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Oil & Gas Industry Trends 2018

Author: Dr. Lakshmi Narasimhan Chari 

Are the changes introduced by upstream oil and gas companies sufficient?

Oil and gas industry is a principal driver of the global economy, involving major commodity markets and trading. However, this industry is facing a plethora of significant and diverse challenges across the globe which encompasses environmental, geopolitical, community unrest and dissatisfaction, regulatory issues, emerging alternative sources of energy and more importantly falling demand due to slow economic growth. The most recent one is the crash in oil price.

Challenges in the Oil & Gas Industry


Between 2011 and 2014, the Brent oil price has been fluctuating between $100 and $110 per barrel. However, from June 2014, the sector witnessed a dramatic fall in the average oil price and the next three years witnessed oil prices hovering around $50/bbl. This price decline has been observed third largest oil price collapse in the last 30 years with prior ones being 2008 and 1986 (Baffles et al., 2015). During this period, the industry especially the upstream companies responded by reducing costs, reduced production, concentrated their efforts and many struggled to adapt. They undertook the following activities in response to the external pressure.

fig 1

Fig 1: Average annual OPEC crude oil price (in US Dollars Per Barrel)
Source: https://www.statista.com/statistics/262858/change-in-opec-crude-oil-prices-since-1960/

1.    Reduction in investment and massive layoffs

Due to declining revenues and uncertainties around oil, global industry wide capital expenditure on exploration activities dropped by 60% in the past four years, around 400,000 workers were laid off between 2014 and 2016. The industry also improved the operating efficiency which indeed resulted in the reduction of production costs. It is estimated that around $200 billion worth of long term projects has been deferred or cancelled. These projects required higher break-even costs - production from deep water fields and oil sands in Canada were the most affected. Likewise, expenditure on exploration reduced by 50% over a period of two years which had a direct impact on the amount of new reserves. Only 2.7 billion barrels were discovered in 2015 which is the worst result since 1947 as per Wood Mackinze. This is a serious concern because if there is no reversal in this trend, we might be heading towards a supply deficit.


Fig 3: World Investment on Oil and Gas Exploration
Source: http://energyfuse.org/oil-gas-industry-dealing-unprecedented-decline-investment/

2. Increased Mergers and Acquisitions

Larger companies with bigger muscle power viewed the current market situation as an opportunity to acquire other companies at a cheaper rate. For e.g. Schlumberger acquired Cameron, Halliburton acquired Baker Hughes, Shell’s acquisition of British Gas and Respol’s takeover of Talisman are some notable examples. In doing so, suppliers were able to offer integrated solutions, reduce cost of operations and become more efficient. Organisations have started focussing on key regions where they have comparative advantage. For example, Hess sold its North Sea assets to Aker BP and its West Africa to Kosmos energy. In doing so, they should be able to focus more on North American onshore, the Gulf of Mexico, and Guyana where both buyers are regionally focussed and potentially derive more value from the assets (Deloitte Report). There is also an emergence of independent operators with deep local knowledge who can create better value in more mature assets due to leaner operations. For e.g. in North Sea, Chrysaor became the largest independent operator following the acquisition of £2.9 billion worth of assets from Shell. 

3. Faced significant financial distress and bankruptcies

According to Haynes and Boone’s between 2015 and 2018, oil and gas producers filed 126 voluntary and involuntary petitions in the United States with a total debt of $88.5 billion. In the UK it increased from 2 in 2015 to 16 in 2016. Obviously, these resulted in drop in oil production wherein US witnessed the largest decline in production to the tune of 400,000 b/day followed by China 310,000 b/day and Nigeria 280,000 b/day. However, this was offset by increase in production by Iran, Iraq and Saudi Arabia.


It is a remarkable achievement by upstream companies who were able to reduce costs and survive the sharp drop in oil prices. Companies optimized their operations through process standardization, effective usage of manufacturing, engineering and project management resources and documentation. They also deferred decisions on new projects. For e.g. BP was able to roughly reduce cash costs by a third between 2014 and 2016 mainly through headcount reduction, supply chain costs and lowering capex. They also significantly reduced supply boats and helicopters through program management.  Other interventions include design changes early stages of the project hence improving cash flow. North Sea and Gulf of Mexico are two cases who were able to significantly reduce costs due to design changes. BP’s regional president for the Gulf of Mexico states “At one time, the cost was well over $200 million per well”, “We’re now seeing multiple wells drilled under $100 million and as low as $50 million. This is transformational for the E&P business”. A McKinsey analysis indicates that the global production costs has fallen by $44 billion (29%) since 2014. Likewise other indicators such as offshore production losses, safety incidents have also seen substantial reduction.  


These initiatives also resulted in falling break even price which means several mature wells, deep water operations will not be economical to operate unless there is a paradigm shift on the way the business operates.


Fig 4: Falling Break even prices

Oil and Gas Industry Performance in 2018

A Deloitte analysis indicates the crude oil prices increased by 25% from Jan 2017 to Feb 2018. However, the stock prices of prices of 73% of upstream companies world-wide has failed to grow. In fact, the current stock prices of 18 pureplay upstream companies with a combined market capitalization of more than $110 billion is even below early 2016 levels when oil touched a 13-year-old low.

Interestingly “The average return on capital of the largest European and US oil companies dropped from 21 per cent in 2000 to 11 per cent in 2013, even though the average price of benchmark Brent crude rose from $29 to $109 in the same period… Even when crude was at those higher levels the financial performance of the large international oil companies was unimpressive” 

This observation begs the following interesting questions:

1.    Are investors not convinced that the cost reduction initiatives by global upstream companies sustainable?

2.    Are oil and gas investments becoming unpopular due to bad publicity and raise of renewables?

3.    What will be the likely future for oil and gas?

Following discussion will provide an insight into how upstream businesses operates and possible risks.

1.    O & G companies returning to old ways of working

Although organisations have aggressively reduced costs through lean processes, these will not be sustainable if they do not change the way they work. By clinging to overly complex processes, they are more likely to go back to old ways of working once the oil prices climb back. BCG research highlights organisations tend to go back to their old behaviour as they witness green shoots of recovery in oil prices.


2. Harnessing the power of digital

Oil and Gas industry is one of the pioneers of technology adoption as they use sophisticated 3D modelling and complex analysis for optimising the production. Being a capital-intensive industry with operations spanning several regions, these are the ideal candidates for advanced digitization. McKinsey’s research on level of digitisation indicates that Oil and Gas companies are yet to fully harness the potential of emerging technologies like Big Data and Internet of Things. They argue that digital technologies has the potential to transform operations which can result in the reduction of capital expenditures by 20% and could reduce upstream operating costs by 3 to 5%.  In a nutshell, better use of technology can result in increased production, efficient supply chain through reduction in engineering time and McKinsey argue that an average big oil company can create additional value of about a billion dollars over a period of three years () .

3. Brain Drain and Talent Development

Recent job cuts resulted in permanent loss of talent as hundreds and thousands of people left the sector. Business leaders are now waking up to the fact and asking themselves “Why did we let all our talent go”?This is more pronounced in the OFS sector which has been aggressive in shedding talent. Moreover, this industry is also facing challenges in attracting fresh talent. More importantly, millennials are against decarbonisation and have a negative perception about this industry. Also, it will be very challenging to attract new talent especially this industry is known for massive layoffs. This industry will face capacity issues due lack of talent during periods of uptrun. Eni is one of the few companies which was able to preserve its human resources by focussing on cost reduction in its supply chain by 20%, reducing dividends, selling of assets worth €7bn (https://www.ft.com/content/0a6dac11-f796-3a78-9002-bcbe963757d1 ). Developing regions like Nigeria is facing even more talent shortage. Rui et al., (2018) undertook a comprehensive review of 65 projects and identified higher average cost overrun of 38% with an SD of 39%, time overrun of 37% with an SD of 41%, fatality rate of 0.027, and oil spillage ratio of 18.51. This is despite the fact that Nigerian oil and gas projects are of low sub surface complexity and low technical challenges. Non-technical factors such as local content, community, security, and partnership are the main factors for poor performance. Organisations must start to focus on upskilling their existing talent base and ensure that they are good decision makers and develop managerial skills.

4. Reduction in R & D Spending

Research and Development are integral part of this industry as it is driven by innovation. Since Operators outsource the capability to OFS, some large OFS spend as much as operators in R and D. However, the recent downturn has resulted in a reduction of 18% in R and D spend (Bloomberg strategy research). It is worth emphasising that innovation and technology adoption is the main factors that can improve competitiveness of the basin. Reduction in R & D can result in long term sustainability of the operations.

For e.g. the sudden drop in oil prices made North Sea wells uneconomical with the threat of being decommissioned prematurely. UK Government quickly intervened and established UK Oil and Gas Technology centre with the main objective of extending the longevity of the basin through innovation and research. On the other hand, Thailand has plenty of mature wells ready to be decommissioned. However, lack of capability, investment, technology and unclear Government policy are some of the challenges faced by the operators in this region.


Key Success factors for the oil and gas industry

Stevens (2016) argue that the fundamental business model upon which the entire industry has been built are not sufficient. He calls for a major change in corporate culture of the IOCs and suggests the following options for improving the situation of IOCs.

  • Squeezing costs in the hope oil prices will revive
  • More mega-mergers
  • Playing vultures with remnants of the US shale gas revolution
  • Reshuffling their portfolios
  • Diversification
  • Becoming a purely OECD operation
  • Rebuilding in-house technology

A Deloitte report indicates that the top 30 of the 230 upstream companies undertook the following five activities to create a differentiation from their peers.

1.    Active portfolio management

2.    Focus on operational excellence over locational advantage

3.    Effective resource management by adopting investment cycle perspective

4.    Grew in natural gas at a measured pace

5.    Followed a moderate risk-return investment strategy

Need to grow and retain talent

Along with the above factors, a key pain point is the loss of talent this industry faced in recent years. Various EPC companies in the middle east for struggling to find key senior management talent and despite winning contracts are unable to meet client expectations. Rigzone’s 2017 global survey involving 1500 oil and gas professionals revealed that more than 54% of the respondents considered leaving the industry. This can have serious consequences as IOCs may struggle to adapt to dynamic environment. However, with technological advancements, businesses can make use of emerging trends like online education which offers flexibility, little disruption from personal and professional commitments and an opportunity to learn from likeminded professionals across the globe.

To conclude, the initiatives by upstream companies although remarkable is not sufficient to convince investors.

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