Big oil has long been synonymous with big spending. Companies like ExxonMobil (NYSE:XOM), Royal Dutch Shell (NYSE:RDS-A), Chevron (NYSE:CVX), and Total (NYSE:TOT) have annual capital budgets in the tens of billions, dwarfing those of almost any other industry.
But now, investors are placing renewed pressure on big oil companies to reduce their massive capital spending programs, and to return that cash to shareholders through dividends and share repurchases. Let's take a closer look.
Big oil's spending debate
With the era of "easy oil" behind us, most oil majors are ratcheting up spending as they attempt to boost production by drilling in costlier, unconventional plays around the world, including North American shale and deepwater prospects off the coasts of Africa and Brazil. But higher spending has so far been unable to deliver commensurately higher returns, with most majors struggling to boost output.
At the heart of big oil's spending debate is the notion of striking the appropriate balance between reinvesting cash into their various business lines, and returning cash to shareholders. Many investors insist that the appropriate balance is to stop spending on megaprojects, where returns are either uncertain or much longer-term in nature, and to instead return cash to shareholders.
Indeed, big oil companies that have heeded shareholders' calls have so far been rewarded through a higher share price. Consider Total, for instance. The French oil giant recently announced that its capital spending will peak this year, and that capex will fall to $24 billion to $25 billion in 2015 to 2017, down from $28 billion to $29 billion this year.
Spend, spend, spend
The markets rewarded the company's decision to taper capital spending while still maintaining its production growth targets by sending shares almost 25% higher since July. But Total is somewhat of an anomaly. The rest of the largest western oil majors aren't planning to slash spending by nearly as much, or at all.
Shell is perhaps the worst offender in this respect. The Hague-based oil giant recently announced that its net spending this year will come in at $45 billion, roughly $5 billion more than the company had previously guided for. Similarly, Exxon announced earlier this year that it will boost annual capital spending by about $1 billion annually over the next five years, which comes out to a record $38 billion a year.
Chevron has also indicated that its capital spending this year will be roughly 10% higher than it had previously guided for, though the company suggested, in its most recent quarterly conference call, that spending will likely level off over the next few years.
A longer-term investment approach
Seeing the oil majors splurge on megaprojects while being unable to deliver decent production growth must obviously be frustrating for investors. But it's important to remember that many of them are investing for the longer term. Take Shell and Exxon, for instance, which have both invested heavily in LNG projects around the world.
As a result of the massive up-front capital expenditures these projects require, capital budgets at both companies are quite front-end loaded. But once that initial investment has been made, things get a lot easier. That's because LNG projects are long-life assets that require little reinvestment after going into service, while generating decades of strong and reliable cash flows.
The bottom line
While the markets have rewarded big oil companies planning to cut spending over the next few years, I don't think long-term investors should overlook oil majors that are keeping their massive capital spending programs intact. Exxon and Shell, in particular, have used much of their capital to cement dominant positions in global LNG projects that should serve them quite well over the long term.