Oil Majors’ Plans – No Relief For Offshore Drillers – Seeking Alpha

In the previous earnings season, I did an evaluation of majors' capital spending plans to find out whether offshore drilling recovery was around the corner (Part 1, Part 2). This time, I am returning to the topic and will look at majors' spending plans once again. The oil companies in question are Chevron (NYSE:CVX), Exxon Mobil (NYSE:XOM), BP (NYSE:BP), Shell (NYSE:RDS.A), Statoil (NYSE:STO), Conoco Phillips (NYSE:COP), and Total (NYSE:TOT). Drillers available on major exchanges are Atwood Oceanics (NYSE:ATW), Diamond Offshore Drilling (NYSE:DO), Ensco (NYSE:ESV), Noble Corp. (NYSE:NE), North Atlantic Drilling (NYSE:NADL), Ocean Rig (NASDAQ:ORIG), Pacific Drilling (NYSE:PACD), Rowan (NYSE:RDC), Transocean (NYSE:RIG), Seadrill (NYSE:SDRL) and Seadrill Partners (NYSE:SDLP).

In my previous articles, I went through the majors' plans one by one. This time, I want to concentrate on big trends and key takeaways, in part because it will be easier to navigate for readers and in part because it is just boring to write in the same format once again. Below I provide links to earnings reports and subsequent earnings calls, so you can read them if you want to dig deeper into the topic.

Inflated stock prices favor short-term thinking. I would argue that some stocks have gone way ahead of themselves. The clearest example is Chevron:

There is no logical valuation reason why Chevron should be worth as much as it was in 2014, when oil prices were twice higher. However, there is a rational explanation to this phenomenon. Chevron stock price reflects the demand for yield. If the yield is good and market participants believe in its sustainability, the stock price increases.

Management surely understands the key driver behind the stock price. Not surprisingly, they want the upside to continue, which is favorable both for them and their shareholders. Thus, they prefer short-cycle projects over long-term projects because longer-term projects are an immediate hit on the bottom line, while the results will be seen later.

During the earnings call, Chevron said the following: "We're further reducing capital spending in 2017 and investing a larger percentage of capital in short-cycle high-return opportunities presented by our advantaged portfolio." The company added: "Our actions support our number one financial priority which is maintaining growing the dividend as the pattern of earnings and cash flow permit."

While the Chevron team was the most straightforward in discussing their vision, other management teams sounded similar. You can't blame them for this; they are doing what their shareholders are demanding, and they want the dividend, which is a primary reason for investing in oil majors.

The takeaway for the offshore drillers is that there is no change of short-term priorities for oil majors. Just like in the previous earnings season, the words "short cycle" and "dividend" are frequent guests in management's vocabulary.

Management teams sound more positive but still cautious despite the OPEC/non-OPEC deal. If you believe that OPEC/non-OPEC deal is a game changer, you'd expect that oil majors will be more focused on their growth plans. However, they appear to be more focused on their EPS or debt management, as highlighted by Exxon Mobil's intention to use excess cash balances to pay down debt or buyback shares.

In my view, nobody wants to get caught in a 2015-like scenario, when the rebound was followed by massive downside, which took oil below $30 at one point. The situation is certainly different now, but it appears as if oil companies want to play it safe and see confirmation that oil prices won't drop once again. So far, oil hit a wall around $57.50 for Brent (NYSEARCA:BNO) and was unable to gain more ground. The more oil spends below $57.50, the more chances for downside increase.

Maximizing project NPV takes back seat to the focus on low breakeven price. This is a huge shift in mentality, a one that is especially dangerous for offshore drilling. Almost everyone keeps talking about which projects they have that are breakeven at $40 per barrel or another low price. The last thing an oil major wants now is to commit to a perspective long-term project only to find out that the price dropped below the breakeven point.

I believe that it highlights the fact that there is not enough "belief" in OPEC in the system right now. Everyone wants to see if the cartel is able to provide long-term support and upside for prices. This is a rational business decision. Certainly, oil majors have no obligation or intent to bail out companies that provide services to them, like offshore drillers. However, one could have expected that there will be some movement toward fixing the present low dayrates for the long-term projects. But that hasn't happened so far.

The year 2017 will be as hard as 2016 for offshore drillers as oil companies' priorities have not changed. Without a dramatic upside in oil prices, any real recovery in contracting activity is postponed until 2018. Keep in mind that oil majors have to deal with dividends that are a legacy from $100+ oil times. Also, oil companies have no duty to think about the long-term balance between supply and demand.

Should demand overcome supply by a big margin sometime in the future, oil prices will skyrocket and oil companies will reap the benefits of higher prices and invest accordingly. I don't buy the typical argument that oil companies should be extremely worried about their reserve replacement and act now, employing offshore drilling (presumably UDW drilling). In my view, they have plenty of time and can increase exploration in a more favorable pricing environment.

I expect downside in offshore drilling shares if oil prices fail to continue their upside. The road to recovery is long, and if it does not start now with the help of higher oil prices, valuations will decrease accordingly.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I may trade any of the abovementioned stocks.

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