The past two years have rocked the oil and gas (O&G) sector, hitting companies with a 50% drop in revenue in less than 12 months. In 2014, the price of crude plummeted from a comfortable $100 per barrel to $60. The following year saw that number sink to $40.
Industry leaders like BP, ExxonMobil, Shell, and Chevron invested billions in exploration when prices were high, but did not enjoy a resulting boost in profits.
To cope, companies were forced to cut capital expenditures, operating expenditures, and headcount. They had to defer major projects while begging suppliers for better prices.
On top of that is the fact that most “easy oil” has already been found and extracted. Future sources will have to be extracted from deep underground (or under the sea). This is a tricky task for engineers, but need not lead to higher prices as long as production methods are improved.
These troubles have drawn in smaller players (state-owned and independent companies) who hope to enter the market while the big companies are struggling, with an expectation of a rebound in oil prices, and with leaner and meaner production techniques with improved margins.
Energy Consumption & Emissions
The rate of global energy consumption has slowed considerably as we develop new technologies and increasingly efficient machines. The IEA (International Energy Agency) estimates that the increase in supply for petroleum in the year 2014 was twice that of consumption. This results in shrinking profits and lower prices (and money saved by the average driver).
But our dependence on traditional fuels isn’t falling nearly as fast as environmentalists might hope. In 2015, coal accounted for a full third of global energy. British Petroleum (BP), the world’s largest coal-producer, links last year’s 1.8% decrease in global coal consumption with an increase in natural gas and oil usage.
In fact according to a Siemans report:
“Although the price of oil can swing wildly, the growth of demand is surprisingly stable. There have been price peaks above $140 and troughs below $20, but over the long term average global energy consumption has grown steadily between one and two percent annually. In addition, roughly five percent of existing production capacity has to be replaced every year in order to offset the decreasing yield of aging oil fields. Meanwhile, new oil fields are being developed and the output of existing fields is being increased through the injection of gas.”
The Environmental Leader reports:
“Over time, the global economy will resume its expansion and thus the energy industry must continually search for new deposits while also working to mitigate carbon releases and the overall carbon footprint. Coal still accounted for a third of the world’s energy use in 2015.”
“Emerging economies now account for 58.1 percent of global energy consumption,” says BP, one of the largest produces. “Chinese consumption growth slowed to just 1.5 percent, while India (+5.2 percent) recorded another robust increase in consumption … A rare increase in European Union consumption (+1.6 percent) more than offset declines in the US (-0.9%) and Japan (-1.2%), where consumption fell to the lowest level since 1991.”
According to a Deloitte report:
“Demand: US demand is responding to lower oil prices in the usual let’s-go-buy-a-new-car, or better yet, a-massive-SUV kind of way. As auto sales go up, expect to see increased US demand. More broadly, Asian demand, beyond just China is showing strong growth. China itself, despite the stock market jitters of the summer, remains a huge source of global demand and China’s move to allow two children per family, rather than one, promises to double the numbers of drivers (and thus, fuel buyers) at some point in the future. (Let’s just say I used very rough math on this prediction).
“Decline: Why is decline in the hope section? Because natural reservoir production decline, which has historically been four to five percent globally, means that even without demand growth, the oil and gas industry must produce another four million barrels per day every year just to keep up with current demand. This naturally puts upward pressure on pricing.
“Production: As noted above, total US production finally started to decline and that trend is expected to continue in 2016. More broadly, billions of dollars of investments have been deferred due to the low price environment, which translates to millions of barrels that will not be produced in the years to come. This sets the stage for a price rally.”
The IEA predicts that global demand for natural gas will rise roughly 2% per year from now until the end of 2019. Analysts expect supply to exceed demand during those years, but note that natural gas will take up an increased share of the global energy mix.
China consumes more energy than any other country, but is currently struggling with growth rates slower than anything the communist nation has experience during the past two decades.
When this lull eventually comes to an end, the energy industry must be ready to look for new deposits while at the same time keeping C02 emissions in check.
Last year’s Paris agreement (COP21) holds numerous countries to the promise of reducing emissions in upcoming years – but the rules don’t go into effect until 2020. The United States has done a decent job so far, reducing emissions by 145 million tons in 2015. China followed suit with a reduction of 12 million tons. Unfortunately, these accomplishments are mitigated by emissions gains in Europe (1.6%) and India (5.2%).
Emerging economies like India account for nearly 60% of global energy consumption, reports BP.
“When you look at the growth in consumption, it quickly becomes clear that oil and gas will remain very important for the next few decades at least,” says a Siemens spokesperson. “Of course we also need renewable energy sources. At least for the time being, we simply need everything we have. And that includes oil and gas.”
As the planet’s biggest energy consumer and fourth largest oil-producer, China yearns to increase its energy independence and reduce its carbon footprint.
The communist nation has bold plans to develop new technologies in the next ten years, with a new report released this month that focuses on export opportunities in areas including thermal power plants and offshore oil and gas exploration.
“In offshore oil drilling we’d like to cut the reliance on imports by improving the self-sufficiency,” says Yang Shuangquan of the China Petroleum and Petrochemical Equipment Industrial Association. The plan outlines “major development projects for the oil industries in exploiting natural gas, shale gas, and offshore oil. The latter two will remain as China’s strategic moves to ensure energy supply.”
Yet, China still struggles with its identity as both a capitalist and socialist society. “10 year plans” common in socialist institutions are famous for being corrupted and failing as they play out. If China’s free enterprise leaders are allowed to pursue energy self-sufficiency, China may have a chance. If its socialist government is in charge, China will be in for a rough time.
Coupled with Chavez’s failed and corrupt policies, the drop in oil prices has caused a humanitarian crisis in Venezuela, the world’s 10th largest oil producer.
“We have the world’s largest oil reserves, but we don’t have food,” says a Venezuelan farmer who is forced to stand in line for 18 hours each week just to purchase a limited supply of basic food.
“The real problem is that imports have been reduced by 40% this year and by two thirds since 2012,” explains David Smilde of the Washington Office on Latin America. “There is simply not enough food to go around.”
Today, over 80% of regulated food products have disappeared from store shelves. The news is full of shocking videos showing Venezuelans looting grocery stores and attacking food trucks, eating garbage and dog food, and even hunting wild animals.
The situation is growing worse every day, with a soaring 400% inflation making the only food left unaffordable for most families.
“The only guilty party for the Venezuelan economic disaster is the present government,” says Henrique Capriles Radonski. “The mismanagement and inefficient use of the oil bonanza that has already concluded, and the dismantlement of the production and commercial apparatus of the country, as well as constant fighting with businessmen have resulted in an humanitarian emergency.”
The forecast for the O&G industry is worlds away from what it was just a few short years ago when the fundamentals of the sector were controlled by cartels. A systemic imbalance of increased supply and decreased demand has replaced this traditional structure. Many factors have led to this decrease, including:
• Slow economic growth in China
• Financial struggles in Europe
• Emissions regulations
• More forms of alternative energy
• More efficient engines
• A glut of shale oil on the market
Oil can be a fickle business, even in the best of times. In order to survive the upcoming years, oil and gas companies must focus on the right questions, such as:
1. Where do we go to lock in demand?
2. Are we prepared for an oversupplied business environment?
Companies that are able to answer these two questions should be able to thrive no matter how uncertain the price of oil.
As oil and gas producers leave a period of high growth and rapid expansion and move into the uncomfortable territory of oversupply, they must redirect their efforts or go bankrupt. Their main focus now should not be “holding out until prices recover,” but on driving capital and efficiency to preserve margins and maintain the reinvestment rates needed to move forward with production.
It may surprise you, but the industry has shown a surprising ability to adapt to change, to focus on innovation, and to lower costs when necessary. Today’s industry leaders are taking advantage of robots, digitization, and analytics to eke out higher volumes with a smaller investment.
The engineering company Siemens has jumped in to offer new and efficient technologies to all parts of the production chain. “We have a lot to offer, especially in the the areas of electrification, automation and digitization. In all three, the aim is to achieve tighter degrees of efficiency,” says Siemens official Lisa Davis.
The company is currently working to build a fully automated O&G field at its development center in Norway (pictured at left).
John England (Vice Chairman and US O&G leader for Deloitte LLP) has high hopes for the oil industry in 2016. Americans are responding to the drop in oil prices by purchasing new and bigger vehicles, he explains. This will increase demand.
We will also see an increase in demand after China’s Jan. 1st, 2016 decision to allow couples to have two children instead of one.
Mr. England notes that natural reservoir production decline will push prices back up. Annual decline, which has “historically been four to five percent globally, means that even without demand growth, the oil and gas industry must produce another four million barrels per day every year just to keep up with current demand. This naturally puts upward pressure on pricing.”
A decline in US production will continue throughout 2016, but the billions of dollars of deferred investments will translate into millions of barrels that will not be produced in future years. This paves the way for a price rally.
“Price forces innovation,” says Mr. England. Just as high natural gas prices forced the shale gas revolution, today’s low crude prices will force powerful innovation in the way oil is developed and produced. Low prices represent both a challenge and an opportunity for the O&G industry. “The endgame is an oil and gas industry that will be stronger, leaner, and built to last,” says Mr. England.
While I doubt there will ever be true stability in the energy sector, experts agree that things are looking up for oil and gas companies if they are smart enough to adapt to an environment of a temporary oversupply. Perhaps one day we will not need to extract oil, but until then, the current environment presents great business opportunities for the companies that have the courage to embrace innovation.