UK Oil and Gas underperforms on another year of lower profits, and higher taxes

It’s been another poor year for the big beasts of the oil and gas sector, although the decline in energy prices has acted as a benefit for the hard-pressed consumer as well as businesses, relieving the pressure on everyday budgets.

Profit margins which came down from the elevated levels seen in 2022, during 2023, have continued to come under pressure, while actual profits have been targeted by governments for punitive windfall taxes, which in turn has served to discourage future capital investment in capacity.

As with previous years the challenge for the oil and gas sector continues to be in how they transition towards a renewable future without hammering their margins, and it’s been a contrast to see the difference in fortunes of how they do this while at least trying to keep the green lobby happy.

When we look at the likes of BP and Shell, and compare their fortunes to the likes of their US counterparts Chevron and Exxon Mobil there is a clear divergence when it comes to share price performance.

Both Chevron and Exxon Mobil shares have outperformed the UK’s BP and Shell by quite some distance and it’s not hard to see why when you look at the way the US conducts energy policy compared to the UK and Europe.

Shell CEO Wael Sarwan got the memo in the middle of 2023, junking his predecessor Ben Van Buerden’s aggressive shift towards renewables by saying that "We need to continue to create profitable business models that can be scaled at pace to truly impact the decarbonisation of the global energy system.

We will invest in the models that work – those with the highest returns that play to our strengths" in a broadside at some of the recent narrative and almost hysterical calls to cut back on fossil fuel use whatever the cost.

Oil price weakness drags on BP and Shell

 

Source: CMC Markets

This new approach helped Shell’s share price mitigate some of the weakness that has afflicted BP which has seen its shares slide to their lowest levels since July 2022, after initially getting off to a string start to 2024.

Since April the weakness in the sector has been broad-based, although the weakness in BP has outpaced the slide in the oil price, it is interesting to note that since Shell hit new record highs in May the same level of weakness hasn’t been seen in its US listed counterparts.

This underperformance may cause Shell CEO Wael Sarwan to reflect on the recent decision not to switch its primary listing to the US given the latter’s better valuation and shareholder returns record.

If it were to happen, and given the current economic illiteracy of the current UK government and its attitude to the oil and gas sector, the pressure for such a move is only likely to grow, it would be a huge blow to the London market.

In its most recent Q3 trading update Shell reported profits of $6bn, which while more than expected, was still 4% lower than the previous year, helped by outperformance in its LNG division, which helped offset weakness in its refining and chemicals division. 

Year to date profits edged above the $20bn mark with management announcing a further $3.5bn share buyback.

Earnings from its LNG division along with increased demand are helping to drive the business with sales increasing to 17m metric tons, up from 16m the previous year, helping to improve cashflow to $14.7bn from $13.5bn in Q2.

In recent months Shell has also scaled back renewables and hydrogen operations, as well as pulling back from European and Chinese power markets, and cutting its oil and gas exploration headcount by 20%. Its renewables business posted yet another loss, $162m this quarter

While Shell reported modest decline in Q3 profits, BP shares posted an even bigger decline in profitability, with a 30% fall to $2.27bn from $3.29n a year ago, and its weakest quarter since Q4 2020.

Incoming CEO Murray Auchinloss tried to put lipstick on a pig by claiming that the company was on course to deliver value over volume, although in a concession to shareholders, management have dropped the pledge to reduce oil and gas production by 2030, which was brought in by his predecessor Bernard Looney.

On a more positive note, BP did keep the rate of its share buyback at $1.75bn, however the uptick in net debt, along with concerns over weak margins appears to be hampering any attempt at a share price recovery. 

With its peers pulling back on various pledges to speed up renewables the pressure is likely to increase on BP management to do the same thing given how much it appears to be costing the wider business in shareholder value.

BP’s problem is that it appears to want to be all things to all men when it comes to the energy transition when the reality is that the profits simply aren’t there. This appears to be borne out in its guidance for 2024 when it warned that refining margins were likely to remain low.

The contrast in fortunes this year compared to last is best illustrated in the profit numbers for its gas and low carbon energy division year to date, compared to 2023.

Profits year to date for this division have fallen from $11.9bn to $1.7bn, with the risk here being that continued underperformance here could signal further takeover interest, as we head into 2025.  

Away from the oil majors the effect of the windfall tax along with the decision by new energy secretary Ed Miliband to terminate all new UK oil and gas licences has also had a chilling effect on the smaller UK oil and gas providers, like Harbour Energy, Serica Energy and EnQuest, whose share price performance has been nothing short of disastrous these past 2 years

Harbour, Serica, and EnQuest share price year to date

Source: CMC Markets

Harbour Energy should have been the poster boy for a UK recovery story, given that it arose from the ashes of the Premier Oil and Chrysaor merger which saw the company carry net debt of $2.9bn, and saw the company able to add 5% to the UK’s oil and gas output capacity when it opened its Tolmount East field back in 2023, and its Talbot operation which looks set to come on stream before the end of this year.

When Harbour reported in August there was some good news even as revenues slipped to $1.9bn, the company was able to generate a small profit before tax of $400m, although with an effective tax rate of 85% that fell to $100m after tax.

The completion of the deal to acquire the Wintershall Dea business, announced this time last year, and which includes assets in Germany, Norway as well as South America and the Middle East should help the business to diversity its portfolio is also expected to complete before the end of this year, as well as boost its revenues away from the UK.    

Of the revenues that were generated crude oil accounted for $1.11bn and gas with the bulk of sales coming from its North Sea operations. International revenue accounted for a mere $98.1m in sales.

The company announced an interim dividend of $100m or 12c a share, while confirming that it had been able to meet its target of becoming debt free and now had $45m in net cash as of the end of June.

As we look ahead to 2025 the focus is likely to be on BP and whether it can stop the rot in its share price and whether shareholder pressure forces management to follow in the footsteps of Shell in reining back on its investment in renewables.

There is also the prospect it might become the subject of further takeover interest after Abu Dhabi’s National Oil company Adnoc reported to be interested, although the UK government might have something to say about that.

Of course, there is also the prospect that Shell could announce its departure from the UK market, having only recently called time on its dual listing in Amsterdam. The friendlier regulatory environment in the US might appeal especially as President Trump has vowed to “drill baby drill”, so it wouldn’t surprise if the pressure for Shell to move its primary listing to the US could be the story for 2025. 

All companies tend to go where the money is and given the current government’s hostile attitude towards business we could see further capital departures in the coming months.

Certainly, the drive towards renewables isn’t the profitable venture government ministers would like to claim it to be, not when you look at the likes of Orsted and Vestas Wind Systems whose shares have struggled over the last few years.    

Orsted is Denmark’s and the world’s biggest providers of renewable energy of offshore wind, with an excess of 13.7GW of installed capacity, with 6.2GW of that installed in the UK, and while their shares have traded sideways this year, Vestas Wind Systems has seen its shares crater to 4-year lows.

This total is expected to increase to 50GW by 2030, by a combination of wind, solar and renewable hydrogen, which is estimated to cost in the region $60bn.

Since then, the prices of key commodities have soared, along with demand. This inconvenient fact continues to be overlooked by climate activists as they continue to peddle the fiction that renewable power is cheaper.

The reality is that oil and gas is likely to be around for some time to come in the absence of a reliable base load alternative which can compensate for dunkelflaute periods of low light and no wind which occurs on average between 50-100 hours a month between November and January.