Monday, July 31, 2006

Until This Changes, Don’t Expect $2.00 Gas…

Not quite a year ago, in the halcyon days when oil was trading at a mere $65 a barrel, I noted (in “Why We Have an Oil Crisis, Or; Wait 'Til Chuck Schumer Gets a Load of This,” September 25, 2005) that British So-Called Petroleum was spending more on dividends and share repurchases than on finding oil.

Seven billion dollars more last year, in fact.

I am not making that up. The Investors Relations person of British So-Called Petroleum told a group of investors back then that it made no sense to plan its exploration spending based on $65 a barrel crude oil when everybody knows crude oil prices fluctuate—so BP was using a more conservative oil forecast when calculating where and how to invest its unstoppable cash flow.

How conservative? If you guessed $50 a barrel, you would be wrong. If you guessed $40 a barrel, you would also be wrong. Not even $35 a barrel would have been close.

No, the crude oil forecast British So-Called Petroleum was using in its forecasts was $20 to $25 a barrel.

I am not making that up, either.

I suggested that BP should change its name to "British Dividends & Share Repurchases," my point at the time being that the energy crisis wasn’t like to end so long as the major oil companies felt compelled to return more money to shareholders than they spent exploring for new sources of crude.

Now, you might think that given, 1) the rising political heat, and 2) the fact that crude oil is now over $70 a barrel, the majors would have re-thought their low-prices-forever forecasts and started pushing the pencil on more expensive projects that would help bring more supply on the market.

But just last week, Exxon Mobil announced earnings, and while the headlines in the mainstream media all focused on the so-called obscene profits now falling into the lap of the world’s largest largest oil company, not much has changed: the world's largest bank—er, oil company—spent $5 billion on capital projects, including oil and gas exploration.

But it spent $8 billion making its shareholders richer.

Personally, I think the U.S. government's Detroit-Friendly energy policy of the last 30 years has been dead wrong, and we're getting exactly what we deserve. The windfall profits tax stuff floating around Washington these days is the usual shoot-the-messenger grandstanding my own Senator Forehead, Chris Dodd, practices every time a crisis comes along.

But with Big Oil getting $70 a barrel and giving more of it to shareholders than to drilling companies...they're asking for it.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


RDS said...

Where should Exxon and BP drill new wells? Nigeria? Venezuela? Ecuador? California? Coastal Florida? Russia? Iran? Iraq? An-wah?

MattKelly54 said...

With institutional investors making more allocation to oil, it does not really matter where the major oil companies allocate capital. By returning it to shareholders, they are allowing them to put more money into E&P companies, oil sands, or others. Your analysis is flawed. But you are accurate on your analysis of how the government interprets the the capital allocation so in the end you are probably right. The Schumer et al are idiots.

supplysider said...

Great blog, but there was an obvious error in today's post. A dividend does NOT make a shareholder richer. Its simply a transfer of capital from the company to the shareholder.

The problem's not with big oil, its with policy. Monetary instability coupled with, more recently, an increase in geopolitical instability, has short-circuited the price signal. When the value of the unit of account is stable, a price increase is assumed to be 'real' and hence a signal to add capital. When the value of the Dollar is all over the place as a result of wild swings in monetary policy, the market will have less confidence that price changes are 'real.'

Throw in a healthy dose of geopolitical uncertainty, which leaves the market uncertain of how much of the recent price increases are temporary or permanenet, and you're left with a market that seems afraid to commit sufficient capital to bring prices back into equilibrium, even at these levels.

But don't blame big oil. Their shareholders are more that welcome to plow those dividiends back into oil-producing ventures if they so wish.

ptkelly said...

really, what's your point here?

yes all politicians are idiots. (have you heard about the chicago city council's recent proposal?)

would you really rather have the oil companies invest YOUR capital at a lower marginal return b/c they are idiosyncratically the target of "windfall profits" taxes or let YOU reinvest it at "normal" tax rates and, all else equal, with higher returns?

Its_strange said...

Looks to me the dividends are used to devour more energy. More cars, cars for the kids. Bigger cars. Big homes, vacation homes and all climate controlled. It takes alot of energy to distract oneself form Iraqi , the money we borrow , the money our Gov borrows.. Energy is the new opiate..

Its_strange said...

" No longer give ( his) directorship at OSTK the effort it deserves " ...You gotta be kidding me Mr Byrne. That is as silly as your sons " steal of a lifetime " comment. ....I drive a forklift for a living but i gotta tell you wallstreeters and i'm not trying to be obnoxious....Some of you people seem pretty dumb and stupidy to me

Alex Khenkin said...

"A dividend does NOT make a shareholder richer. Its simply a transfer of capital from the company to the shareholder."
Yes it does. A minority shareholder has no other way to directly benefit from the company's profits. Allowing the self-serving hired managers to "invest" (read - "waste") the profits on empire-building projects or on obscene bonuses for themselves does no good to the owner. Paying out dividends is the only discipline that can restrain these clowns.
Small Investor Chronicles

Alex Khenkin said...

Jeff, not for posting - moderation really does suck the life out of your blog. IMHO, of cource.

oilyfuture said...

There price targets maybe off a little, but not much. If you are going to start a project that will take 5 or 10 years, i think you would be stupid to "assume" oil will be above 50 or 60 a bbl. My guess is they have some executives that were around in the 70s and understand the 70s were followed by the 80s and 90s with very low oil prices.

The reality is big oil has less and less opportunities to invest in production. A BW article indicated only 11% or world reserves are available for them to exploit. The reason for this is nationalization and psuedo nationalization by state owned oil companies (aka yukos takover, CNOOC). The result is there are 1) not many projects available, 2) they are being overbid by state owned companies that can't make a profit on it and 3) if you start on a long term project that will not make money unless oil stays above 60 and 4 years from now oil goes to 40 your in trouble.

The point to remember is that oil was at 10$/bbl in 1999. That is only 7 years ago. These long term projects can take longer than this to start paying off. The only way to smartly run an oil company is to ignore the short term commodity bubble and focus on the long term.

Jeff Matthews said...

"oilyfuture" is exactly right, on all counts, although there are occassion in economic history where oil has gone to 'permanently higher' plateaus.

Nobody is sitting around waiting for oil to back to the $2.00 a barrel price of the early 1970's. Yet the majors appear to be waiting for it fall back to the $10 level of the late 1980's.

And until that mindset changes, oil prices will not go down to that price. Excess returns on capital normally attractive excess capital. In this case, it hasn't yet happened.

When the majors finally throw in the towel and start drilling based on higher-oil-prices-forever assumptions, we'll get BP's $20-25 target.

But not until then.