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30 July 2020

Oil trading offers marginal protection for very few oil majors

We’re back into earnings season, and the figures from the oil majors are far from pretty pictures for their investors. So far, we’ve heard from Shell and Total, who have written off billions in impairments and seen profits decimated, despite some small recompense from their oil trading segments.

Starting with Shell, the most dramatic figure is its bottom line, with net income falling from a positive $3 billion in Q2 2019 down to a whopping loss of $18.1 billion in Q2 2020. Adjusted earnings, which are what would have happened if there were no impairments to deal with, were down by 82%, to just $638 million from the quarter, compared to $3.5 billion this time last year, and $2.9 billion for the first quarter of this year.

This figure also includes the value ascribed to $16.8 billion in impairments that the company had announced that it would write off due to changes in plummeting valuations of its oil and gas assets – it had previously anticipated that this would be in the range of $15 billion to $22 billion and actually the impairment charge was $21,780 million, but post tax it comes down and Shell’s accountants want us to see the smaller figure.

The most significant number is that revenues fell from $90.5 billion down to $32.5 billion, with fuel sales tumbling 39% in the quarter.

Losses were most focused on the company’s integrated gas sector (-$8 billion), upstream (-$6.7 billion), refining and trading (-$3.9 billion) and petroleum products (-$3 billion).

There is some strength to be seen in the company’s $6.5 billion cash flow, although Shell CEO Ben van Beurden has identified that the company is having to “learn a lot of new tricks quite quickly,” with the energy transition coming faster than expected. The insanity of paying a dividend had already been promised, but it amounts to the band playing on, on the Titanic. Dividends stayed at their Q1 levels ($0.16 per share), after being cut for the first time since World War II, as well as significant cost reductions across almost all segments. In Q3 the company has identified that it will likely have to limit extraction of oil and gas as well as its LNG activities as it ramps up its renewables operations, although curiously, Shell’s average output of 3.378 billion barrels per day was only just less than the 3.583 figure seen last year. Another piece of insanity we are sure, “keep pumping the gas guys.”

For Total the story is much the same. Net profit was again produced as if impairments had not happened and Total tried to suggest it would have made $126 million, but actually group net loss was $8.4 billion.

We’re not sure why analysts debate whether or not business as usual would have given the company a profit, when there is no longer any business as usual. Analysts had cited an expectation that adjusted profit could have been a loss of $520 million, so they were pleasantly surprised, although how pleasant an $8.4 billion loss can be we don’t know.

This has meant that Total has decided to hold its dividend at the level of €0.66 per share, claiming that this is sustainable with Brent crude oil trading at $40 per barrel.

Oil and gas production from the company fell by 4% to 2.85 million barrels of oil per day, meaning that it has had to trim its output forecast. With the near-term outlook appearing bleak for oil, it has also had to cut its investments for 2020 below $14 billion, from $15 billion previously. The worst hit sector for Total was that of exploration and production, with net income falling by 87%, while integrated gas, renewables and power managed to post the group’s only growth figure, with a 21%.

The other thing we’ve finally seen from Total, is the company following the footsteps of Shell and BP in announcing write-offs for their oil and gas assets, acknowledging that many of these assets will not see the returns that the company initially envisaged. While BP and Shell posted figures of $17.5 billion and $16.8 billion respectively, Total has announced a more modest $8.1 billion, with the bulk of the impairment – around $7 billion – coming from Canadian oil sands, which are typically higher in carbon content and operating cost than conventional oil fields. Total has stated that it will not allow the capacity of these projects to increase any further, and that it will also leave Canada’s oil industry lobby group. In our opinion this just leaves more impairments to come and it is too conservative a view.

We’re also starting to see more and more divestment from the likes of BP and Total. This week Total Gabon struck a deal to sell stakes in seven mature offshore fields to Perenco for $290 to $350 million, while it also offloaded its Lindsey refinery in the UK to the Prax Group.

Echoing Shell’s sentiment of an accelerating energy transition, this is a first, albeit tentative step for these oil majors in acknowledging the waning profits in the fossil fuel sector, and will hopefully prompt an all guns blazing shift into the renewables sector. In reality, their transition will probably be more sluggish than this, although we are starting to see more involvement in renewables projects, including this week’s victory for Shell in the development of the Hollandse Kust North offshore wind farm.

The fact that these impairment figures and minimal profit margins exist shouldn’t come as a surprise. Oil demand has collapsed by over 20% through Covid-19, and with production ramping up in the oil fracas between Saudi Arabia and Russia, an oversupply of oil and a lack of available storage saw the price of oil dip from $60 per barrel down into the negative in some corners of the market. Even Brent Crude was down below $20, and while it’s now back up above $40, it’s still not high enough to put a smile on the faces of the oil majors and it is likely being massaged to that number by artificially holding back supply.

The global demand for oil may never recover to pre-Covid levels, and neither will its price. Shell has already had to adjust its price assumptions for Crude Oil, having previously expected a steady price of $60 per barrel. It is now assuming $35 for 2020, $40 for 2021, $50 for 2022, and $60 from 2023 onwards. But the grim reality is that for every $10 that the price per barrel falls, Shell sees $6 billion tumble out of its operating cash flow.

The reason that Total, and to a lesser extent Shell, have posted results that were marginally better than expected however, is their secretive oil-trading sectors, which have brought in significant levels of cash that have helped offset some of the strain from Covid-19, although neither was willing to disclose exactly how much.

Shell did however state that it had been the segment’s best ever quarter, as it took advantage of its infrastructure capabilities to store or use low-cost oil in its operations, before making sales in the derivatives market as prices started to recover. Profit was possible because spot prices fell significantly lower than prices in the futures market, a situation referred to as contango. Shell benefited from “all sorts of arbitrages that opened up in unusual parts of the world,” Chief Executive Officer Ben van Beurden said in a Bloomberg Television interview. It is worth noting that now oil prices have somewhat stabilized, profits from trading will fall to more typical levels, and will not be able to offset any impacts from the long-term drop in oil demand.

Last week Equinor also announced that its trading division turned record gains of $1 billion in Q2 2020, and BP is likely to post similar sectoral gains in its results next Thursday. Companies with a less established presence in trading, like Italian giant Eni, have been less protected from expected losses, posting an $839 net loss, which has forced the company into slashing its dividend.

Similarly, the US oil majors, which operate their trading sectors in a slightly less sophisticated way, are unlikely to report any protection from losses in other business segments.

Typically, oil majors can offset low crude oil prices by utilizing cheaper inputs for their refining sectors, increasing margins, but with lockdowns slashing demand across all segments, petrochemical and gas markets have struggled in a similar regard to oil.

Following the announcements from Total and Shell, we are also expecting to hear from other oil majors ExxonMobil and Chevron tomorrow (31st of July), while BP intends to report its earnings on the 4th of August.