When you handicap Total's (TTE 1.10%) earnings results over the past couple years, the company has put together a rather impressive streak of results. Cost cuts, high rates of production growth, and select investments in refining, chemical, and marketing assets have translated into the highest return on equity among the integrated majors.
To remain the best in the business, Total is going to have to make investments in the right places, and probably look to shed itself of some assets. On the company's most recent conference call, management talked at length about some of the challenges it foresees in the coming years as well as some of the opportunities it can take advantage of today. Here is a selection of quotes from Chief Financial Officer Patrick de la Chevardiere that highlight the obstacles and opportunities ahead of the company.
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A new place to invest
This past quarter, management started breaking out a new business segment for reporting: gas, renewables & power. This segment includes all of its investments in alternative energy such as its equity interest in solar panel manufacturer SunPower and wholly owned battery producer Saft. It also includes its LNG trading platform. Since it was the first time the company broke out these results, de la Chevardiere went out of his way to give the details of this business even though it contributed such a small portion of overall results.
Gas, Renewables and Power contributed $61 million of adjusted net operating income in the first quarter, compared to $73 million a year ago and $132 million in the previous quarter. The bulk of the GRP results are coming from our well-established Downstream gas business, including LNG trading. These businesses are growing steadily and delivering results. The results also include our new battery business from the Saft acquisition last year. And we are pleased with the way it is performing. We cannot comment on some of our results, but I think most of you know this is a difficult time for Upstream solar cell producers. Looking forward, I remind you that we are expanding our organic business, including new opportunities with LNG [ as a fuel ] in Ivory Coast, Pakistan, and Brazil, as well as a new partnership in Singapore for LNG bunker fuel.
It's working off of a small base, but Total expects this business to generate $1 billion in cash from operations from this business segment by 2020. Chances are, most of those gains will come from the LNG trading side since its investments in renewable power are still in their nascent stages.
Using divestitures to pay for new growth
Every integrated oil and gas company has some sort of asset divestiture plan. For Total, it wants to shed $10 billion in assets that could be deployed in more effective ways. According to de la Chevardiere, the company is almost finished with this divestiture, and those proceeds have been put to work on some of its most recent investments.
The first quarter includes a $3.2 billion Atotech sale. With Atotech, we are close to delivering on our $10 billion objective and we plan to finalize it for gain in 2017. We announced the sale of mature fields in Gabon for $350 million in the first quarter. We are discussing the sale of our TotalErg retail business in Italy and some E&P assets in the North Sea. Asset sale proceeds increase our ability to take advantage of the current environment and add resources to the portfolio, as we have done in recent deals in Brazil, Uganda, and the U.S.
While the company is close to finished with this $10 billion target, there is a possibility the company could go over this target soon. Later in the call, Chevardiere confirmed that it is considering selling its stake in the Fort Hills oil sand project in Canada. If it were to do so, chances are it would command a multi-billion dollar price tag.
The dividend debate
Total avoided the painful step of cutting its dividend during the recent price collapse because it enacted a scrip dividend. By paying investors with additional shares in lieu of cash, it was able to maintain current payout rates while reducing its cash outlays -- and even netting some cash from the issuance of shares. A company can't offer a scrip dividend forever, and some analysts asked how much longer de la Chevardiere plans on keeping it in tact. Surprisingly, he said he foresees the company maintaining this scrip dividend for a while
Obviously, we had a strong free cash flow this quarter but the environment remains volatile. And we see recently last week, the oil price, it's going down by $7 per barrel. We reduced the discounts to 5% for the scrip dividend for the last 2 interim dividend payments. And the take-up was good, I'll remind you, at 60%. We will remove and we repeat it. We will remove the discount on the scrip if Brent is at $60. We are not at $60 and far from $60 today. By removing the discount on the scrip, we are confident that take-up in shares will be minimal. But we might buy back some shares if Brent is about $60 and take-up is high, even at 0 discount. To be complete on this question, we will focus to the AGM in May, to extend the scrip for one more year because of the volatility of the market.
Previously, investors received a 10% share price discount to take shares instead of cash as part of this scrip dividend. As long as we don't see oil prices consistently at a higher rate, management expects to keep this current plan in place.
A great time to invest in new projects
One story making its rounds in the oil and gas market is that oil services companies are starting to demand higher prices for equipment & services. This could be concerning for Total and others because they are able to turn a profit at today's prices in large part because of lower oil services costs. If producers had to start paying more at current oil prices, then investors can throw any chance of making a decent profit out the window.
According to de la Chevardiere, this isn't necessarily the case. While there are some pockets of the market where oil services prices are on the rise, there are others where producers are still in the driver's seat when it comes to price.
As of today, honestly, we don't see cost increasing in the medium-term outside of the U.S. Investment levels remain low. There is less competition internationally, with many U.S. and European independents having gone home. And the U.S. majors focusing more on the onshore U.S., as well. And the capital cost came down by more than 30% since 2014, that was a peak. The market may be bottoming out, but we don't foresee any increase in our core areas like deep offshore or LNG. They are, obviously, courting our purchasing teams, indications that contractors are extremely hungry for business. So in our view, it is now the time for us to sanction new projects. We want to harvest the benefit of this low-cost environment.
This suggests that Total and others with deep pockets to sign up equipment to long-term contracts now. By locking in low rates for equipment like offshore rigs into long-term contracts, they could prove to be incredibly valuable five to 10 years from now.
Troubles for a fast growing market?
Total is betting big on LNG in recent years. It doesn't have as much LNG infrastructure as some of its larger peers, but it has big plans for the Yamal LNG facility in Russia, a proposed facility in Papua New Guinea, and a recent investment in a prospective LNG export facility in the U.S. One of the compelling aspects of investing in LNG is that it is a fast growing market relative to the broader oil & gas market, and the regional price discrepancies for natural gas made for some compelling arbitrage opportunities.
As companies invest in LNG and vessels transport more and more product, that arbitrage opportunity has eroded. According to de la Chevardiere, the economics of LNG are changing such that the company could be headed for some issues related to its legacy contracts down the road.
First thing to understood is that LNG price remains above the consolidated of the average realized gas price. At least, that was true the first quarter of this year. Our price rate guidance was about 20% of the volume and 30% of the results. I don't change that... The market is not so bad for our existing contracts today. What might be more difficult in the future is to market additional production coming from the market. This may be difficult on deals, I would say, late 2020.
Companies with higher cost facilities are going to suffer in the coming years despite fast-growing demand. American shale gas prices are so low that any U.S. based facility has an immense price advantage over other parts of the world. While the company is investing in U.S. based LNG today, many of its other LNG facilities could struggle as de la Chevardiere suggests.
