Oil majors' cost cuts helping to ease the pain

The British oil majors are set to evade the worst market expectations in the third quarter, as they become ever more resourceful at savings.

Cost cuts accounted for about two thirds of the $300bn (£247bn) fall in oil and gas production spending in 2015-16, an analysis of International Energy Agency data shows. The economies have largely been shouldered by the biggest producers.

Recent reports by oilfield services groups point to increased demand for everything from improved data usage, robots and drones, to cutting-edge deepwater pipe designs. This shows the drive to rein in costs is no less intense despite oil prices bouncing this year from their lowest levels in decades.

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Such measures have already enabled groups like Total, Exxon and Chevron to report better-than-expected downstream operating profits for the third quarter, even if overall profits fell again year-on-year.

It’s a trend that is already evident at UK-listed oil majors. Royal Dutch Shell, which reports third quarter results today, saved £1.8bn in 2015 at its projects and technology division, about the same amount as its core upstream profits in the same year.

Neither Shell, nor rival BP, which also reports today, are expected to increase production significantly this year. Yet both have reduced estimated prices at which they expect oil production to break even to between $50-$55 barrels of oil equivalent from around $60 in the first half of 2015.

And, given that the rate of cost cuts has not yet peaked and new capital expenditure is all but suspended (for example Shell has essentially frozen capex till 2020) breakeven oil prices will fall further.

This new wave of ingenuity among integrated oil companies is well-timed. Refining margins are coming under pressure in the same way that crude oil production profits did. Refining kept the oil industry afloat over the past few years, but downstream earnings are expected to fall sharply in the third quarter.

One hope for the largest integrated energy producers lies in an unforeseen benefit from US environmental regulations. Rules designed to boost ethanol levels in gasoline award credits to participating companies, whilst demanding that those who don’t join in—often smaller producers—must buy credits to comply.

An analysis by US refinery operator CVR says up to $1bn could be reaped this year from ethanol credit sales, including by Shell and BP. If CVR’s analysis is correct, British oil majors may see refining margins tail off, rather than crash, as they did at Chevron, which saw downstream profits drop 50 per cent in the third quarter.

It is a big if, particularly at BP, which guided that “industry refining margins will continue to be under significant pressure” in the quarter. The caution itself reflects a prudence born out of oil price adversity. It also allows the widest possible leeway for managing expectations in the medium term, particularly dividend expectations.

Anxieties about dividends remain a major concern for oil company investors. Dividends at both Shell and BP have been flashing the traditional orange alert about risks to sustainability for some time, given that they’re well above the FTSE 100 average.

Concerns have been most acute on Shell, where profit collapsed about 70 per cent in the second quarter, and which has been impacted by sabotage in Nigeria, whilst it struggles to reduce debts following its BG buy.

Analysts have nevertheless grown more optimistic about third quarter profits for both Shell and BP in recent weeks.