The Incredible Shrinking Oil Majors – Part II


“Chevron Girds for Activist Challenge After Exxon’s Proxy Battle Defeat”
Wall Street Journal, September 3, 2021

“Exxon Debates Abandoning Some of Its Biggest Oil and Gas Projects”
Wall Street Journal, October 20, 2021

“Aramco Warns World’s Spare Oil Supplies are Falling Rapidly”
Bloomberg, October 26, 2021

The super-majors’ problems continue to mount. Last quarter in “The Incredible Shrinking Oil Majors,” we discussed their inability to replace production with new reserves and how production of both oil and gas would significantly disappoint as we progressed through this decade -- especially considering the collapse of upstream capital spending budgets last year. We also discussed the forces now being applied to the companies by various ESG groups, both shareholders with de minimis ownership and various court systems, and how these forces would only exacerbate the reserve replacement and production problems being faced by these companies today.


A number of recent developments merit discussion. Both capital spending and production of oil and natural gas continue to fall for the four super-majors (Exxon, Chevron, Royal Dutch Shell and Total Energies). In 2019, upstream capital expenditures averaged $15 bn per quarter for these four companies. Upstream spending collapsed in tandem with oil prices in 2020; by 1Q21 it had fallen by over 50%. Even though oil prices have rebounded, capital spending has lagged far behind, trending upward in 2021 off last year’s low, but still well below 2019 levels.

The large drop in capital spending has already put notable pressure on oil and gas production across the four super-majors. The surge in finding and development costs over the previous decade, combined with any extended drop in upstream capital spending, will produce large drops in reserve replacement and production going forward.

Our models originally suggested hydrocarbon reserve replacement will fall to only 40% while production itself will fall over 30% by 2030 unless capital spending trends move much higher. It now looks like the severe drop (and weak subsequent rebound) in capital spending over the past 20 months is already pressuring oil and natural gas production. Super-major production has now fallen over 10% since the beginning of 2019.

Three out of the four super-majors face intense ESG-related scrutiny.

After successfully replacing 25% of Exxon’s board of directors despite owning just 0.02% of the outstanding equity, Engine No. 1, the climate-focused activist hedge fund, met with Chevron’s management late last summer. In discussions that were later described as “cordial,” Chevron executives shared their plan to reduce carbon emissions. Subsequently, Chevron announced new plans to further reduce carbon output, along with their intention to appoint a new director with “environmental expertise.” Although it remains unclear exactly what Engine No. 1 is planning, rumors suggest the fund has contacted other investors, strongly suggesting they intend to launch a second campaign in the not-too-distant future.


What should Chevron expect?

It was recently reported by The Wall Street Journal that Exxon was considering abandoning two massive natural gas projects: the 75 trillion cubic foot (tcf) Rovuma LNG project (capital cost $30 bn) and the 5 tcf Ca Voi Xanh offshore-Vietnam gas project (capital cost $10 bn). Exxon board members (most likely including the three supported by Engine No. 1) have publicly expressed concerns about both projects.

According to internal reports, these projects are among the highest CO2 producers in Exxon’s pipeline; it is no surprise these projects have been called into question. However, we find the plight of both fields to be perplexing since production would almost certainly be used to displace coal in electricity generation, cutting CO2 emissions by nearly 50%. This fact seems to be lost on the new Exxon board members.

Vietnam’s electricity generation is 50% coal-based while only 8% comes from natural gas. The country has stated its long-term goal is to have 80% of its electricity come from natural gas. If Vietnam is successful in its ambitious goal, it would reduce carbon emissions by nearly 30%. The development of the Ca Voi Xanh field is a critical part of this plan.

Similarly, large volumes of Rovuma LNG will likely go to displacing coal in India. Only 7% of all Indian electricity comes from natural gas while coal represents 55%. India wants natural gas to represent 15% of its energy mix by 2030. Cancelling the Rovuma LNG project would certainly complicate this goal with large implications for CO2 reduction.

A global natural gas shortage has already developed and we believe this is only the beginning of a long period of structural deficit. The world desperately needs the development of massive natural gas fields like Ca Voi Xanh and Rovuma to meet demand going forward.

Royal Dutch Shell’s ESG challenges continue unabated. A Dutch court ruled in May that Royal Dutch Shell must cut its CO2 output by 45% by 2030 to align their policies with the Paris Climate Accord. In a statement issued after the verdict, a Shell spokesperson acknowledged that “urgent action is needed on climate change and the company is accelerating efforts to reduce emissions.” If the pressure from the Dutch court system was not enough, an activist shareholder has proposed breaking the company apart to address ESG concerns. On October 27th, Third Point Management announced the following.

“If Shell pursues this type of strategy it would probably lead to an acceleration of carbon dioxide reduction. […] Breaking Shell into two operating units would create a standalone legacy energy business (upstream, refining, and chemicals) that could slow capex beyond what is has already promised, sell assets, and prioritize return of cash to shareholder which can be reallocated into low-carbon areas of the market.”


Shell has already cut spending dramatically over the last decade. After having peaked at $39 bn in 2013, upstream capital spending fell to only $17 bn in 2020 – a drop of nearly 60%. Spending has barely recovered in the three quarters of 2021. A lack of spending has already impacted production. Proforma for the 2016 acquisition of BG Group, Shell’s total production has fallen 13% since capital spending peaked in 2013. These trends are accelerating: Shell’s production over the first nine months of 2021 have fallen 7% compared with the same period last year.

If Royal Dutch Shell’s upstream capital spending remains at today’s depressed levels, we estimate the company will only be able to replace 30% of production with new reserves and that production will fall 40% over the next nine years. If spending is further curtailed (as is being proposed), Shell’s oil and natural gas production would collapse – something that may have already started.

As we have outlined many times in these letters, we believe growth in non-OPEC+ oil supply will turn negative this decade. The issues faced by the super-majors are a great example of pressures exerted on the energy industry as a whole.

As non-OPEC+ production declines, OPEC will gain ever more market share and pricing power. The first oil crisis of the 21st century is now upon us. You have to look no further than the plight of the super-majors to see why.


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