Big Oil’s Cash ‘Golden Age’ Puts Dealmaking Back on the Agenda

Big Oil used last year’s unexpected windfall from surging energy prices to shower investors with rewards and pay down debt. As the cash continues to flow in 2023, the question is whether they will find more adventurous uses for their money.

(Bloomberg) — Big Oil used last year’s unexpected windfall from surging energy prices to shower investors with rewards and pay down debt. As the cash continues to flow in 2023, the question is whether they will find more adventurous uses for their money.

While lower oil and gas prices mean the record profits seen in 2022 are unlikely to be repeated when the majors begin announcing first-quarter earnings later this week, underlying cash flows are still far above historical norms.

Having used buybacks to trim the amount of outstanding shares by as much as 8% in aggregate and paying down debt by $87 billion last year, this could be the moment for the oil majors to pursue growth through big deals. That’s especially true if the rift between Russia and the West over the invasion of Ukraine has created a new normal where fossil fuel prices stay high in the long term.

“Consolidation will be a potential solution for companies to deliver volume growth in order to take advantage of the supercycle,” said Christyan Malek, global head of energy strategy at JPMorgan Chase & Co. 

Combined, the biggest western oil companies are forecast to have made adjusted net income of $36.5 billion in the first quarter of 2023, according to data compiled by Bloomberg. While that’s down more than 40% from the peak in the second quarter of 2022, it would still mark the seventh-highest level recorded since the mega-mergers of the 2000s created the companies in their current form. 

“They’re still generating an extraordinary amount of free cash flow,” said Lydia Rainforth, an analyst at Barclays Plc. It’s evidence of a normalization of earnings at a higher level, she said. 

The total includes estimates for Exxon Mobil Corp, Chevron Corp, Shell Plc, BP Plc and TotalEnergies SE, which kicks off earnings season on April 27. The two US oil giants report the following day, with BP and Shell announcing their results next week.

The supermajors are consistently spending tens of billions of dollars every year on exploration and development of new resources. That’s significantly less than they were investing a decade ago and generally serves to sustain, or slow the decline of, their current production levels. 

The surge in energy prices has created a surplus of cash that could allow companies to invest greater amounts in larger and more ambitious projects, but the industry has a patchy record of generating good returns from such ventures. Instead, Big Oil has prioritized giving cash back to shareholders.

Chevron increased its buyback 17% to $17.5 billion already this year while Exxon hiked its repurchase rate multiple times last year to about the same level as its smaller US rival. Shell and BP both announced further dividend and buyback increases earlier this year when reporting fourth-quarter earnings.

But with so much cash on hand and relatively high stock valuations, this could be an opportune moment to buy smaller competitors. Acquisitions would add production and reserves at a time when the Organization of Petroleum Exporting Countries and its allies appear to be putting a floor under the oil price with their surprise production cut earlier this month. 

Exxon, which has expressed interest in Permian Basin acquisitions, held early-stage talks with Pioneer Natural Resources Co., the Wall Street Journal reported earlier this month. Buying Pioneer would make Exxon far and away the basin’s biggest producer and expand its runway of top-tier drilling locations from about 12 years to more than 40 years, according to Rystad Energy. 

That wouldn’t come cheap, given Pioneer’s enterprise value of about $60 billion, and Exxon may have reason to be cautious.

“It’s only been three years since Exxon had to lean heavily on its balance sheet to sustain the dividend” during the pandemic price slump, Morgan Stanley analysts led by Devin McDermott said in a note. “We would be surprised if management uses its excess capacity for a large acquisition at a relatively high point in the price cycle.”

So far, the European majors have signaled reluctance to chase acquisitions. BP Chief Executive Officer Bernard Looney said he could consider “smart M&A” to add to its current production portfolio. 

Shell’s boss told analysts earlier this year that it won’t pursue big deals, instead prioritizing shareholder payouts. Any strategic changes for Shell may come later this year when new CEO Wael Sawan gives his first big presentation to investors in June in New York. 

Both companies are focused closing the valuation gap that’s opened up between them and their US rivals by further improving shareholder returns. 

Even if discipline is the watchword today, attitudes could change as the profits continues to pour in this year.

“Leverage targets have now been achieved, paving the way for surplus free cash capacity likely opening a window for M&A, either in energy-transition or oil & gas,” said Will Hares, an analyst at Bloomberg Intelligence. “Energy majors are in a golden age of free cash flow.”

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