Enough dust has settled over the past year to give the global oil and gas business a clearer view of its new landscape. Holding little back, speakers at the annual IHS CERAWeek conference in February discussed how the industry has been shaped by the disruptive impact of North American shale production and predicted that many more months of financial pressure will spell the end for some companies.
The current industry situation is often compared with the last prolonged downturn in the 1980s—used by many in the oil patch as the measuring stick for rough times. But for Ali Al-Naimi, the Saudi Arabian minister of petroleum, the contributing factors are different this time around. Speaking in Houston at the annual gathering of top executives from operators, national oil companies, the service sector, and government, he explained that today’s crude market includes an expanded roster of producing nations and is under the influence of financial instruments that did not exist 3 decades ago. Al-Naimi then disputed the idea that his country is engaged in a global battle for market share that some claim is prolonging the bust. “Let me say for the record, again, we have not declared war on shale or on production from any given country or company—contrary to all the rumors that you hear and see,” he said. “We are responding to challenging market conditions and seeking the best possible outcome in a highly competitive environment.”
Nevertheless, Al-Naimi also argued that the market is simply not big enough for high-cost producers, and said they have three options: lower their costs, borrow more money, or liquidate.
“It sounds harsh, and unfortunately it is, but it is the most efficient way to rebalance markets,” he said. “Cutting low-cost production to subsidize higher-cost supplies only delays an inevitable reckoning.”
On the topic of a potential production freeze proposed by a minority group of the Organization of Petroleum Export Countries (OPEC) and Russia, Al-Naimi said such a move could happen but ruled out any notion that Saudi Arabia would cut oil production.
“That is not going to happen,” he said. “Because not many countries are going to deliver, even if they say they will cut production, they will not deliver. So there is no sense in wasting our time seeking production cuts.”
Al-Naimi reiterated his country’s resolve to maintain its current policy. “Inefficient, uneconomic producers will have to get out,” he said. “This is tough to say and that’s a fact. We can coexist with USD 20 (per bbl). We don’t want to, but if we have to, we will.”
Slow Shale Recovery Expected
When oil prices do begin heading north, several industry leaders said to not expect companies to rush back to the high levels of activity seen in the first half of the decade.
Among them was Mark Richard, senior vice president of business development and marketing at Halliburton. He said that while it might be technically feasible for shale activity to be flicked on like a light switch, companies will be using a dimmer switch instead.
“It’s not going to be able to ramp up all at once,” he said. “We’ll see it turn back on, but maybe the lights won’t be quite as bright right at the beginning.”
The challenges facing a speedy shale recovery are plenty. Hundreds of horizontal rigs and thousands of pumping trucks have been cold stacked. Many are quickly rusting out and not likely to return to service, ever. Thousands of workers have been let go, a proportion of whom will think twice about returning to a business that is facing the prospect of a long and volatile commodity cycle.
Another key factor that will not only affect the shale sector, but the industry as a whole, will be the end of cheap money. Large banks are shrinking their positions in the oil and gas industry and private equity firms are shoring up their bets as the global outlook turns bearish.
And because the downturn has cut so deep, it is expected that many industry players will be licking their wounds for a long time to come. Richard explained that with current prices so low, even if a notable rebound takes hold, “We still don’t see the money and capital being spent by our customers as they try to replenish their coffers with cash.”
Looking Long Term
The near-term outlook for the oil business, particularly in North America, is brutal, but there appear to be rewards for those who can hang on long term. That message was offered by current and former high-profile former chief executive officers at the conference.
“The last 4 or 5 years was a run-and-gun period, with lots of new companies starting up. In the next 6 to 12 months there will be a decimation of that industry with lots of bankruptcies,” said Mark Papa, a partner in Riverstone Holdings, who is best known for leading EOG Resources, which was a pioneer in oil shale development.
While consolidation is expected, little has happened because buyers are offering significantly less than sellers think their assets are worth. While there has been speculation about acquisitions by the biggest, strongest companies, in the past they have been slow to act.
“The balance sheet capacity you thought you had in January is reduced,” said Ryan Lance, president and chief executive officer of ConocoPhillips. Maintaining the cash flow is a critical consideration when making investment decisions at a time when credit ratings agencies have sharply reduced the ratings of some big names in oil and gas.
“The upturn will come but you cannot bet on it coming quickly or rapidly,” Lance said.
Papa predicted that demand will gradually eliminate the supply glut this year. Future supply growth will be stunted because so many large projects have been delayed or canceled.
“If (global demand) keeps growing by 1 million B/D year after year, we will see global demand rise from 95 million B/D to 100 million B/D in 4 to 5 years,” he said, adding, “I can see a case where the biggest supplier in world is the US shale producers. The world needs that incremental oil and the biggest available source is US shale producers.”
In the meantime, the industry will be changed by the current economic experience. New money will come into the industry to pick up assets lacking industry buyers at a time when even the companies with solid balance sheets are in cash-conservation mode.
“Financial sponsors new in industry will change the way people think about investment banks” for better or worse, said John Browne, chairman of L1 Energy and former chief executive of BP. Investors who funded the shale boom are likely to invest this time “with a bit more thoughtfulness than they used to.”
As a result of this experience, Papa sees a more stable, financially conservative industry, “but it will be really, really ugly to get through this valley.”
| speaking at IHS CERAWeek in Houston. |
The Trouble With M&As
Despite two years of distressed prices and lowering stock prices, there have been fewer mergers and acquisitions than many predicted. This has been especially true for the service sector, minus a small number of moves that include the yet-to-be approved Halliburton acquisition of Baker Hughes announced in 2014.
Osmar Abib, managing director and global head of oil and gas at Credit Suisse, listed several reasons, not the least of which is that the service sector is already fairly consolidated compared with oil and gas companies. But he said that as long as the oil price bottom remains elusive, buyers and sellers will continue to find difficulty in coming together.
“To do deals in this environment, I think oil prices need to stabilize,” he said. “If they keep bouncing around 5%-plus every day or every week, that bid/ask spread keeps bouncing around and people don’t know what kind of environment they are in.”
As things settle down, Abib said that the prime targets for acquisitions will naturally be small firms and those struggling with debt. And with many service company’s share prices hitting new 52-week lows, he expects more transactions will involve incentivized stock deals that offer sellers a potentially brighter upside when oil and gas prices rise.
One place where merger and acquisitions seemed more likely to happen but have not materialized, is Asia—China in particular. Abib said that the big money in Asia simply has not come to the table because access to financing has been limited amid lower confidence in the service sector. “I think people are very spooked about the downturn,” he said.
Middle East Outlook
In times past, oil prices were highly sensitive to turmoil in the Middle East. The region is now witness to more destabilizing conflicts than at any other time in recent history, yet the markets seem unpersuaded by their ability to threaten global supply. But there is the real possibility that low oil prices will threaten the solvency of Middle East producers and accelerate the worsening security situation.
Amos Hochstien, special envoy and coordinator for international energy affairs at the US State Department, is concerned that national budgets are becoming unsustainable. He pointed out that in addition to their high-cost social programs, Middle East nations are also increasing their spend on various wars and national security efforts.
Questioning whether the regional power brokers wrongly expected a V-shaped price recovery, he said, “If the spending in 2016 [and] the drawdown from reserves mirrors 2015, then the Middle East will have a problem sooner than anybody imagined.”
With regard to major suppliers, the wild card is Iraq. The country has been besieged by the Islamic State of Iraq and Syria (ISIS) and is gradually moving toward “a disintegration of some sort,” said Raad Alkadiri, managing director of petroleum risk at IHS. The drop in oil prices has robbed Iraq of about 80% of its revenue and it may soon have to redraw its borders as the oil-rich Kurdish region plans to hold a referendum on independence this year.
In 2015, the Kurdish regional government began bypassing Baghdad by directly selling oil to the global market. This was a blow to the central government’s efforts to fund its ongoing war against ISIS forces and maintain popular support. Alkadiri said the Kurdish chess moves against Baghdad have been backed by Turkish policy, which for several years has been seeking a more powerful posture in Middle East affairs.
“That’s one example of a number that you can look around the region and say that the regional states are not working together to contain this violence—the regional states are exacerbating it,” he said.
On the flip side is the situation involving Iran. Earlier this year, the US and the European Union lifted sanctions that allowed the cash-strapped country to re-enter the oil export market for the first time since 2012. While considered a major diplomatic milestone, it has dampened the hope that a production freeze by some OPEC members and Russia may hasten an upward price correction.
Bijan Khajehpour, managing partner of the Iranian consulting firm Atieh International, said Iran’s mid-term production goal is to return to its 2012 levels of 4.2 million B/D, and only then might consider freezing production. “Getting there will take a few years,” he said.
To meet near-term targets, he added that Iran believes it can ramp up production by 400,000 to 500,000 B/D by the end of the year. Khajehpour also said that the country is in the process of signing contracts with European buyers for about 250,000 B/D as it figures out how to bring the rest onto the market.
