"Show me the money! A-ha-ha! Jerry, doesn't it make you feel good just to say that!"
--Rod Tidwell, Jerry Maguire
Last week investors weren't subtle in their message to the oil industry's supermajors: Cut the expensive growth projects, divest low-returning assets, and line our pockets with dividends and buybacks. To borrow the famous phrase from Rod Tidwell, all shareholders had to say to big oil last week was "Show me the money!"
But is this the best policy or are investors being short-sighted?
After reporting third quarter results, oil majors vowed to reign in spending and return more capital to shareholders. BP (NYSE:BP) was the most aggressive in this regard. Management hiked the company's dividend nearly 6% and promised to ramp up asset sales. BP is now targeting $10 billion in divestments over the next two years -- up from the previous target of $4 billion to $6 billion. Shares were up over 6.5% last week.
ExxonMobil (NYSE:XOM) promised smaller changes. The company returned $5.8 billion to shareholders during the third quarter, through it did not raise its dividend payout. Management also indicated that they expect capex to subside next year, which could free up room for a bigger payout in the future. Shares were up 2.6%.
Meanwhile Simon Henry, CFO at Royal Dutch Shell (NYSE:RDS.A), warned of the dangers of cutting back on investment: "10-15 years ago the entire industry cut CapEx, obsessed by returns and with the market egging them on, but cutting investment is one of the reasons we've got a $110 oil price." Shell shares fell 5% after the company reported its earnings on Thursday.
Investors have made their view on the matter quite clear.
Is this a good thing?
But does Mr. Henry have a point? Is the current rush for dividends and buybacks just another example of short-term thinking on the part of Wall Street?
I don't think investors have any sort of irrational dividend obsession. The question as to whether a company should return capital to shareholders is simple: Can the business earn a return in excess of its cost of capital? If yes, please, keep my money. I'd rather the company reinvest my funds than bother searching for better investments elsewhere. But if not, management should return excess capital to investors.
So what is the case of big oil? There's some evidence to suggest the supermajors have failed in this regard. Over the past five years, combined output from the top four majors has fallen by 300,000 barrels of oil equivalent per day despite the industry spending hundreds of billions of dollars to grow production. And an increasing proportion of those equivalent barrels is less profitable natural gas.
In the desperate hunt for growth, we've seen the supermajors turning to less profitable and risky ventures. For example, the first phase of Exxon's Kearl oil sands project, located in remote northern Alberta, came in $5 billion overbudget and six months behind schedule. BP forays into Russia have ended up in part with it owning a 20% stake of Kremlin-backed Rosneft, a low return investment of which the company has little control.
Today, investors are increasingly rewarding dividends over growth. ConocoPhillips (NYSE:COP) has been one of the best performers of its peers over the past few years. That's mostly because management has engaged in a policy of spinning off assets and increasing dividends, not growing the business just for the sake of it.
Oil industry shareholders are concerned about poor returns and costly projects. No longer are investors watching production growth, but rather return on capital employed. Conoco and BP have gotten the message. The other oil majors should take note.
Foolish bottom line
So like Rod Tidwell egging on Jerry Maguire, investors should continue to hassle energy executives for more dividends and share buybacks. Repeat after me big oil: "Show me the money!" Doesn't it feel good to say that?