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The air is very thin at the altitude where Big Oil operates. Second-quarter results were a breathless mix of missed expectations, rising costs, lower upstream production, and deteriorating downstream operations. Analysts say investor interest in the big energy companies has rarely been lower. In a recent Morgan Stanley ranking, energy stocks are the cheapest of a group of sectors on a forward earnings basis – 12.9 times compared with 13.6 times for financials and 16.4 times for healthcare.
Europe's oil majors – Royal Dutch Shell, BP, Eni, Total – reported second-quarter earnings nearly 10 per cent below consensus estimates. The U.S. supermajors also floundered. ExxonMobil's second-quarter net income of $7-billion (U.S.) was less than half the level of a year ago; Chevron's earnings decline was the steepest in four years. Blame a combination of groupthink and complacent finance operations for the deviation from the consensus.
The sector's biggest problem is declining returns on continued high spending. In a recent study Citi Research found that the return on capital employed from a group of 30 oil and gas companies was just 9 per cent on average in 2012 and was set to fall by another 100 basis points by 2015 (assuming Brent at $100 a barrel). That compares with levels of ROCE approaching 20 per cent in the middle of the last decade.
The returns that Big Oil gets on the money it spends depend on several factors. One is whether it is invested in oil or gas – and much of it was invested in U.S. gas developments before the collapse of the gas price. Now investors are paying the price. Shell took a second-quarter writedown of $2-billion on its $24-billion of capital tied up in U.S. shale gas. Exxon has cut back on its share repurchase plans. Dividend rises in the quarter were minimal.
Yet the sector is not cheap. Big Oil has trailed the broader market, but the U.S. supermajors are at five-year highs with European peers not far behind. The lack of operational momentum is now a real threat to further shareholder returns from a bloated and complacent sector.