What We've Learned From Shell Writedown, BP Divestment

By David Hodari

Royal Dutch Shell on Tuesday wrote down the value of its assets by as much as $22 billion. Also this week, BP, which made a similar move earlier this month, announced the $5 billion sale of its petrochemicals division.

In some respects, the moves can be seen as ripples from the impact of the coronavirus pandemic which crashed oil markets earlier this year. In others, the companies' decisions mark a continuation of a broader sector trend, with investors and oil companies asking when the world will reach 'Peak Oil.' With the second quarter earnings season just around the corner, here's what we've learned:

Oil's Covid-19 Perfect Storm

One of the major factors cited by Shell in its decision was lower energy demand--and therefore lower oil prices--in the wake of the seismic impact of the coronavirus. A damaging price-war between Saudi Arabia and Russia may have combined with lockdowns and travel bans to crash prices, but that short-term pain has intensified pressure that had long been building on energy demand, according to Per Magnus Nysveen, head of analysis at consultancy Rystad Energy.

"The impact of 'Peak Oil' questions, electrification, and then Covid has added to the pressure on oil companies that did not plan for [low] oil prices," Mr. Nysveen says, adding that "there might be high prices after the peak in [oil] demand... but you can not plan to have high prices."

ESG Secondary to Debt

Both majors announced plans to decarbonise before the full force of the pandemic hit the West. Those strategic changes have "been driven by ESG of course," says Rystad's Mr. Nysveen. Shell's and BP's recent decisions have also been partly related to the effort to decarbonize the energy industry, he adds, but only insofar as recent events have weighed on oil prices and potentially hastened the arrival of Peak Oil.

Still, BP's sale of its petrochemicals division represents an effort to clean up the company's balance sheet rather than the environment, says Jason Gammel, equity analyst at Jefferies. Petrochemicals can boost a company's ESG credentials, "as you don't burn the end product," he adds, "but BP don't have the scale in that business."

BP's divestment, at a relatively unattractive valuation, is a signal that the company is still grappling with a debt problem, according to Biraj Borkhataria, co-head of European energy research at RBC Capital Markets.

The sale could also be a gamble, he adds, saying that "you lose earnings, you lose diversity in your earnings base, and that can make your business more volatile."

Project Math No Longer Adds Up

BP isn't the only oil major struggling with high leveraging. The broader oil sector is now struggling to make lower oil-price forecasts work, given that assumptions made when commissioning exploration and production projects can quickly change. Shell's writedown and BP's asset sale come in that context, says Jefferies's Mr. Gammel.

"A lot of projects were sanctioned a few years ago when oil was averaging $100 a barrel," he says, adding that "a lot of the assets have been built that are not making money in the current price environment."

The International Energy Agency said in May that it expects global oil-and-gas investment in 2020 to drop by a third. Oil majors are engaging in some serious belt-tightening. Shell, for example, announced its first dividend cut since the Second World War.

What About the U.S.?

Along with BP and Shell, Chevron has said it plans to cut jobs amid a sharp drop-off in capital expenditure in the U.S. sector. Chevron took a $10 billion write-down late last year and sector peers Hess and Occidental have both recently taken large impairments.

Elsewhere in that sector, though, ExxonMobil has resisted adjusting the value of its holdings, although it may not be able to hold out forever, analysts say.

Expensive projects such as the one Exxon has in the Arctic have long lead times and are no longer cost effective, says Rystad's Mr. Nysveen. Along with expensive projects in Canada's oil sands, Exxon "will have to reconsider those positions," he adds.

Still, large U.S. integrated oil companies came into the coronavirus downturn with lower debt levels than European ones, which are attempting to decarbonize more quickly, RBC's Mr. Borkhataria says.

Write to David Hodari at [e-mail]

(END) Dow Jones Newswires

July 03, 2020 07:02 ET (11:02 GMT)

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