Integrated Oils: A Free Cash Flow Story
These companies are finally set to deliver free cash flow, and in several cases the market is missing it.
Integrated oil companies are set to reverse years of little or no free cash flow despite significantly lower oil and gas prices as high levels of investment give way to growth and capital restraint. We expect increased free cash flow from both upstream and downstream segments. In upstream segments, improved cost structures and the addition of higher-margin production will increase cash margins, offsetting much of the impact of lower oil prices. Meanwhile, service cost deflation, standardization, and simplification combine to reduce the capital intensity of key project areas such as deep-water, shelf, and onshore, creating the opportunity to do more with less. In downstream segments, continued strong market conditions combined with earnings growth lead to strong free cash flow generation. This results in financially stronger and healthier companies that can increase dividends and repurchase shares. Importantly, this improvement can occur at our midcycle oil price of $60 a barrel--well below current levels--and in many cases, the market is underpricing the improvement. We think Shell (RDS.A)/(RDS.B) and Total (TOT) present the greatest opportunity.
Upstream: Cost Improvements Lead to Greater Free Cash Flow
The combination of improved cost structures and lower capital-intensive production growth has culminated in improved free cash flow generation for the upstream operations of integrated oils compared with recent years. Driving the improvement in free cash flow generation is a reset in upstream development capital and operating costs to sustainably lower levels that will allow integrated oils to deliver greater free cash flow at much lower oil prices.
Allen Good does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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