So far in 2017, Total's (TOT +0.00%) management team has made the pivot from preserving capital to growing the business with several new project announcements and joint venture deals. The knee jerk reaction to these moves is that Total's management team sees higher oil prices around the corner, and it wants to grow production to reap the rewards. If you listen to the things that management has said recently, though, this higher oil price environment isn't part of its thinking.
Here are a few quotes from Total's CFO Patrick de la Chevardiere that should give investors more insight into how Total views the future of oil prices, how the company plans to invest, and how it plans to manage the risks its current strategy could face.
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Future of oil prices
It's pretty much a given that on any conference call with an oil company executive, someone is going to ask what that company's oil price outlook is and how that will influence their decision making in the future. De La Chevardiere's response to the question wasn't that detailed, but it did give some idea of what we can expect in the near term.
[C]onsistent with our view, oil price has been volatile this year and unlikely, in our view, to remain so until the market has more clarity on the supply demand equilibrium. For the short term, we don't see any reason, which could explain substantially higher oil price. Nevertheless, the agreement between OPEC and Russia last year is a historic agreement. The recent announcement to extend the cut for 9 months is good news. It demonstrates their commitment to sustain prices. Nevertheless, we see volatility between $45 and $50 per barrel at the moment.
This statement is very much in line with what other executives have said on recent conference calls. There isn't a whole lot of reasons for oil prices to move one way or another right now. Demand for oil continues to grow at a reasonable rate, but production growth is strong right now thanks to the rapid expansion of shale in North America and several long scheduled development projects coming on line. Until something in that equation changes, we're likely stuck in this oil price range for a while.
A better way to look at oil companies
Even though de la Chevardiere gave some indication of where he sees oil prices in the future, he was more interested in having analysts and investors think about the company's profitability in a different way than the direction of oil prices.
I think that instead of predicting oil prices, we remain focused on the things we can control, like reducing the breakeven. This is the best way to face volatility. And this is how Total outperformed its peers since 2014.
This has been an interesting wrinkle that has emerged following the oil price crash. While companies did have breakeven prices for their production, they didn't emphasize it as much because oil was $100 a barrel and everyone in the industry was fat and happy. Today, though, integrated oil producers have shifted their message toward "value over volume" because many have become skeptical of oil prices drifting much higher than $60 a barrel between now and 2020. In that kind of oil price environment, it is more important to find additional barrels that will add cash flow now rather than banking on development projects that are out of the money today but could be profitable a few years down the road.
This thinking seems out of step with Total's production growth plans over the next several years and the decision to spend on new development projects now. If you look at the economics of the sanctioned projects, though, it looks like these new production sources could be high return projects today. One example is its discovery in Uganda. According to de la Chevardiere, Total's capital commitment for this project translates to an operating breakeven cost of $10 per barrel of oil equivalent.
Too much exposure in the Middle East?
Over the past year or so, Total has signed a lot of deals with OPEC producers to be the operator of various projects. First, there was the Al-Shaheen commission in Qatar, then the South Pars gas field in Iran, and now the Halfaya field expansion in Iraq. Of course, the countries in the region aren't what you would call best friends. Iran and Saudi Arabia have been at odds for several years, and then there was the recent blockade of Qatar by the rest of the Persian Gulf Nations.
With significant assets in all of these countries -- Total is a joint venture owner of a massive refining complex in Saudi Arabia as well -- it can make for a delicate situation. Several times, analysts asked about the potential conflicts of interest that Total may have with assets with all parties involved and what kind of detriment it could have to the business if any of these assets were to be shut down for political reasons.
While there is no specific quote to encompass what De la Chevardiere had to say on the matter, the underlying message that he gave was that Total remains a neutral operator that hasn't had any issues thus far. In fact, he did mention that the company had spoken with its counterparts in Saudi Arabia before signing the South Pars deal. He also mentioned that since the company was taking over for former operators in these projects, the capital commitments are rather light.
Perhaps it isn't a problem today, but it is certainly something to consider when looking at Total as a potential investment. If the political situation in the Middle East were to deteriorate for one reason or another, Total has several billion in high return assets at stake.
What a Fool believes
So far, Total's strategic moves to wind down capital spending much sooner than its big oil peers and invest in less capital intense projects such as operating Middle Eastern expansion projects has been a rather effective playbook. The company has vaulted to the top spot among the integrated oil and gas players for returns on equity.
TOT Return on Equity (TTM) data by YCharts.
What's even more encouraging, though, is that the company is more or less preparing its future production growth based on the idea that oil prices aren't going much higher from here for a while. So even though the company has indicated it plans to increase capital spending, it's not reverting to the old thinking that it can bank on rising prices to justify spending today. As long as it doesn't run into any significant risks with these Middle Eastern projects, Total should be well positioned for many years to come.
