday, Norway's Statoil (NYSE: STO  ) became the latest Western oil major to scale back spending plans and abandon previous production targets in an effort to boost free cash flow and improve shareholder returns. Will the company's new strategy pay off?

Statoil's new plan
After reporting a 27% drop in fourth-quarter earnings, Statoil said it will reduce capital spending by $5 billion over the next three years and will abandon its previous production target of 2.5 million barrels of oil equivalent a day by 2020. It will instead target 3% annual production growth through 2016.

Like its peers, Statoil has spent aggressively over the past few years, but facing rising exploration costs and stagnant energy prices, the company hopes to find a better balance between growth and return. It has already postponed major projects, including Johan Castberg in the Norwegian Arctic and Bressay in the U.K. North Sea and also plans to curb its Arctic exploration efforts.

By targeting only its highest-value opportunities, the company hopes to generate stronger cash flows and return much of that cash to shareholders through dividends and share buybacks. It boosted its dividend by 4% last year and plans to start paying a quarterly, instead of annual, dividend this year. It also said it would use share buybacks more actively in the years ahead.

Many of Statoil's peers are also employing similar approaches. Royal Dutch Shell (NYSE: RDS-A  ) , for instance, vows to cut spending from $46 billion last year to $37 billion this year, as it targets greater capital efficiency to boost shareholder returns. Total (NYSE: TOT  ) has also said it expects its spending to fall to $24 billion to $25 billion over the next few years, down from an estimated $28 billion to $29 billion last year.

Meanwhile, BP (NYSE: BP  ) said its spending will be more or less unchanged this year at around $24 billion to $25 billion, though the company expects cash flow to rise dramatically because of major project start-ups and the reversal of working capital build. Like Statoil, the British oil giant promises to return more cash to shareholders in the years ahead.

Will Statoil's move pay off?
In my view, Statoil's decision to enforce stricter capital discipline is an encouraging development. It signals to investors that the company is serious about improving shareholder returns by being more meticulous in its choice of new projects and focusing on value creation over production. Given its strong portfolio of existing and upcoming projects and its demonstrated ability to deliver projects on schedule and within budget, Statoil's new target of 3% annual production growth through 2016 looks achievable.

Major project start-ups this year, including Gudrun, Valemon, Vilje South in the Norwegian Continental Shelf, and Total-operated CLOV in Angola and Chevron-operated (NYSE: CVX  ) Jack/St. Malo in the Gulf of Mexico, combined with existing production from Statoil's North American onshore resource plays, should help deliver organic production growth of around 2% this year.

Beyond that, the start-up of two major projects -- Big Foot in the Gulf of Mexico and Goliat in the Barents Sea -- should help boost annual production growth to 3% through 2016. Goliat, operated by Eni, is expected to begin producing in the third quarter of this year and will have a production capacity of a little under 40,000 barrels of oil per day net to Statoil, while Big Foot, operated by Chevron, will have a production capacity of about 22,000 BOE/d net to Statoil and is expected to start up by late this year.

Despite their massive production capacity, however, large deepwater projects such as these face significant risks such as cost overruns and delays. For instance, Chevron has already warned that Big Foot could be delayed beyond its original late 2014 start-up date because of construction delays. Investors may want to keep an eye out for any further developments regarding delays.

The bottom line
As long as the price of Brent crude oil stays at around $100 and project delays and cost overruns are avoided, the aforementioned projects should generate sufficient organic free cash flow to cover Statoil's dividend from 2016. In my view, the company's new focus on capital discipline and its proposal to change its payout schedule from annual to quarterly dividends may be just the catalyst the company needs to boost its share price and bring its valuation in line with peers.

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