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 October 19, 2016
After Lean Years, Big Oil May Emerge Stronger Than Ever

 Big Oil is clawing its way back.

After a heart-stopping plunge in the price of crude over the last two years, along with slashed dividends and the elimination of tens of thousands of jobs, the biggest oil companies are proving surprisingly adept at again pumping profits, as well as oil, out of the ground.

Indeed, with oil trading in a range of $40 to $50 barrel for most of the 2016, experts say the biggest energy producers are poised to rebound if prices remain stable.

"It's a hunger games environment, but they are learning how to be more efficient," said Evan Calio, an equity analyst with Morgan Stanley. "Two years ago, nobody thought costs could drop as quickly as they did. It's staggering, and there's no doubt this has surprised people."

Not that it has been easy.

Over the last 12 months, drillers have eliminated nearly 20,000 jobs in the United States, according to the Labor Department, and Morgan Stanley expects domestic oil production to finish 2016 half a million barrels below where it started. Deepwater drilling has been curtailed in places like the Gulf of Mexico, as have multibillion dollar projects around the world.

In the continental United States, once red-hot regions like North Dakota, where the fracking boom transformed the economy, have abruptly cooled. Individual companies that were especially aggressive about seeking new finds have been humbled.

Besides being forced to cut its dividend, ConocoPhillips reduced its capital budget for exploration and production by more than $10 billion --- or roughly two-thirds. Since late 2014, its shares have fallen from over $70 to around $40 recently.

But if crude prices can stay above $40 a barrel, the dividends, and stock prices, of the big American oil companies should be secure. And if oil stays above $50, or even hits $60 in the coming months or years, Big Oil may well emerge from the recent lean years stronger than ever.

"Whoever survives this is going to win," said Michael Rothman, a veteran oil analyst who is president of Cornerstone Analytics, a New Jersey-based research firm. "They're going to come out smelling like roses."

What is more, the big pullback in exploration has caused a steady drop in the cost of completing those projects that are still underway, as prices for steel, drilling rigs and other services have plunged. That should enable major energy firms to take advantage of economies of scale and increase their profit margins further.

"Capital spending has come down massively, and majors have taken a lot of the fat out of their organizations," said Neil Mehta, who tracks the North American integrated oil and refining industry for Goldman Sachs.

Now, after investing tens of billions of dollars, many of these giant projects are set to come online in the next few years, and Mr. Mehta said he expected Big Oil to move from investment mode to what he termed "harvest mode."

"You spend a lot upfront and the capital is sunk, but now free cash flow profiles are going to get better," Mr. Mehta said.

For example, Chevron's large Gorgon natural gas project in Australia saw costs balloon to more than $50 billion from a projected $37 billion. That strained the company's budget, but as Gorgon's production finally increases, Chevron's bottom line will benefit, with Japanese and Korean customers lined up to take delivery of natural gas.

Next year and 2018 "look to be an inflection point for Chevron," said Phil Gresh, an analyst with JPMorgan, noting that as projects like Gorgon near the finish line, the company's free cash flow should rise, providing additional support for Chevron's 4.2 percent dividend.

What if oil prices do, in fact, start tumbling again, or at least don't budge from their current level of about $50 a barrel? If benchmark oil prices dip below $40, sustaining dividends will be tough, according to Mr. Mehta. "At $50, American companies can make it, Europeans maybe not," he said. "At $60, it's likely everybody can sustain their dividends."

And the oil bulls do have some long-term trends in their favor.

Despite the push to reduce dependence on fossil fuels in many countries in the face of climate change, as well as the increasing popularity of electric cars in the United States, the global appetite for oil is still expected to rise.

Mr. Mehta estimates oil will trade in the $50 to $60 range from 2017 to 2020, with global demand rising annually by slightly more than one millions barrels a day. "There are many countries that want to work their way up the economic ladder, and that means more demand for energy," he said.

Indeed, even with slower growth than in years past, China continues to consume more crude as new drivers hit the roads. India, too, has a growing middle class that will need gasoline and other fuels to power new automobiles. Many American drivers, not to mention Detroit automakers, still favor gas-guzzling sport utility vehicles and other large cars.

At the same time, Middle East oil producers as well as Russia have been showing a bit more willingness to work together to maintain price stability after the volatility of 2014 and 2015.

To be sure, there's no guarantee oil prices will rise --- or even stay where they are.

A little more than two years ago, when oil was trading higher than $100 per barrel, many experts, not to mention executives, had no inkling a crash was coming. With prices high, they borrowed -- and drilled -- as fast as they could.

Some small exploration and production companies in the United States were forced to file for bankruptcy, unable to sustain debt payments as crude collapsed. But that weakness actually has provided an opening for bigger companies to scoop up assets, essentially drilling for oil on Wall Street by buying struggling firms on the cheap.

Even if prices do drop again, the biggest energy companies that possess both upstream production capacity and downstream businesses like refining, chemicals and retail outlets will still fare better than smaller rivals, Mr. Rothman said.

"There's an advantage to being an integrated oil company with both upstream and downstream operations and gas stations," Mr. Rothman said. "It's interesting that retail gas stations make more money selling beer and cigarettes than gasoline."