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Wood Mackenzie: Deeper cuts may be needed to achieve cash flow neutrality

The rapid and aggressive response by oil and gas companies to low oil prices has stabilized the sector; the price required for companies to be cash flow neutral in 2015 has dropped by more than $20/bbl to $72/bbl, Wood Mackenzie stated in a news release. The firm believes further cuts will be required to achieve cash flow neutrality if oil prices remain around current levels. For some companies, this will mean selling assets; others may suspend or limit dividend and buyback programs.

“Capital cost cutting has been both rapid and, in some cases, dramatic,” Tom Ellacott, Head of Corporate Upstream Analysis for Wood Mackenzie, explained. “Individual companies have had one, two and sometimes three bites at the cherry, and industry has for the time being settled on a 24% or $126 billion fall year-on-year. Dividends and share buyback programs have also been targeted, while companies have turned to both the debt and equity markets to boost liquidity.”

“Two peer groups are particularly interesting. For the majors, cutting or suspending buybacks have been the key levers which have contributed to a 25% reduction in cash flow breakevens,” Mr Ellacott continued. “For the smaller North American onshore players, the ability to rapidly dial back spend has been a key competitive advantage. Some players have cut costs by up to 80%, and these companies join a select group with cash flow breakevens below $60/bbl.”

While stock market performance indicates that investors believe there will be an oil price recovery, Wood Mackenzie says that a period of sustained prices at $60/bbl will need further measures to conserve cash. “The Q1 results will underline how much still needs to be done if oil prices do not continue to recover,” he said. “More cuts to dividends and buybacks are likely if $50-60/bbl prices persist.” But Mr Ellacott said he believes there are opportunities for the financially strong, as evidenced by Shell‘s $82 billion offer for BG.

Wood Mackenzie’s analysis shows there is a huge inventory of assets on the market, with 340 potential deals worth more than $300 billion. However, activity has collapsed. “Buyer and seller expectations remain far apart, and buyers of material size are limited to the most financially secure,” Mr Ellacott said. “But a buyer’s market in M&A might emerge as companies are forced to sell assets to balance the books. The $300 billion question is: With Shell having made the first move, who will follow?”

In closing, Mr Ellacott said: “Investors will be watching the upcoming Q1 results season for indications of how effective the reaction to oil prices at below $60/bbl has been. Companies are facing a choice of paring-back investment or maintaining momentum throughout the cycle, depending on their financial position. There is a high degree of optionality regarding planned spend in 2016 and 2017, much of which is discretionary. How companies react to this strategic challenge will affect their production growth and positioning in the future.”

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