Big Oil is making big profits again. Here’s what they’re doing with the cash

July 30, 2021, 2:04 PM UTC

Here’s the word that oil and gas CEOs can’t stop saying this week: “buybacks.”

As oil and gas companies large and small began announcing a wave of supersize profits for the second quarter this week, driven by sharply rebounding oil prices, it was clear what executives are choosing to do with the extra cash: make wary investors happy, especially after a year of bruising losses and pressure over climate change.

On Friday morning, Chevron kicked off the pledges to bring back the buyback, announcing alongside its second quarter results that it would resume purchases between $2 billion and $3 billion per year, beginning this quarter.

The oil giant announced a $3.3 billion adjusted profit in Q2, compared with a $2.9 billion loss in the second quarter of 2020.

Exxon Mobil was an exception; it did not report buybacks, but it has also kept its dividend steady throughout the pandemic. On Friday, the company reported a profit of $4.7 billion in the second quarter.

Chevron’s announcement came a day after Shell said it would spend $2 billion on a share buyback program by the end of 2021, alongside a 40% dividend hike that was so unexpectedly large it “caught the market a bit unawares,” said Tom Ellacott, senior vice president of corporate research at consultancy Wood Mackenzie.

While buybacks and dividend hikes have been announced across sectors suddenly flooded with cash, the oil majors’ approach follows a simple logic. Rising oil prices driven by reopening economies and surging demand has pushed up profits, which has helped majors pay off the debt accumulated during the COVID-19 bust far earlier than expected.

Rather than plowing those returns back into reversing 2020’s steep operating cuts, investing in production growth—or even bumping up their investments into transitioning toward clean energy—they have instead largely chosen to prioritize keeping investors on side.

Lower debt, higher returns—happier investors?

Since the start of this year, Brent and WTI crude oil contracts have risen around 50%, as demand has rebounded and economies have strengthened; both contracts rose at least 16% in Q2 and ended June at multiyear highs in the mid-$70/barrel range.

That meant Shell, which cut costs by $5 billion in 2020, was able to hit its target to reduce debt to below $65 billion, said Shell CEO Ben van Beurden. (Or close enough: Debt was actually $65.7 billion at the end of Q2.) That in turn kick-started pledges to restart shareholder returns cut back during the pandemic.

“We are very clearly looking with confidence at what’s next,” van Beurden said in an interview with Bloomberg TV. Shell’s net earnings for the quarter were $5.5 billion, up from $3.2 billion in Q1 and from just $638 million in the same quarter of 2020.

Shell, which has said it will target net zero by 2050 and has been ordered to reduce its emissions still faster by a Dutch court, said last year that it would devote 25% of its overall capital expenditure to clean energy by 2025—a proportion that could eventually total up to $5 billion annually, according to Reuters. However, as with the other majors, the company did not announce an increase in spending this quarter.

On Thursday, French energy giant TotalEnergies announced it, too, would increase its share buyback program, noting that if oil prices hit an average of $68/barrel this year—“and we are not far,” added CEO Patrick Pouyanné in a call with investors—that could mean a $1 billion program.

Eni, the Italian energy major, also said Friday morning it would hike its dividend back to pre-pandemic levels.

If prices stay high, that could mean that the largest oil majors’ balance sheets will have essentially recovered from the pandemic by the end of this year, said Ellacott.

‘A higher hurdle rate

Energy companies have long lured investors not just with their supersize profits in times of oil booms, but their reliable pledges of consistent returns for shareholders.

But the game has changed over the course of the past year, analysts say; while a reliable dividend may have been enough to bring in investors before, the bar is now higher.

This “shows that ESG is working,” said Aniket Shah, managing director and global head of environmental, social, and governance (ESG) and sustainability research at Jefferies Group. “Investors realize that there’s a higher hurdle rate that they need, because there are many, many risks associated with investments in this space.”

The waning enthusiasm is obvious, senior U.S. oil and gas analyst at Bloomberg Intelligence Vincent Piazza pointed out.

“The interest level, the sentiment really isn’t there, even with a significant recovery in WTI oil and Henry Hub gas,” the key U.S. gas benchmark, he said.

While the larger majors have more financial strength to deleverage, entice back investors, and talk about transitioning their businesses, the smaller independent companies that fueled the U.S. shale boom went into the pandemic with far more debt, and face more immediate questions of survival in an industry that is shrinking and consolidating, Piazza said.

But even those larger energy majors face a delicate balancing act in which they must keep a wide range of investors on side: not just those who are skeptical of oil majors’ willingness to hit net zero by 2050 targets, but also investors who want assurances that they won’t have to give up the kinds of oil market returns they’ve come to expect.

For those investors, increasing dividends has the benefit of signaling confidence, while buyback programs provide the option of flexibility. And if oil demand once again heads south, they’re easier to cut without inciting blowback, Ellacott pointed out.

As for whether that money could be better spent on making the kinds of investments necessary to transitioning their businesses away from fossil fuels, that can seems to have been kicked down the road to 2022.

“I think this year is really to batten down the hatches,” said Ellacott.

If the cash keeps coming, companies might then start looking at how—other than on keeping investors happy—to start spending it.

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