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Oil Sector's Cash Recovery Isn't Total Success

Europe's major oil companies are starting to pay their own way. The sector has beaten the market so far this year in the hope that spending cuts and improving operations would mean companies could cover their investment and dividends from operating cash flow.

Covering its out-goings should shore up investors' faith in the sector's ability to churn out healthy payouts to shareholders, after years where funds were shoveled into grandiose capital projects, depressing returns.

Now the sector finally seems to be making progress.

Europe's biggest oil and gas companies—Royal Dutch Shell, BP, Total, Eni E and Statoil — generated nearly $32 billion of operating cash flow in the second quarter, notes Morgan Stanley, up 32% on last year. That covers the five's total bill for capital expenditure at $30.7 billion but is some way short of picking up the tab for dividends, a combined $9 billion.

Among the largest three, BP and Shell  have made clear strides. BP, whose results were overshadowed by concerns around its 20% investment in Russia's Rosneft, generated close to $4 billion in first-half free cash flow, enough to cover its dividends. Shell repeatedly rattled investors in a dismal 2013 but the company is nowlargely funding itself internally, even without funds from asset sales: adjusting for double-counting of exploration expenses, which hit both Shell's income and investment figures, the company churned out $7 billion in free cash flow this half, against the $12 billion it pays out in dividends annually.

Total, meanwhile, faltered: the French company won plaudits for leading the sector in embracing spending restraint and investment discipline. But its cash flow from operations, excluding volatile movements in working capital, barely covered its first-half spending.

Excluding proceeds from asset sales Total remains squarely in the red. Thanks to delays at non-operated large projects, like Kashagan, Total will struggle to hit its target of $10 billion in free cash flow for 2015. Changes to this and its production outlook are likely at an investor day in September.

That could weigh on the stock while the market reassesses Total's likely trajectory. Jettisoning production targets is de rigueur given the sector's focus on value rather than size. Growth in Total's cash flow should still beat rivals in 2015. But with peers getting their houses in order, it will get harder to stand out from here.