Oil & gas: a new reality

November 2018  |  FEATURE  |  SECTOR ANALYSIS

Financier Worldwide Magazine

November 2018 Issue


The oil & gas space has undergone several notable and rapid changes over the last 20 years. The first decade of the 21st century saw a virtually unprecedented spike in oil prices, as a barrel climbed from under $25 to nearly $150. The global financial crisis brought a crash to $40 per barrel in 2008, before a recovery drove prices above $100 once again.

Geopolitical and economic pressures forced the price of a barrel down for two years, starting in 2014. China and other emerging markets, which had previously driven oil prices higher, were consuming significantly less oil. Although demand slowed, production by Saudi Arabia and other oil-rich countries continued unabashed. Further, Canada, the US and a number of other markets began to explore fracking opportunities, greatly increasing oil production and slashing oil imports sharply.

Oil prices have, however, stabilised of late. At the start of 2018 there was significant short-term optimism about the market given the return of inventories to relatively ‘normal’ levels. Yet, the sector continues to underperform the S&P and is largely unattractive to a good portion of the investment community. But why?

Since 2014 and the crude downturn, there has been a sharp fall in investment in the oil & gas space. In the UK, for example, investment in the sector collapsed to just under 0.9 percent of total investment in the first quarter of 2018, according to Thomson Reuters Datastream. Globally, investment in conventional oil & gas remains subdued, according to the International Energy Agency (IEA), with much of the investment in the industry focused on brownfield projects.

Oil production is also a major issue. According to the US Energy Information Administration (EIA), output in the US will average 10.7 million barrels per day (BPD) in 2018, 1.3 million BPD higher than last year’s average, easily surpassing the record set in 1970. The EIA expects BPD to grow by a further million in 2019. However, pipeline difficulties in one of the country’s main oil producing regions – the Permian Basin – could create difficulties in getting oil out of the region as there is not enough available pipeline capacity. As a result, regional oil prices have declined, creating downward pressure on the stock prices of producers in the area.

Further, the World Bank announced in 2017 that it was ending its financial support for oil & gas extraction after 2019 in response to the growing threat posed by climate change, a move which has cast further doubt over the future of the industry. The oil & gas sector has experienced significant fundraising challenges in recent years. The sector, with limited access to capital, has grown dependent on free cash flow to fund exploration and development, which has pleased investors, despite lagging shareholder returns.

The oil & gas industry is changing. As demand for cleaner energy grows the sector could be in a period of long-term decline.

Further, in September, the Organisation of the Petroleum Exporting Countries (OPEC) reigned in its forecast for 2019 global oil demand. “Rising challenges in some emerging and developing economies are skewing the current global economic growth risk forecast to the downside,” OPEC said in its report. “Rising trade tensions, and the consequences of further potential monetary tightening by G4 central banks, in combination with rising global debt levels, are additional concerns.”

Perhaps the biggest threat to the future of the oil & gas industry, however, is the growth of renewables. Energy investment is changing in line with consumer trends. Clean and renewable energy, for example, has been on the march in recent years, and though investment in renewable power declined last year by its largest amount ever (7 percent, according to the International Energy Agency) the oil & gas industry must be aware of shifting priorities. A number of major oil & gas companies, including BP, Shell and Total, have recently expanded their portfolios to include renewables, diversifying their holdings, driven, in part, by climate change concerns. As a result, oil & gas companies are investing in research and development (R&D) projects, developing techniques including carbon capture, utilisation and storage, which will help meet emission reduction targets and increase their clean energy offerings.

Trade wars and geopolitical tensions could also serve to destabilise the market going into 2019, including the imposition of tariffs by the US and China. “Recent signs of protectionism from the US are a risk to the forecast, raising the possibility of a global trade war,” the Institute of Economic Affairs said in March, when the Trump administration’s proposed tariffs first came to light. “A slowdown [in global trade] would have strong consequences, particularly for fuel used in the maritime sector and in the trucking industry.”

Should the increasing threat of a trade war lead to a global economic slowdown, there could be serious implications for oil & gas demand, which could tip the world supply balance back into surplus, increasing downward pressure on prices.

Ultimately, the oil & gas industry is changing. As demand for cleaner energy grows the sector could be in a period of long-term decline.

© Financier Worldwide


BY

Richard Summerfield


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