Navigating the Shifting Tides: Assessing the Oil and Gas Sector's Trajectory After a Year of Profit Fluctuations

What next for UK oil and gas after a year of lower profits

By Michael Hewson (Chief Market Analyst at CMC Markets UK)

In contrast to the strong gains seen in 2022 the oil and gas sector has had a much more mixed year as a sharp fall in natural gas prices, and a slowdown in oil prices saw profits return to more normal levels for the sector.

In 2022 the likes of Exxon Mobil and Shell saw share price gains in excess of 60%, as both oil giants reaped the benefits of higher margins as they bounced back from the huge losses posted during the Covid pandemic.

As a whole the sector posted losses of $76bn with around $70bn of that amount as a result of write-downs and impairments on unviable or stranded assets.

As with last year the challenge for the likes of Exxon Mobil, BP and Royal Dutch Shell remains in how they transition towards a renewable future without hammering their margins, and while we've seen a period of share price consolidation this year, we've also seen a shift in tone away from keeping the green lobby happy.

There now seems to be a more hard-nosed and pragmatic approach, which has helped both Exxon and Shell's share price make new record highs over the second half of the year, although as oil and gas prices have declined so have share prices.

Consolidation year for BP and Shell

As a whole the sector saw demand and prices collapse during that Covid period and it would appear that those experiences during that time may have shaped OPEC's response to this year's supply and demand concerns.

Fearing another oversupply issue OPEC and Russia have kept much tighter control over production output, announcing cuts in April and then continuing those caps through the summer and into next year in an attempt to keep a floor under prices.

Along with further geopolitical uncertainty on top of Russia's war in Ukraine, in October we also had to contend with the Hamas savage attack on Israel's northern border, and Israel's response which prompted concerns over transit routes around the Gulf region.

With inflationary pressures subsiding and energy prices stabilising at lower levels the oil and gas sector for now appears to focussing on what it does best in generating cash, with new CEOs for both Shell and BP marking a potential shift in thinking when it comes to renewables.

Under their previous incumbents, Shell's Ben Van Buerden and BP's Patrick Looney the focus was very much on transitioning away from oil and gas and towards a much lower margin future of renewable energy.

While a laudable goal it soon became apparent that while the politics was very much geared to that, there was a growing realisation that it couldn't be done cheaply and not without enormous damage to the energy and economic security of everybody.

When Wael Sarwan took over as CEO of Shell he recognised this reality quickly, pushing back against the prevailing narrative and outright hysteria of politicians and activists that it could be done cheaply and easily.

In June he pushed back 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 reckless narrative and almost hysterical calls to cut back on fossil fuel use whatever the cost.

While this has caused some unease in some parts of the Shell business it appears to be an acknowledgment of the reality that the transition to renewables will be a gradual process especially given the current levels of geopolitical uncertainty that are serving to drive the costs of the energy transition ever higher.

It is a little worrying that politicians have been unable to grasp this reality, continuing to push the myth that wind power is cheap, as the silent majority push back over the reality that the transition will be ruinously expensive if done too quickly.

When Shell reported its Q2 numbers in July profits fell short of expectations due to the sharp falls in both natural gas and crude oil prices that occurred over that quarter.

The rally in oil and gas prices since then has ensured that this didn't happen in Q3 with profits coming in line with forecasts, which given that all its peers saw their numbers come in light was particularly notable.

Q3 profits came in at $6.22bn, in line with expectations helped by improvements in refining margins as well as higher oil and gas prices and a better performance in its trading division.

The integrated gas part of the business saw profits remain steady and were in line with Q2 at $2.5bn.

Upstream saw a solid improvement on Q2's $1.68bn, rising to $2.22bn, although we've still seen a steep fall from the same quarter last year.

On renewables we saw that part of the business sink to a loss of -$67m, due to lower margins and seasonal impacts in Europe, as well as higher operating expenses.

Shell's chemicals and products division also did much better in Q3, its profits rising to $1.38bn helped by an improvement in refining margins due to lower global product supply as well as higher margins in trading and optimisation, although chemicals were still a drag on profitability overall.

On the outlook Shell nudged the upper end of expectations for capital expenditure down by $1bn to between $23bn to $25bn, as well as increasing the buyback to $3.5bn.

While Shell's share price has held up reasonably well the same can't be said for BP which while holding onto last year's gains has lagged behind Shell, although BP was able to get close to its February highs in the middle of October.