International oil companies (IOCs) are primed for a V-shaped recovery in free cash flow, and may generate record figures this year should oil prices average US$55 a barrel, according to analysis from global natural resources consultancy Wood Mackenzie
“Savage cost cuts imposed last year as the global economy contracted in the face of the COVID-19 pandemic saw average IOC corporate cash flow breakevens reduced from US$54/bbl pre-crisis to US$38/bbl,” Tom Ellacott, senior vice-president, corporate analysis, said.
“The record annual losses being announced in the Q4 earnings season serve as a stark reminder that 2020 was one of the toughest years in the industry's history. But IOCs emerged from the crisis far more resilient to lower prices. The scale of their financial reset has primed the sector for a V-shaped recovery in free cash flow,” he said.
“At an average price of US$55/bbl, our US$140bn estimate of 2021 free cash flow before shareholder distributions exceeds any previous year since 2006. Free cash flow generation would be double the previous peak if prices jumped to US$70/bbl.”
Ellacott added, “Our IOC peer group of 40 companies generates over US$115bn of surplus cash flow over the next three years after shareholder distributions, investment and interest at US$55/bbl prices. At US$70/bbl, cumulative surplus cash flow generation over the next three years would rocket to US$400bn.”
However, capital allocation priorities will be very different to any previous up-cycle.
Mending broken balance sheets will be at the top of the list. Average leverage - excluding operating leases - ballooned from 15% a decade ago to 35% by the end of 2019. The crisis of 2020 pushed it to 44% by Q3 2020, the highest this century.
Companies will aim to lower gearing to help weather future price volatility, either by cutting debt or growing equity – or both. Ellacott believes most players would prefer to deleverage towards the low end of historical gearing ranges, which is about 20%.
“We expect companies to continue to plan for the worst, prioritising net debt reduction in redeploying surplus cash flow,” he said. “Some players will also look to speed up debt reduction by selling non-core assets.”
Restoring investor confidence will be the second priority. Investment will recover only slowly even if confidence in higher prices grows. Strategic M&A will continue to favour paper over cash; share buybacks will be preferred over dividends for any surplus cash post-deleveraging.
“The sector is in ultra-capital-disciplined mode to win over investors,” Ellacott said. “We think the industry will stick to its tight management of investment for some time.”
Concerns are growing that under-investment may lead to a supply squeeze mid-term. Indeed, the free cash flow generation Wood Mackenzie forecasts is in part a result of scaled-back spend.
