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Investors to Big Oil: Make It Rain

The Wall Street Journal. logo The Wall Street Journal. 11/1/2019 Bradley Olson and Sarah McFarlane
a bridge over a body of water with a city in the background© frederic j. brown/Agence France-Presse/Getty Images

Investors want just one thing from the world’s biggest oil companies: cold, hard cash. But it is becoming harder for the oil giants to deliver.

Companies such as Exxon Mobil Corp., Royal Dutch Shell PLC and BP PLC have long used hefty and reliable dividends to keep investors on board in a sector that has volatile profits tied to commodity prices. The importance of the payments has only grown recently, as investors have become wary of the companies due to short-term concerns about oil overabundance, and long-term fears that climate change and electric vehicles cloud the future of fossil fuels.

But as the companies throw money at investors through dividends and share buybacks to keep them from fleeing, the payouts have begun to strain their balance sheets.

Exxon and France’s Total SA haven't generated enough cash this year to cover new expenses and dividends, according to FactSet data and company disclosures. BP was able to cover its dividend, but the company’s debt levels rose relative to its market capitalization. Shell needed asset sales to help cover dividends and buybacks.

Energy has been the worst-performing sector of the S&P 500 for more than a decade, and the third-quarter earnings have continued a lackluster streak that has lasted throughout the year.

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Exxon, which remains under pressure to return to its practice of buying back billions of dollars in shares annually, reported net income of $3.17 billion, down about 50% from the same period a year ago, but slightly better than what analysts had expected. Exxon increased its annual dividend in the first quarter, a step the company has taken for 37 years in a row.

The company announced that it would begin production next month at its massive new megaproject in the South American nation of Guyana next month, earlier than an anticipated 2020 startup. Guyana is one of several areas where Exxon is investing new sums to boost growth and returns in the future.

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Unlike other companies that are buying back shares, Exxon “is increasing capital spending to increase growth,” Jennifer Rowland, an analyst at Edward Jones, said in a note. “Investor sentiment is likely to remain poor until the company starts to show positive results from its large spending program. This isn’t likely to occur until 2021 at the earliest,” she said.

Chevron Corp. reported net income of $2.6 billion from July to September, down from $4 billion in the same period in 2018. The company increased share buybacks to $1.25 billion in the quarter.

Shell’s U.S. shares fell 3.5% Thursday after the company warned that it might not finish buying back $25 billion in shares by 2020 as originally expected. BP’s U.S. shares fell by more than 3.3% Tuesday after BP reported a loss and failed to increase its dividend.

Oil-and-gas companies now make up about 5% of the S&P 500 index, down from 14% a decade ago, according to Evercore ISI. Their middling recent returns limit their ability to step up shareholder payments that investors increasingly demand as a key step that would bring them back into the sector.

“Eventually, oil demand is going to go down,” said Kevin Holt, a senior portfolio manager for Invesco Ltd., which has more than $1 trillion in assets under management. “With that question of terminal value, it’s even more important that companies ramp up the cash return. Why grow the business if we won’t need as much oil in 20 years?”

While Mr. Holt says oil demand may not decline for two decades, investors now want more cash returns because companies spent too much when prices were high, setting the stage for poor performance when prices fell.

Investors have long gotten generous dividends from Big Oil. In the U.K., Shell and BP combined pay one in every seven pounds of the FTSE 100 dividend, said Jason Kenney, an analyst at Spanish bank Santander. Shell hasn’t cut its dividend since 1945.

Giant oil companies have found this harder to sustain since 2016, when oil prices plummeted to below $30 a barrel, from above $100. For at least two years, many big oil companies were generating a free cash flow that was either negative or below the combination of their capital-expenditure commitments and their dividends, said Mr. Kenney.

Chevron, the second-largest U.S. oil company, has been an exception to this trend. For years, Chevron spent far more on new oil projects than it generated from operations, but the company has entered a harvest mode in recent years as those developments began production. In the first half of this year, Chevron generated $7.3 billion in excess cash, more than enough to pay for about $4.5 billion in dividends and almost $1 billion in buybacks.

Chevron’s production rose 3%, and in the Permian Basin in Texas and New Mexico, output rose 35% compared with a year ago, up to 455,000 barrels of oil and gas a day. The company also said it expects costs in one of its flagship projects in Kazakhstan to rise by 25% from an estimate of about $36.8 billion three years ago to $46.5 billion. Exxon is also part of the partnership funding the development.

Many big oil companies have relied heavily on asset sales to help pay for buybacks, dividends and in some cases even fund new investments, as the amount of cash they generated wasn’t nearly enough to cover those costs. Since 2014, Exxon, Shell, BP, Total and Chevron have sold off more than $110 billion in assets, according to FactSet data.

That strategy worked as long as assets sold for a high enough price. But the lack of investor interest in fossil fuel companies has brought new challenges in this arena as well. BP sold off some U.S. assets at lower prices than expected in the quarter and was forced to book a $2.6 billion write-down.

Exxon has so far fared better as it launched a plan to sell $15 billion of assets by 2021. In September, the company announced a $4.5 billion sale of properties in Norway. Analysts at Mizuho Securities had pegged the value at about $3.3 billion. Exxon Chief Executive Darren Woods said the company reached about a third of its target, and the company continues to weigh potential asset sales in the Gulf of Mexico, Malaysia, Australia and Azerbaijan.

Exxon’s oil and gas production rose by about 3% to 3.9 million barrels a day in the third quarter, driven primarily by its massive ramp-up in the Permian Basin. It reported a third-quarter profit of $3.17 billion, or 75 cents a share, compared with $6.24 billion, or $1.46 a share, a year ago.

Exxon Vice President Neil Hansen said the company is also actively looking at potential acquisition opportunities as the value of other U.S. oil operators has fallen this year.

“It’s going to have to compete with what is already in our portfolio,” Mr. Hansen said in a call with investors. “The environment is generally pretty good. There are a lot of things to look at, there are a lot of things to consider.”

Write to Bradley Olson at Bradley.Olson@wsj.com and Sarah McFarlane at sarah.mcfarlane@wsj.com

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