Oil crash may see drillers cut spending to shield dividends

LONDON – For the world's largest oil companies, the accelerating crash in crude prices will probably mean scrapping investments from America's shale fields to the seas off Brazil as CEOs protect dividend payments.

The parts of the industry most exposed to cutbacks include certain U.S. shale deposits, where break-even costs vary from $40 to more than $100 a barrel. While some, like Russian oil tycoon Leonid Fedun, say the slump will halt a good deal of production, others argue that the shale industry will be able to maintain production for some time at these price levels.

In the longer term, the greater dilemma for oil producers is that even as crude drops, the costs of developing new reserves remain higher than ever. An extended period of lower prices will prevent companies from being able to replace production as existing fields dwindle. In ensuring investors get paid, companies may have to sacrifice future growth.

Oil industry shares fell worldwide after crude slumped to a four-year low on the back of OPEC's decision Thursday to leave output unchanged. On Friday, the price of benchmark U.S. crude tumbled another 10 percent to settle at $66.15 a barrel. Investors are concerned that companies including Royal Dutch Shell PLC and BP PLC won't have enough cash to cover both investment plans and dividends.

"What we are about to see is a knife taken to non-OPEC industry capex [capital expenditures]," analysts at Bernstein Research led by Oswald Clint said in a note Friday. "It's painful, but yields remain payable."

As well as shale, the most vulnerable projects include deep water offshore developments and Canadian tar sands, the sources that the International Energy Agency said this month are vital to ensuring global energy supply in coming years.

U.S. shale, for instance, accounted for about 20 percent of world investment in oil in 2013 and supplied only four percent of global production, according to Mark Lewis and Peter Oppitzhauser, analysts at Kepler Cheuvreux SA in Paris. Other places vulnerable to lower spending include heavy oil fields in Venezuela, Brazil's deepwater and Iraq, Lewis said.

"The irony of the times is that the break-even threshold for oil prices is higher, not lower, than it has been," said CSIS Energy and National Security Program director Sarah Ladislaw. "To the extent that the market is not incentivizing that investment, what you end up with is a period, five to 10 years in the future, where there has been dramatic underinvestment."

The IEA, an adviser for the world's industrialized countries, warned this month in its annual World Energy Outlook that the U.S. shale boom is masking threats to supply. With shale drilling now set to slow, global oil security is uncertain because of the cost of developing new oil and gas reserves.

"At $70 a barrel for Brent, it is hard to imagine how any new major international project gets the green light from the majors," Lewis at Kepler Cheuvreux said in an e-mail Thursday. Prices at these levels "will also put a huge squeeze on shale companies looking to drill new wells."

Even before Thursday's 6.7 percent tumble in benchmark Brent crude prices, oil producers expected to reduce investment. Shell, Italy's Eni SpA and Houston-based ConocoPhillips all said last month they would cut capital spending to maintain profitability.

At today's prices, exploration spending is likely to fall 50 percent, while investment in developing new fields already discovered will drop 10 percent, Bernstein said.

"Oil companies will keep focusing on high-margin projects," said Teodor Sveen Nilsen, an analyst at Swedbank Markets in Oslo. "That will happen at the expense of low-margin things like oil sands and Arctic projects."

Meanwhile, large oil and gas companies remain among the best payers of dividends. Shell's yield today is 5.4 percent, while BP pays 6 percent. That compares with an average of 2.3 percent for the MSCI World Index.

While U.S. companies typically pay less in dividends than European counterparts, Chevron Corp.'s yield is 3.9 percent and Exxon Mobil Corp.'s is 3 percent.

"We do not see any of the companies covering both capex and dividends in the current environment," Barclays analysts said in a note to clients Thursday on the impact of lower prices on the top European oil producers. "Recent conference calls have seen management teams highlight that dividends remain a priority."