The first quarterly earnings reports since the collapse of oil prices are in and the numbers show a significant deterioration in profits for the oil majors.
Royal Dutch Shell (NYSE:RDS-A)(NYSE:RDS-B) went first on January 29, revealing a big jump from the same quarter a year ago, but down from the third quarter of 2014. In fact, Shell announced that it would cut $15 billion in spending over the next few years, an about-face from just a few months ago when it stated that it would leave capital expenditures unchanged in 2015. Shell's CEO, concerned about the poor state of oil and gas markets, said that it may even consider withdrawing itself from significant assets held around the world, retrenching and focusing on North America.
On the same day, ConocoPhillips (NYSE:COP) also reported gloomy numbers. It plans on slashing 2015 spending by an additional 15 percent, which comes after a December announcement of a 20 percent cut in expenditures for the year.
Chevron followed that up on January 30, posting its worst showing in five years. The $3.5 billion in earnings for the fourth quarter of 2014 was 30 percent lower than from the previous year. The California-based oil major says that it will trim spending by 13 percent.
And on February 2, ExxonMobil (NYSE:XOM) reported a drop in earnings from $8.4 billion in the fourth quarter of 2013 down to $6.6 billion for the same quarter in 2014. The company blamed almost the entirety of its 21% fall in earnings on lower oil prices. ExxonMobil was alone in not revealing its spending plans for the rest of this year, pushing off an announcement until March.
BP (NYSE:BP) is expected to fare worse. Analysts expect a sharp decline in quarterly earnings, a result that goes beyond falling oil prices. BP is heavily exposed to Russia's deteriorating economy, and should see earnings suffer as a result. The British oil giant is set to announce its quarterly earnings before the markets open on February 3.
The earnings reports underscore the volatility of the oil business and the vanishing profits for these corporate titans now that oil prices have tanked.
The big question is how long the oil majors can maintain their status as attractive investment vehicles, which hinges on their generous dividend and share buyback policies. Chevron (NYSE:CVX) announced that it was freezing its share buybacks for this year, saving the company $5 billion annually. Shell's CEO Ben van Beurden strongly affirmed his company's commitment to its dividend, which it has not cut since 1945. The dividend payment is an "iconic item at Shell, I will do everything to protect it," van Buerden said in an interview.
BP agrees. "We will be able to preserve the dividend. It is absolutely our rock solid intention," BP CEO Bob Dudley said at the most recent World Economic Forum in Davos.
Terrified of losing their darling-status with shareholders by trimming dividends, big oil companies are charting a risky course: maintain costly dividends by slashing spending, at the risk of seeing long-term production decline.
Bringing future oil projects online from harder to reach places facing extreme conditions – ultra-deep and pre-salt offshore, Arctic, and marginal shale oil – will require higher and sustained levels of spending.
"The projects that are going to meet demand going forward are more complex than 20 or 30 years ago, and so the costs of the projects will be higher, and will require a higher price than we're seeing today," Chevron's CEO John Watson admitted when announcing his firm's results.
Crucially, existing oil field production suffers from decline every year, requiring a constant influx of new projects to offset depletion. The decline rate varies – it can be anywhere from 5 to 7 percent per year for conventional fields, but it can easily be ten times that rate for shale.
The problem for the majors is that the current price of oil can't support expensive new projects. Each of them is scrambling to divest and slash spending to bolster their bottom lines. But that merely ensures that supplies will tighten soon enough as production stagnates and begins to dip.
As a result, prices will shoot up. Indeed the rally may already be under way.