BP and Shell get smarter on cost cuts

The British oil majors are set to evade the worst market expectations in the third quarter, as they become ever more resourceful at savings, whilst U.S. environmental credits may aid downstream revenues.

Cost cuts accounted for about two thirds of the $300bn 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.

We also note recent reports by oilfield services groups pointing 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.

Such measures have already enabled groups like Total, Exxon and Chevron to report better-than-expected downstream operating profits for the third quarter (Q3), even if overall profits fell again year-on-year.

It’s a trend that was already evident at U.K-listed oil majors.

For instance, Royal Dutch Shell, which reports Q3 results on Tuesday 1st November, 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 on Tuesday, 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 Q3.

One hope for the largest integrated energy producers lies in an unforeseen benefit from U.S. 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 U.S. 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% in Q3.

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% in Q2, 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 Q3 profits for both Shell and BP in recent weeks.

Average earnings expectations for both have risen a few cents apiece over the last month judging by Thomson Reuters I/B/E/S consensus forecasts.

BP’s Q3 EPS is now seen at 25 cents, about 57.6% lower on the year, whilst Shell is expected to make 44 cents a share, down about 20%.