After the oil industry’s worst quarter in history, companies are taking a variety of approaches towards their finances, and getting a variety of advice and criticism from the pundits and media. Saudi Aramco’s decision to maintain its dividend has been called in question, as the Wall Street Journal’s Rochelle Toplensky notes that dividend discipline might not be enough to make the shares attractive to foreign investors.

What should oil companies do with their cash?- oil and gas 360

Source: Forbes

Private sector majors appear divided on their capital allocations as well. BP and Royal Dutch Shell have both cut their payouts, while Exxon has maintained its despite “pressure” to follow the others’ path.

Some go further, arguing that finding more oil could be a mistake, as it might not ultimately be produced due to climate concerns, making new reserves a ‘stranded asset.’ Carbon Tracker Initiative thinks that one-third of upstream investment between now and 2030 could “fail to deliver adequate returns” if climate targets are to be met.

The debate is hardly new, with some companies deciding in the 1970s to diversify away from oil, because it was a ‘mature’ or ‘sunset’ industry. Then-Mobil CEO Rawleigh Warner said in 1977, “The oil business has come to maturity, and with this maturity comes a new set of challenges…oil companies have no other choice. They must diversify or go the way of the buggy-whip makers.” Many of the oil companies invested in, not just alternative energy such as photovoltaics, but department stores and office equipment manufacturers. The vast majority of those investments were later unwound at significant losses. (See Chapter 3 of my book The Peak Oil Scare and the Coming Oil Flood for more detail.)

This failed approach prompted a major factor in the shift towards returning cash to shareholders either through dividends or share buybacks. The late T. Boone Pickens argued that lacking good investment opportunities, companies should return cash to shareholders instead of continuing to sink cash into existing business through shear momentum. (The upstream in the U.S. was a particular target of his, as high costs made much of the 1980s investments perform poorly.)

Saudi Aramco is in a unique position when it comes to distributing its cash because of its role as a national oil company, a main source of income for the government, and a leading producer in OPEC. Although Saudi Arabia has some of the world’s cheapest oil (in terms of production costs), that is not an attractive investment if OPEC quotas prevent the company from selling incremental production. And as a state-owned enterprise, it would find it difficult to diversify into, say, the airline business as a hedge against lower oil prices. (Airlines prosper when oil prices are low, all else being equal.)

In the past, OPEC members and especially Saudi Aramco have found themselves with severe amounts of unused oil production capacity, but the levels seen in the 1980s are unlikely to recur. However, that doesn’t mean that the company wants to recycle its revenue to create additional oil production capacity when future demand for its oil is so uncertain. The government has a policy of maintaining a strategic surplus of capacity on the order of 2 mb/d, to cope with market disruptions such as caused by the Gulf War II shutdown of Iraqi production, but it makes no sense to drill for the sake of drilling in order to add even more capacity that might go unused for years.

Conceivably, there are other opportunities for the company that are currently more attractive than investing in oil production, but returning the surplus cash to shareholders appears pretty sensible, even ignoring the role that the dividend plays in funding the Saudi government. And given the transient nature of the pandemic and its effect on oil markets, it is understandable that private companies with strong balance sheets would take the same approach. Still, companies like Exxon, Chevron and others will continue to invest in exploration and production where the economics are favorable, as they (usually) are not subject to quotas but can produce at will.

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