The oil industry is extremely capital-intensive. Oil wells don't produce forever. Many see their output steadily declining before running dry. Producers must stay ahead of this decline by reinvesting capital into new wells and related infrastructure.
Some producers earn higher returns on their reinvested capital dollars than rivals. Here's a look at the return on invested capital (ROIC) among some of the largest integrated oil companies using data from New Constructs.
Drilling down into the data
ROIC helps measure the profitability of a company's investments as a percentage of its debt and equity capital. New Constructs' ROIC formula is net operating profit after taxes (NOPAT) divided by average invested capital.
Here's a look at the ROICs of BP (BP -0.38%), Chevron (CVX 0.37%), ExxonMobil (XOM -2.78%), Shell (SHEL), and TotalEnergies (TTE 1.10%) and how that compares to their weighted average cost of capital (WAAC).
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As that chart shows, Exxon and TotalEnergies reign supreme over the rivals with a 13.5% ROIC over the last 12 months. That metric implies that their management teams are investing in profitable projects.
It's also worth noting that the ROICs of both companies significantly exceed their cost of capital. That's important because it suggests their investments are creating value for shareholders after factoring in debt and equity financing. While that's the case across the board, TotalEnergies has a much wider spread between its ROIC and WACC than Shell, suggesting it's making more money on its investments for shareholders.
Focusing on investing for returns
The oil industry has shifted its mindset in recent years. Producers have gone from drilling to grow oil and gas production at all costs to focusing on investing capital to earn high returns that grow earnings and shareholder value.
That's evident in ExxonMobil's long-term investment strategy. The oil behemoth's corporate plan is to invest $20 billion to $25 billion in capital annually through 2027. The company noted that this "disciplined approach prioritizes high-return, low-cost-of-supply assets in the upstream and product solutions businesses." By investing for returns, Exxon expects its earnings and cash flow to double by 2027 from 2019's baseline without assuming higher commodity prices.
Exxon has also taken its disciplined returns-focused approach to its lower carbon investments. For example, Exxon plans to reconfigure existing refineries to produce biofuels instead of building new greenfield projects. Reconfiguration projects can earn 15% to 30% returns, while the returns on new greenfield projects range from 8% to 15%.
TotalEneriges also takes a value-over-volume investment approach. That helped it deliver the highest return on average capital employed last year among its rivals at 28%. The company seeks to invest in capital projects that earn high returns while producing lower emissions. It focuses on high-return oil and liquefied natural gas projects. It's also building out a cost-competitive renewable energy business. This returns-focused investment strategy is enabling TotalEnegies to generate growing profits and cash flow, giving it more money to invest and return to shareholders.
While Exxon and TotalEneriges currently lead the sector, Chevron is working hard to improve its returns to create more shareholder value in the coming years. It has delivered a peer-leading improvement in its return on capital employed over the last five years. It targets to get that metric above 12% by 2027. Improving investment returns is part of Chevron's strategy to grow its free cash flow by more than 10% annually over that timeframe. That would give Chevron more cash to increase its dividend and buyback shares.
Drilling for returns
Oil companies have become a lot more focused on investing for returns in recent years. That's enabling them to grow their earnings without relying on higher prices. It's giving them more cash to return to shareholders via dividends and buybacks, which should help boost their total returns over the long term.
Exxon and TotalEnergies currently earn the highest ROIC compared to their rivals. If they can maintain their lead, they could grow shareholder value faster than rivals in the future.
