Marathon Oil's Huge 2016 Budget Reduction Shows OPEC is Killing Something, but It Isn't Shale

Marathon Oil Corporation (NYSE: MRO) just released its 2016 guidance and capital spending plans. Capital spending in 2016 is expected to come in at $1.4 billion, a drop of nearly 55% from 2015 levels. That's a big decline. What's even more eye-opening is the 75% decrease from 2014 levels.

With oil barely over $30 per barrel and natural gas under $2, huge spending reductions aren't surprising. What might be surprising is what Marathon is choosing to continue to spend on and what it's choosing to cut.

Maximizing allocation to short-cycle resource plays

Of the $1.4 billion Marathon is planning to spend in 2016, $998 million (over 70%) will be allocated to horizontal resource plays.

Source: Marathon corporate presentation.

Unlike companies such as Continental Resources or Whiting Petroleum , which are pure plays on certain shale basins, Marathon has a diversified asset base. Marathon is continuing to spend on resource play development not because it has no other option, but rather because it chooses to.

While Marathon continues developing its resource plays, spending elsewhere is being curtailed as much as possible.

Image source: Marathon Oil Corporation.

Marathon International: Marathon will spend $170 million in its international business segment. That spending is directed toward the completion of long-cycle projects in Equatorial Guinea and the Kurdistan Region of Iraq.

While existing long-cycle projects are being completed, new long-cycle projects won't be receiving any capital.

Marathon Conventional Exploration: The amount of money being spent looking for new conventional oil and gas will be a minuscule $30 million in 2016. That's down from $250 million in 2015 and $500 million in 2014.

All of that $30 million relates to existing spending commitments in the Gulf of Mexico and Gabon. Without those, exploration spending would be zero, as there are no new exploration wells planned.

The Marathon 2016 capital spending plan provides a terrific glimpse of what's happening across the industry. An extremely low oil price is certainly reducing the rate of resource play development, but it isn't killing it.

The spending that's being killed by the low oil price is conventional exploration and big-ticket long-lead-time projects such as offshore deepwater and oil sands. Companies simply can't afford to sink cash into exploration wells that even if successful provide no immediate return on investment. And the idea of committing huge sums of capital over several years to build out an offshore or oil sands project is a non-starter in the this world of crimped cash flows.

OPEC may have set out to crush shale, but conventional exploration and long-lead-time projects got caught in the crosshairs.

2015 took a toll on Marathon's balance sheet

Like many companies, Marathon's balance sheet paid a price in 2015.

During the year, Marathon generated $1.57 billion in cash from operations and had capital spending of $3.4 billion (more than 200% of cash flow). The company outspent cash flow by a whopping $1.83 billion.

To fund that outspending, Marathon increased its long-term debt by $2 billion, from $5.3 billion to $7.3 billion. The company also cut its dividend in October from $0.21 per share to $0.05 per share and eliminated all stock repurchases.

Marathon spent $3.5 billion in 2014 repurchasing shares at much higher stock prices.

Even with capital spending down 55% from 2015 levels Marathon is still not expected to be able to generate enough cash flow to cover spending in 2016. This issue came up in the Q4 earnings conference call, with one analyst asking how Marathon expected to cover a nearly $600 million spending shortfall (using current strip pricing).

Marathon's plan for that is a non-core asset sale target of $750 million to $1 billion, along with the fact that it has $4.2 billion of liquidity in the form of $1.2 billion in cash and an undrawn $3 billion revolving credit facility.

A new era in the oil business

In this seemingly endless oil crash, it's becoming clear that shale oil isn't going to go away. The fact that you can start drilling and have a shale well on production within a couple of months is a very attractive proposition.

At some point, I expect to see the better financed oil majors start to aggressively take out larger independents such as Marathon that have large positions in the major U.S. shale plays. The balance sheet deterioration that companies such as Marathon are experiencing can't go on forever, and sooner or later a takeover from a stronger rival is going to be an appealing option.

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