What's Causing European Oil Majors So Much Pain?

A slew of European oil majors reported weak production and profits in 2013. Companies including Eni (NYSE: E  ) , Royal Dutch Shell (NYSE: RDS-B  ) , and Statoil (NYSE: STO  ) are encountering difficulties in keeping production growth going in the right direction. They're suffering from a variety of issues, the most prominent of which are ongoing security challenges in the Middle East and Africa that are causing supply disruptions.

Going forward, investors should temper their expectations. Not only are those overseas supply disruptions expected to remain for the foreseeable future, but harsh cuts to capital expenditures will place an even greater strain on production in the months ahead.

Supply disruptions overseas
Eni and Royal Dutch Shell are each going through a very difficult situation in Nigeria. Both companies have highlighted the escalating security challenges in their Nigerian operations as cause for concern. In addition, Eni is suffering from labor disputes and other problems in Libya. This is particularly troubling for Eni, since it's the biggest oil producer in Libya. Royal Dutch Shell has reported oil thefts in Nigeria, which is casting a dark cloud over the company's near-term outlook.

All told, the security challenges in the Middle East and Africa are having a significant effect on output. Eni produced 1.58 million barrels of oil per day in the fourth quarter, compared to 1.75 million barrels of oil per day in the same quarter last year. That amounts to a nearly 10% decline. Royal Dutch Shell's total production of barrels of oil equivalent fell 5% in the fourth quarter, year over year.

This casts doubt on whether the companies can hit their production targets, since they generate more production from international operations than they do in North America. Further complicating matters are the aggressive cost cuts they have planned this year and next.

European majors cut spending, increase cash returns
Eni, Royal Dutch Shell, and Statoil are laying out extremely similar plans over the next few years. Each company has notified investors that they'll be enacting strict discipline over capital expenditures. In addition, they intend to keep raising cash from divestitures.

Eni will reduce its spending over the next four years by 5% per year. Shell's planned cuts are even harsher. It will reduce capital expenditures to around $37 billion this year, down from $46 billion the year before. In percentage terms, that represents a nearly 20% decline. Statoil's management intends to cut spending by more than $5 billion from 2014 to 2016 as compared to previous plans.

To smooth things over with investors who fear these harsh cuts will come at a severe cost to future growth, these majors are going to increase cash returns to shareholders.

Eni, Royal Dutch Shell, and Statoil have each stated their intentions to raise dividends in the upcoming years. Eni plans to increase its dividend by roughly 2% this year and in 2015. Shell expects to bump up its own payout by 4%. Statoil plans to pay two quarterly dividends in addition to its regularly scheduled annual payout next year.

While increased dividends look great on the surface, they're a short-term fix to calm their investors' fears. Questions surrounding their long-term growth should take precedent over small increases in their dividend payments.

Investors should question growth potential
European majors Eni, Royal Dutch Shell, and Statoil are each planning to aggressively cut costs and sell off assets to raise cash. Eni expects to generate 9 billion euros from disposals. Shell is even more aggressive, since it wants to raise as much as $15 billion by the end of 2015. For its part, Statoil has divested $18 billion of assets since 2010.

This means that each of these companies is a slimmed-down version of their former selves. Their focus on capital discipline is admirable, and investors are likely pleased to receive higher cash dividends going forward. However, maintaining capital expenditures is necessary for oil and gas companies to keep growing. In other words, their future growth may not reach expectations. Each company expects to deliver production growth in the low-to-mid single digits over the long term, but they will have to maximize their existing projects in order to reach their goals.

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