Big Oil’s Lost Decade: Are the supermajors past their prime?

The past decade has been a disappointing one for the supermajors, a group of six or seven of the world’s largest publicly traded oil companies, as manifest in their meager profit increases compared to other sectors. The supermajors focused on searching for expensive and politically risky oilfields, and as a result, missed the ‘shale’ revolution in the United States, and then paid dearly to get involved, only to see oil prices collapse thereafter.

Scott McKnight - May 10, 2020

The first-quarter earnings reports of 2020 for the supermajors, a group of six or seven of the world’s largest publicly traded oil companies, were predictably devastating. The coronavirus led many governments to greatly restrict work and travel. This, along with a month-long price war led by Saudi Arabia, resulted in nearly 30 million barrels per day (bpd) from being consumed in the month of April. At the start of May, benchmark crudes like West Texas Intermediate (WTI) traded in the dismal range of $25 per barrel, with Brent trading in the high $20-range. These prices made much of global oil production unprofitable, which forced oil and gas companies of all sizes to dramatically cut spending and production, as well as to engage in massive write-downs of assets.

The oil market bloodbath of the past several months, including the unimaginable event of WTI contracts closing in negative territory (largely due to lack of storage), misses the longer trend besetting the supermajors. For nearly a decade before the coronavirus pandemic wreaked havoc on the global economy, investors have shown themselves less eager to invest in the supermajors. There are several reasons for this lack of investor enthusiasm: stagnant prices from late 2014 on as well as the rise of climate change discourse and the Damocles’ sword of carbon-limiting legislation.

This article will focus on how the supermajors made big mistakes, missing out on the ‘shale revolution’ in oil and gas in the United States, while instead choosing to invest in projects that were either high-cost (like the Albertan oil sands), politically risky (like the Russian Arctic), or buying into shale companies at heavy premiums, only to see oil prices collapse soon thereafter.

Origins and evolution

Each of the supermajors has operated in the oil (and to a lesser extent gas) industry for over a hundred years. Indeed, this group, previously called the ‘Seven Sisters’ or ‘oil trusts’ to more critical observers, were major drivers for internationalizing the oil industry in the first place, as they opened up new lands for oil production and sales, while gobbling up smaller competitors along the way.

Two of today’s supermajors are grandchildren of Rockefeller’s Standard Oil, broken up in 1911: Exxon (formerly Standard of Jersey) is the biggest, which also includes Mobil and the popular Esso brand; and Chevron (formerly Standard of California) notably absorbed Gulf (in 1984) and Texaco (in 2000). Others are European-based, like the Britain-based BP was born out of the massive Iranian concession but get rich producing oil in other parts of the Middle East, and notably acquired Arco as a way to enter in the US market; France’s Total, absorbed Elf and Petrofina; and Royal Dutch Shell, now Europe’s biggest energy company, was a major force that prevented Standard Oil from global dominance at the turn of the twentieth century. ConocoPhillips, known for its Phillips 66 brand in the US and Jet brand in Europe, was originally an ‘independent’ and may now be considered a supermajor.

The last big wave of mergers was in 1998-2000, which also came during a period of very low oil prices and financial crises. All of these companies are vertically integrated, meaning they both explore for and produce crude oil as well as refine and sell oil products. BP, Exxon, Chevron and Royal-Dutch Shell together produced some 15m bpd in 2015.

The Golden Decade

The years 2005-14 were a golden decade for Big Oil. After a miserable stretch of low oil prices from 1986 to 2002, oil prices finally hardened and started their steady upward climb. The two big factors behind rising oil prices were the ‘commodities’ boom led by China, India and other oil-hungry emerging economies as well as greater discipline from member-states of the oil-producing group OPEC. For the first decade of the 21st century, talk of ‘energy insecurity’ and the world ‘running out of oil’ stemmed from the empirical fact that the United States was importing rising volumes of oil, which seemed to justify everything from military adventures in the Middle East to wild attempts to find alternative fuel sources.

ExxonMobil, primus inter pares among the supermajors or what Stephen Coll called ‘a corporate state within the American state’, made a profit of $45.2bn in 2008, making it the largest publicly traded company in the world. The price countershock that followed the Global Financial Crisis of 2008-09 seemed like a blip to what seemed like an inexorable fact: the world, especially these rapidly growing economies, wanted more petroleum products with which geology and investment couldn’t keep pace, pushing oil prices even higher. This golden decade led to a sense of complacency among the supermajors, which left them unprepared for the tectonic changes of the 2010s. In April 2010, the Deepwater Horizon platform of BP, another supermajor, collapsed in the Gulf of Mexico, raising serious questions about corporate responsibility and the environmental impact of the industry. In retrospect, it seemed like a tragic metaphor for what was in store for Big Oil in the years to come.

The tide turns

Encouraged by robust demand and high prices from the mid-2000s on, the supermajors harnessed their vast resources and copious access to credit to search for and develop high-cost fields, dealing in challenging environments and sometimes with unsavoury governments. A few national oil companies (NOCs) were also part of this charge.

The supermajors were single-minded in their hunt for oil and gas ‘supergiants’ in exotic places or expensive projects like the oil sands of western Canada, Kazakhstan, the Russian Arctic and Brazil’s ultra-deep waters (though Brazil’s so-called ‘pre-salt’ fields were effectively off limits after 2006).

There were a few successes along the way. As a result of this search, this effectively created oil and gas producers from scratch in parts of east, central and west Africa, as well as the little-known republic of Guyana wedged between Venezuela and Brazil.

The most ambitious of these projects was Exxon’s $300bn for oilfields in the Russian Arctic. After nearly a decade of back-and-forth, Vladimir Putin and Rex Tillerson, then Exxon’s CEO, reached the deal in 2011. But after Russia annexed Crimea in 2014 and Russia was hit by sanctions from the United States and the European Union, the deal fell apart (Tillerson joined the Trump administration and served as Secretary of State from February 2017 to March 2018).

The most ambitious of these projects was Exxon’s $300bn for oilfields in the Russian Arctic. After nearly a decade of back-and-forth, Vladimir Putin and Rex Tillerson, then Exxon’s CEO, reached the deal in 2011.

In late 2014, Saudi Arabia was tired of shouldering the burden of production cuts to stabilize prices and seeking to destroy the shale producers in the United States, flooded the market with oil—not unlike its tactic from this March—sending oil prices plummeting below $40 per barrel. Now there was no doubt left: Big Oil’s golden decade was over.

The shale revolution passed them by

The supermajors over the last decade have shown a general inability to adapt and accurately predict change. According to Paul Stevens, veteran scholar of the oil and gas industry, a big source of their troubles is that they tend to operate under the ‘fallacy of composition’, a type of consensus behaviour in which all actors behave more or less in the same way.

All of these companies seemed convinced that the next motherlode was in some exotic places and unforgiving environment—many kilometres under the jungle, ocean floor or trapped in bitumen. This led the supermajors to ignore the continental United States altogether. Instead, much smaller ‘wildcatting’ firms like Mitchell Energy, Continental Resources or Pioneer Natural Resources, or ambitious empire-building ones like Chesapeake, led what became the ‘shale’ revolution, combining the techniques of horizontal drilling with hydraulic fracturing (‘fracking’) in various oil- and gas-rich basins scattered throughout the continental United States. American oil production, which had been declining since the early 1970s and raised paranoid fears about ‘energy insecurity’, climbed rapidly. Natural gas, too, emerged as a relatively clean, accessible and affordable source of energy for American homes and industries. The shale revolution returned the US to the status of energy superpower.

When the supermajors finally caught on, they paid exorbitant premiums to get in. For example, the Tillerson-led Exxon purchased of XTO, a skilled fracker of natural gas, for $31bn. Gas prices soon after collapsed. (Tillerson only recently openly regretted the deal as a mistake). Oil prices plummeted below $40 per barrel in late 2014, forcing Exxon to write off its Canadian oil sands assets. Oil prices stayed low for several years thereafter, then stabilized in the lukewarm range of $50-60 per barrel, far too low to justify the hefty prices that the supermajors paid to buy skilled ‘frackers’ or acreage in these basins. American oil production continued to surge, infuriating the members of OPEC but without enriching the supermajors either.

The coronavirus-induced cuts

The coronavirus has forced the supermajors to their biggest production cuts in nearly two decades. BP announced reductions of its US shale oil production by 70,000 barrels of oil equivalent per day (boepd). That makes its 2020 output levels about 14% lower than its 2019 levels of 499,000 boepd.

But the coronavirus pandemic caught the supermajors in different positions. For California-based Chevron, the company was emerging from its worst loss in a decade, struggling in particular with the Tengiz project in Kazakhstan and a massive writedown of natural gas assets. Chevron has recently announced cutting about 125,000 bpd of production and $5bn in spending in the Permian basin of west Texas. On the other extreme, Exxon was in the midst of a multi-year spending project, which planned $30bn in spending for 2020. Its management stuck to this target, seeing low prices as an opportunity, but eventually the depth of the oil crisis led it to reduce spending as well. Exxon’s enormous $14.7 billion dividend required the company to borrow to cover it. In response to the oil price plunge, Exxon and Chevron combined to shut 800,000 bpd.

Royal Dutch Shell, Chevron, Total halted share buybacks. Exxon had done so in 2016, shifting excess cash to dividends and new projects. The belt-tightening affected dividend payments as well. For example, Royal Dutch Shell, the Anglo-Dutch major, cut its dividend for the first time since WWII. The oil crisis dragged the company’s first-quarter earnings down 46%, while bracing for permanent change in consumer behaviour. Ben van Beurden, the company’s CEO, was forthright: ‘We do not expect a recovery of oil prices or demand for our products in the medium term’.

These cuts mask an underlying trend and troubles of the past decade. Share prices for the supermajors have at best underperformed relative to the rest of the market; at worst, they’ve been stagnant or actually declined compared to where they were ten years ago. As a result of the shift in investment away from fossil fuels to sectors like big tech, pharma and health, energy now makes up less than 3% of the S&P 500. Worse yet, while non-energy stocks on the S&P 500 nearly doubled their returns over the past decade, the supermajors at best saw their profits in the middling single-digits. Aside from BP, reeling from the Deepwater Horizon catastrophe, Exxon has been the most disappointing. The company has been saddled low earnings, skyrocketing debt, a sinking share price (in March, it reached its lowest point in 18 years) and eventually a downgrading from credit ratings agencies (from AA+ to AA), marking what Bloomberg scathingly called the ‘humbling of Exxon’.

Pain, although unevenly distributed, has nevertheless been the common experience of supermajors in the past decade.

Learning to live with less

Investors have long seen supermajors as trustworthy investments. Of course, these companies produce a vital input for any modern economy, but they were also expertly managed, had an army of high-skilled talent, along with assets spread across many countries and with operations in different parts of the oil value chain. As unimaginably capital-intensive companies in a volatile commodity business dealing with sometimes whiplashing prices, the supermajors shared a general recipe for success: keep the share price steady, provide healthy financial returns and a steadily rising dividend. This recipe was tried and true, able to weather wars and recessions, and able to endure change in governments in London, Paris but especially Washington, DC. Now the executives of supermajors face problems they’ve never faced before: an unprecedented oil price collapse that rendered large portions of their asset portfolio unproductive; colossal dividend payments and debt; and a general indifference from investors uninterested in companies whose primary businesses are in extractive industries.

Dark clouds over the horizon

Overall, the supermajors for the past decade have been operating under various questionable assumptions, the three biggest ones being that the world is running out of oil, that the world needs oil for many decades in the future, and that the United States was a graveyard for oil and gas investment. The first two may yet prove to be true in the post-coronavirus world, but the consistent underperformance of the supermajors, as evident in their stagnant share prices, may have indicated that the best years are behind these companies

The supermajors will survive the Covid-19 pandemic, bolstered by vast portfolios in dozens of countries, robust balance sheets and political connections. But the horizon is gloomy, with indefinitely weak demand leading to unattractive commodity prices and likely even more price volatility.