Reality in the Low-Price Era
After nearly four years of low oil and gas prices, energy producers have emerged battered but with stronger balance sheets, a better grasp of technology, and a new outlook on how to manage their portfolios.
Change was slow to come. Oil prices, at $100 a barrel in 2014, plunged beneath $30 in January 2016 and have traded in the $40-$55 a barrel range since then. Natural gas, at $5.27 per thousand cubic feet in early 2014, fell below the $4 mark and, as recently as August, was trading at $2.95.
The industry’s initial response to slumping prices was to revert to old habits: slashing headcount, mothballing new projects and squeezing suppliers. The idea was to ride out the storm until prices climbed back to comfortable levels.
The trigger for broader restructuring was the arrival of a second wave of low-cost shale production from the Permian Basin of Texas and New Mexico. North America’s energy revival has effectively made the United States energy sufficient and reshaped global energy dynamics. With the renewed surge in U.S. shale production came the realisation that the era of oversupply and low prices could persist — and that most in the industry couldn’t survive without painful change.
The transformation has been dramatic. Energy majors reported encouraging first-half 2017 financial results, which “show how billions of dollars of cost cuts across the industry have begun to pay off, adding to optimism that even if prices don’t recover beyond their current levels in the near term, the companies have weathered the worst of the market rout,” said The Wall Street Journal.
Everyone in the industry “is trying to create a leaner, stronger, built-to-last company that can weather price cycles without boom-bust volatility,” says Grant Wattman, CEO of Agility Project Logistics.
Shell CFO Jessica Uhl spoke for many in the industry this spring when she said changes at Shell were “about transforming the company for the future. We’re not waiting for prices to increase.”
Capital Efficiency & Short-Cycle Projects
Leaders throughout the industry are preaching the need to drive change and develop new operating models. The weak price environment has prompted “a shift away from long-term, capital-intense projects with uncertain outcomes, and toward those with clear line-of-sight to value over the coming 12-18 months. … (and) an emphasis on cost management and efficiency,” says IHS Markit, the global research and analysis firm.
Globally, upstream oil and gas investment declined 44% from 2014 to 2016, and capital spending fell 38%, according to the International Energy Agency’s (IEA) World Energy Investment report. “The oil and gas industry is undertaking a major transformation in the way it operates, with an increased focus on activities delivering paybacks in a shorter period of time and the sanctioning of simplified and streamlined projects.”
Alessandro Blasi, Senior Programme Officer at the IEA, says: “Companies have significantly changed the way they pick projects and execute on them. Conventional onshore development has shifted towards brownfield and satellite fields to minimise capital spending. Meanwhile the offshore industry is experiencing even more rapid change as companies have scaled down projects, introduced strict standards for facilities and equipment and optimised project design.”
On the financial side, producers have been forced to improve capital efficiency and balance sheets, and to boost free cash flow and EBITDA. They have sold off or divested themselves of unproductive assets and increased investments in technology. Eyeing lower capital expenditure commitments and quicker returns, they are prioritising short-cycle projects that can generate returns in as little as six months.
As oil majors have offloaded investment-intensive assets, they also have set ambitious break-even targets — under $50 a barrel in most cases and a breathtaking $27 a barrel in the case of Norway’s Statoil. At the same time, they have begun investing in renewables and tried to envision a future for themselves in a low-carbon world.
Energy consumption in 2035 is forecast to be one third higher than in 2014. Much of this will go toward power generation. Worldwide, fossil fuels are expected to provide 60% of the additional energy and remain 80% of total consumption.
The energy industry has been a slow technology adopter, capturing enormous amounts of data but making use of very little. At the annual spring CERA Week conference in Houston, Big Data, cloud computing, machine learning and artificial intelligence were themes, and there was a sense among attendees that the industry is in catch-up mode.
Oil companies have begun plowing resources into data analytics that help them make sense of the enormous quantities of data they use to find oil and gas, and manage production. BP, for instance, now takes just a few weeks to process data that not long ago took a year to analyse. Algorithms also are employed for predictive maintenance that reduces costly, unplanned downtime. Cloud processing can generate millions of production scenarios, and “when firms can evaluate more options, production from fields can rise by five percent, with a 30 percent cut in the investment required to drill holes and begin producing oil,” according to David G. Victor and Kassia Yanosek, writing in Foreign Affairs.
Better use of data can cut by 30% the cost of bringing a new field on line.
New mobile apps allow users — including small operators — to control drills that are hundreds of miles away and thousands of feet beneath the ground or sea bed. Sensors on drilling equipment transmit data to technicians who use the information to adjust the depth and direction of drills to maximise output and maintain stable flow.
“Advanced analytics and equipment are creating the digital oil field and gas field,” Wattman says. “Technology is now a differentiator between companies that are competitive and those that aren’t. There is huge risk in leaving your supply chain to a provider that can’t keep pace with your technology and give you tailored IT answers that provide an edge.”
The Foreign Affairs authors say the industry is on the cusp of rolling out tools that will allow robots, controlled remotely from data rooms, to perform sensitive and sophisticated jobs on drilling rigs and along the ocean floor, tasks previously entrusted only to engineers, technicians and other skilled workers. One company, Schlumberger, says it has been working to develop the “rig of the future,” increasing the use of data and automation in a way that will reduce the size of drilling crews and change the nature of their work.
The Logistics Piece
Shifts in strategy, combined with new technology and lower raw materials costs have driven down production costs. But IHS Markit and others suggest that at least some of the reduction has come from “counter-cyclical cost declines” rather than lasting structural change. Indeed, researchers say overall deepwater costs are down more than 30% over the past two years, but they caution that much of the savings could be the result of lower supply chain expenditures and other costs that are likely to rise as prices increase.
“The fundamental question that the industry now faces is to what extent these cost reductions can be sustained in the future,” the IEA’s Blasi says. “Standardisation of equipment and operations, improved design, efficiency in projects and corporate activities, integrated approaches in supply chains and increased use of digital technologies are all areas that have contributed to bringing costs down.”
The industry entered the current down cycle demanding sizeable across-the-board cuts and easier payment terms from logistics providers. As the slump wore on, more companies decided to engage in deeper discussions with providers, giving joint scrutiny to the supply chain.
Wattman says there’s a welcome new emphasis on pre-project planning. “We’re seeing more interest in figuring out integrated delivery across the whole supply chain, lean project management, and designs that use modular approaches. It would be a mistake to slip back into old habits.”
During development, logistics typically accounts for 3% to 10% of capital expenditure before shrinking as a percentage of operating expenses and downstream costs. But the complexity of the work means there are variables with cost risk and opportunity at every stage: purchase-order management, pricing, packing, risk assessment, hub setup, rig transport, chartering, health and safety, and compliance.
Wattman points to the industry’s shift to short-cycle project development as an example. The focus on quick-turn projects did little to address endemic weaknesses in planning and coordination that have huge costs attached.
“It’s not just the length of projects that’s a problem,” he says. “Sixty-five percent of the industry’s capital projects went 25% over budget and/or ran past their deadlines by 50%. Logistics cost is buried in every cost category of project scope.”
The Organisation of Petroleum Exporting Countries and other big producing nations have tried to restrain production in an effort to cut about 2% out of global output and bring stability to prices. Even so, global oil supply exceeds demand by about 2 million barrels a day. And the reality, according to Victor and Yanosek, is that the world spends $2 trillion less on the crude oil it consumes each year.
Most in the industry say an end to the low-price era is inevitable. Renewables and other alternatives can’t supply enough to meet the demands of a growing global population. Other factors signal long-term supply pressure and increasing demand: declining reservoir production, expanded access to energy for existing populations, the transition to modern energy products by emerging markets countries, and the deferral of huge new projects.
IEA says the industry needs to invest $600 billion in long-cycle projects to meet future demand.
Much of the growth in energy consumption will go toward power generation. Energy consumption in 2035 is forecast to be 34% higher than 2014 levels. Fossil fuels are expected to provide 60% of the additional energy and remain 80% of total consumption, despite a quadrupling of renewable supplies.
Will we return to the days of energy mega-projects that require massive spending and long planning cycles?
The IEA believes we will. It says the industry needs to invest $600 billion in long-cycle projects in order to meet future needs. Production from conventional oil fields is dropping to its lowest level in more than 70 years, which could tighten supplies. Likewise In the gas industry, experts warn of the need to invest counter-cyclically or risk being unable to meet increasing demand in six to eight years. Near-term, southeast Africa and the eastern Mediterranean look to come on as sources of global gas supply, but momentum for new investment could be complicated by an apparent shift from secure, long-term purchase agreements to a more commoditised marketplace.
Keeping up on the logistics side “requires a global footprint, technical expertise, and standards and processes that have been repeatedly stress tested, refined and improved,” Wattman says. “In addition to ‘best practices,’ you have to identify the ‘next practices’ that you can use to keep your customers ahead of the competition.”