Angst mounts as oil & gas uncertainty climbs


Financier Worldwide Magazine

May 2016 Issue

May 2016 Issue

Turn to the business pages of any periodical on any given day and there is a strong chance that the latest instalment in the tale of woe that is the current state of the global oil & gas industry will have pride of place.

And a tale of woe it most certainly is.

Top of the industry’s problem pile, of course, is the impact of tumbling oil prices but, according to analysts, companies should be preparing themselves for a spate of emerging threats that are expected to trouble the oil & gas fraternity in the next five to 15 years.

An analysis of these threats is at the core of a recent PwC report – ‘New energy futures: perspectives on the transformation of the oil & gas sector’, released February 2016 – which, alongside recognising the uncertainty enveloping the sector, highlights four potential future scenarios for the industry that may help companies successfully navigate an increasingly complex and volatile global market.

Those future scenarios are as follows. First, the oil & gas industry evolves along current lines with limited government intervention. Second, demand from energy consumers (retail & commercial) for cleaner energy drives the transition toward a low carbon. Third, governments drive increased energy efficiency, expansion of renewable energy demand and accelerated development of disruptive technologies. Finally, supply constraints are triggered through direct government action, such as implementing carbon legislation or withholding licences.

As well as being clear testament to the extent of uncertainty surrounding the industry, the above-listed scenarios also serve as a signpost for oil & gas companies as to the need for them to consider their futures amid the harsh realities of the depressed environment in which they currently find themselves.

Industry challenges

At present, the challenges facing the oil & gas industry are considerable. In addition to the future scenarios prophesised by PwC, many other analysts have opined on the range of threats likely to bedevil the industry over the coming years.

“From a global perspective, one of the challenges of a prolonged downturn in the oil price is ensuring that companies with the correct resources – skilled personnel, equipment and new technology – remain available for the inevitable upturn which will occur,” says Clare Munro, head of energy and infrastructure at Brodies LLP. “There will be continued growing global demand for energy and – even though there are continuing efforts toward diversifying energy supply, particularly with low carbon alternatives – for the foreseeable future fossil fuels will provide the lion’s share.”

The UK perspective on lessening the industry’s woes recommends the use of fiscal and regulatory levers as a means of ensuring that it is economically attractive to continue to produce resources rather than decommission platforms and infrastructure.

A spate of emerging threats that are expected to trouble the oil & gas fraternity in the next five to 15 years.

Some experts do not consider the precipitous decline in oil prices to be a short-term phenomenon. In Canada, due to economic and geopolitical factors, the oil & gas industry remains in a state of flux, and this will create real challenges and certain opportunities in the months and years ahead. “Over the short term, there may be less exploration and production activities and infrastructure projects – although Canadian overall production is expected to increase – and forced or semi-involuntary sales of assets,” suggests Julia C. Loney, a senior associate at McMillan LLP. “For investors keen to capitalise on the situation, opportunities may be forthcoming in the coming months, such as consolidations with American and other foreign companies, and potential bargains from companies in distress and sales to private equity funds.”

Other experts believe that the challenges extend well beyond low oil prices. “The volatility in present and future prices frustrates the planning of the long-term giga-projects and the commitments to fund them,” says Rob James, a partner at Pillsbury Winthrop Shaw Pittman LLP. “This difficulty is compounded in the case of project-on-project risk, where a production project is dependent on developments in transport or a destination market.”

For Charles Daly, chairman of Channoil Consulting Ltd, the threats to the oil industry will come primarily from political forces. “Changes in regulation, without knowledge of the unintended consequences, is the biggest danger to the industry,” he says. “We have seen the ups and downs of bio diesel, the effect of wind and solar electricity generation and the restriction in emissions on shipping operations. All these have an impact on refining and demand. To change refinery configuration to meet these ever changing restrictions entails billions of dollars of investment, which sometimes cannot be achieved because the restrictions themselves depress refining margins and thus make the investments unpalatable to the banks.”

Ongoing impact of Paris

In December 2015, the Paris Climate Accord, a global agreement on the reduction of climate change, resulted in a stipulation for 195 countries to cut their carbon emissions every five years from 2023, an arrangement that will have a major impact on fossil-fuel companies and their alternative energy programmes. But the industry has mixed views about how long it will take for alternative sources of energy, such as renewable technologies, to play a significant part in the restructuring of the oil & gas industry.

“It will take a long time for non-fossil fuel energy technologies to be improved and for the economics of non-fossil-fuel energy to be sufficiently robust to persuade governments and oil & gas companies to move away from fossil fuels entirely,” Ms Munro anticipates. “Inevitably, there will be ongoing research and it will be down to individual oil & gas company strategies as to whether they expect non-fossil fuels to make up a large part of their future focus or not and therefore whether they will participate in such research.”

For Mr James, the expectation is that oil & gas companies will, first and foremost, innovate and research “close to home”, with more emphasis being placed on reducing emissions of all greenhouse gases through their own value chain. “An urgent and important area of concern is reducing methane escapes in gas operations from production to consumption,” he says. “However, the efforts of these companies in response to Paris will vary nation to nation, as some states pursue mandates more fervently than others.”

When assessing the ramifications of Paris, understanding the past can go a long way towards an accurate determination of the future, whatever the circumstances may be. “The oil industry is extremely resilient,” asserts Mr Daly. “A reader of history will tell that in 1974 the oil industry had all its assets in the Mid East Gulf nationalised overnight and the price of oil quadrupled. This led to a slump in demand of up to 25 percent. The industry then immediately turned its attention to politically safe, if costly, areas of production.”

The likes of BP, Exxon Mobil and IEA have shown that, although the Paris Climate Accord set targets for carbon emissions, no government has yet enacted laws to enforce the limits. “Unless there is a collective agreement to set a carbon tax which turns the economic direction away from burning fossils fuels, oil and gas will still be contributing over 60 percent to primary energy demand,” adds Mr Daly. “Governments talk the talk but are not prepared to face the electorate with the true cost of a post hydrocarbon era.”

Potential trends and developments

“Lower for longer” is the mantra of Christopher Mirick, a partner at Pillsbury Winthrop Shaw Pittman LLP, when considering the oil & gas industry’s prospects over the coming 12 months. “I’ve seen forecasts for a rebound of sorts in oil & gas in 2016, but nothing close to $100 a barrel,” he notes. “If the industry is hanging out between $25 and $50 per barrel, and similarly depressed on the gas side, the year is going to be focused on cutting costs.”

The goal for companies that have cash to spend, says Mr Mirick, is to make those reserves last as long as possible – by renegotiating payment terms, stretching out obligations and hoping for a rebound. “Companies without cash need to raise it, by selling assets or equity,” he says. “If there are deep-pocketed, opportunistic buyers out there, this might be the time to buy assets or companies and see if you can be the last one standing when the rebound occurs.”

While expecting oil prices to remain low throughout 2016, Ms Munro is confident that developments could quickly alter the industry’s largely subdued outlook. “Although pricing is low, oil & gas companies will remain in sustainability mode and will continue to focus on improving operational efficiency and reducing both capital and operating costs,” she says. “Some will have to re-evaluate business models and may be required to sell assets or merge businesses to allow them to start investing again.”

For others, the second half of 2016 may see a modest recovery, but not to the levels of mid-2014 before oil & gas prices started to tumble. “Although investment in the global oil & gas industry is now down significantly for the second straight year in a row, it will be three or four years before we feel the full impact of this,” says Alicia Quesnel, a partner at Burnet, Duckworth & Palmer LLP. “Investments made three or four years ago have tempered current declines in global production leading to a more prolonged supply glut. Likewise, notwithstanding the lack of investment today, the pace of recovery will initially be tempered.”

Conclusion: taking stock and looking to the future

As well as taking stock of its current predicament, the oil & gas industry is of course concerning itself with the future, determining how best to deal with extant risks and those yet to emerge.

As a means of doing this, PwC’s report recommends that companies across the oil & gas chain implement a number of measures, including having a clear strategy and alignment with portfolio, decision-making processes and capabilities; an ability to be agile and resilient in uncertain times; an innovative response to disruptive change using existing assets as well as technology, knowledge and capabilities; and a readiness to form alliances and collaborate across the supply chain.

However slight these suggestions may seem, given the magnitude of the issues at hand, Jan-Willem Velthuijsen, PwC’s chief economist in Europe, believes that they will allow companies to “reassess their current strategy and plans, with implications for the operating model, partnering strategy, resourcing and technical capabilities”.

Furthermore, in March 2016, the world’s three biggest oil producers – Russia, Saudi Arabia and Qatar – met to discuss, among other things, restricting global crude production in an effort to at least maintain, and perhaps increase, prices. However, few are convinced that the outcome of these talks will produce meaningful price supports in the medium term.

Although there has been some recent indications that the pendulum may be shifting just a little, such as the International Energy Agency (IEA) unveiling evidence that oil prices are stabilising and could be set to rise again, due to lower oil input in the US and a less than expected supply from Iran, for the moment the oil & gas industry is in turmoil, a state of affairs compounded by fear and uncertainty and discussions that dwell on worst-case scenarios, rather than the exploration of legitimate means of salvation.

© Financier Worldwide


Fraser Tennant

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