Regret capital spend or regret dividend cut?

March 14, 2016 Jon Allwood

The debate about high dividends in the oil and gas sector rages on. Personally, I have lived through a number of the "damned if you do, damned if you don't cut dividend" debates. Rarely have I emerged totally unscathed.

This issue of dividend policy in a downturn reminds me somewhat of triage for the emergency patient in the medical world. When an emergency patient arrives at the entrance to the hospital, do you send them to Accident and Emergency immediately, send them back to their local doctor or send them home and hope the minor injury will be ok? Drastic surgery on the dividend, a mild dose of dividend cuts, or hoping that drastic capital expenditure will cure the ailment and keep the company paying dividends as normal. Is over $500bn in capex reduction so far in this industry enough to keep the patient alive and well?

Although we at KBC are tempted to have an opinion on this debate, we don't take a position. We leave that client advice to the strategy consultants such as McKinsey, Bain, BCG or the investment banks.

However, KBC is clear on promoting one particular medicine in a downturn within the much needed profit improvement and operational excellence programs, which is our core service for Upstream Producers, Midstream and Downstream Operators alike. That medicine is the ruthless elimination of so called "regret capital", an essential profit target in a capital-intensive industry.

KBC knows, from over 35 years of experience, that oil and gas companies have a systematic bias to spending too much capital to achieve the results required. Some estimate this to be 15% of all capital spend. One reason is the vested interests of licensors, engineering firms and capital providers over-promoting their products and services. The other is the layers of insecure middle management piling on contingencies or seeking to solve complex operating problems through throwing capital at the problem - someone else's problem. For whatever reason, it is a fact that there is an overspend on capital, so called "regret capital", even in tough times. We see this in many areas: a spend of $200m on new capital which was substituted at a cost of $100m by an operational improvement program for the same long term profit results; capacity that arrives many years too early or too late for the market; and spending on compromised, subscale facilities rather than waiting for world scale investment opportunities. Much of this "regret capital" is found in the detail of existing projects rather than the simple wholesale cancellation of projects.

One of KBC's most rewarding services is this forensic search for unnecessary or overdesigned capital spending using advanced software, substituting capital with real and sustainable operating performance improvement. This, combined with price pressure on suppliers, is at the heart of profit improvement.

So as you seek to decide on your 2016, 2017 and 2018 dividend policy make sure you have taken this medicine. Root out the in-built "regret capital" that the industry spends, even within existing slimmed programs and assets, identifying multiple millions that could be spent more wisely on focused investment or the avoidance of "regret dividend cuts".

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