OREANDA-NEWS. Cost-cutting initiatives announced by Shell, Total and BP are modest compared with their upstream-focused US peers. This shows EMEA companies are still trying to balance keeping strong balance sheets with a commitment to dividends and investment from which they will benefit when the cycle turns, Fitch Ratings says. The capital and operating expenditure plans of the three companies should reduce their cash flow deficits over the next two or three years if oil prices gradually recover in line with our expectations. However, they may not be enough to reduce the deficits in a lower-for-longer price scenario.

Our base rating case assumes Brent will gradually recover to USD45/bbl in 2016, USD55 in 2017 and USD60 in 2018. If our forecasts show that some companies' metrics are unlikely to be in line with our rating guidance under the base case, this could result in some negative rating actions in the near term. However, we expect the number and magnitude of actions to be moderate, in line with our approach of rating through the cycle. We have already revised the Outlook on BP's 'A' IDR to Stable from Positive, reflecting our view that leverage will be higher than originally expected for the next few years.

The rating picture may change if oil prices do not recover as quickly as we expect. Our current stress case assumes USD35/bbl in 2016, USD40 in 2017 and USD42 in 2018. In this 'lower for longer' scenario, we expect oil majors to more aggressively cut their discretionary spending, including dividends, to balance their cash flows and keep debt under control. This scenario also assumes more significant cost deflation, which should make cost cutting an easier task. However, the deflation alone would be insufficient to fully offset the effect of lower oil prices. This could spark more negative rating actions but much will depend on how oil companies react.

Shell (AA/Rating Watch Negative), Total (AA-/Stable) and BP reported 2015 results that were weak but in line with our expectations, reflecting a near 50% drop in average Brent prices from 2014. The companies' cumulative EBITDAX fell 38% as booming refining margins and initial cost cutting partially offset price declines. Earnings will probably drop even further in 2016 as oil prices remain depressed and refining margins will shrink. We expect their total EBITDAX to fall 10% in 2016 if Brent recovers to USD45/bbl. Under our USD35/bbl scenario, the decline may be 30%, but much will depend on the magnitude of operating expenditure cuts and cost deflation.

Based on company announcements, we expect aggregate 2016 capital expenditure to fall by a further 15%, following an average reduction of 15% in 2015. On operating expenditure, our base case assumes upstream unit costs in the next two to three years will be 30% lower than in 2014. This is in line with the measures announced by companies and results already achieved.

With a few exceptions, dividends have remained the sacred cow for oil majors. BP said it views dividends as its financial priority and will aim to sustain them even at the expense of more borrowing, whereas Shell plans to keep its dividend unchanged, but sees this aim as subordinate to debt reduction. Total also committed to support its dividends, though its scrip programme helped to reduce cash distributions by 60% in 2015. ConocoPhillips's and Eni's decisions to reduce pay-outs to shareholders are still the exception, but we expect more companies to follow suit if oil prices do not start to recover by the second half of the year.