Big Oil Is Spending More, Producing Less

Feb. 6

Last week saw oil and gas giants ExxonMobil (NYSE: XOM  ) and Chevron (NYSE: CVX  ) release their quarterly and full-year results. Both companies saw a drop in profit for the fourth quarter due to weaker refining margins and lower production. The drop in production comes at a time when the U.S. is seeing record oil and gas output thanks to the shale boom. Additionally, both Exxon and Chevron have been spending heavily over the past few years; still, their output has been falling.

Rising capital expenditureExxon and Chevron, along with other major Western oil companies, have seen a significant increase in capital expenditures over the past few years. The table below shows the substantial increase in capital expenditure at Exxon and Chevron between 2010 and 2013.

	2010	2011	2012	2013
ExxonMobil	$32.22 billion	$36.76 billion	$39.80 billion	$42.50 billion
Chevron	$21.75 billion	$29.06 billion	$34.23 billion	$41.90 billion

Europe's Royal Dutch Shell (NYSE: RDS-A  ) saw its capital expenditure rise to $44.3 billion in 2013. This even as the company's cash flow from operating activities slipped from $42.7 billion in 2012 to $37.5 billion in 2013.

Rising capital expenditure is not such a bad thing in itself as it means that companies are investing in growth opportunities. However, for big oil companies the increase in capital spending has not yet been accompanied by an increase in output as the table below shows. Both Exxon and Chevron have seen a drop in their total net oil-equivalent production in recent years.

	2011	2012	2013
ExxonMobil	4.5 mboed	4.24 mboed	4.18 mboed
Chevron	2.67 mboed	2.61 mboed	2.60 mboed

Mboed: Million barrels of oil equivalent per day

The key question is why big oil companies are spending more but producing less oil. This is because rising oil demand, coupled with depleting conventional resources, has meant that oil companies have been forced to take on more complex projects, which require substantial initial investment. The investment would be justified if oil prices were rising, however, to add to oil companies' woes, prices have been flat in the past year.

Rising debtHigher capital expenditure has also resulted in big oil companies taking on more debt. Both Exxon and Chevron have not been generating sufficient cash from operations to cover their rising capital expenditures and shareholder distributions. As a result, both companies saw a substantial increase in their debt levels at the end of 2013. Exxon had $22.7 billion in debt on its balance sheet at the end of 2013, nearly double the amount of debt at the end of 2012. Meanwhile, the company's cash balance slipped to $4.9 billion at the end of 2013 from $9.9 billion at the end of 2012.

Chevron also saw a sharp increase in its total debt and a decline in its cash reserves at the end of 2013. 

While the situation at Exxon and Chevron is not alarming, it does raise some concerns over both companies' ability to continue paying out shareholders.

What to watch going forwardBoth Exxon and Chevron have not given any indication that they plan to lower payouts to shareholders. However, there is no doubt that both companies' balance sheets are being stretched due to higher capital expenditure and shareholder distributions. Therefore, it is important that both Chevron and Exxon reduce spending in the coming years. There are already signs that capital spending at big oil companies may have peaked. Speaking at a conference call following the release of fourth-quarter results, John Watson, Chairman and CEO of Chevron, said that he expects 2013 to be a relative peak spending year, and 2014 to represent the peak year for LNG spending as the company's two Australian LNG projects move closer to production.

If indeed capital spending has peaked and we start seeing a slowdown in the coming years, this would be a positive for shareholders. In fact, this would be one of the main things I would watch in the next two to three years. Another thing to watch moving forward will be production. While production has been falling at both Exxon and Chevron, both companies are expecting an increase as large new projects come on board. If there is an increase in output going forward, the increase in capital spending in recent years would be justified. Apart from these, the outlook for big oil companies would of course depend on oil demand and prices. Despite recent worries over a slowdown in China, oil demand and prices should remain robust in the long term. 

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