Oil & gas after 2020: Will the latest downturn lead to permanent transformation?

Following its third price collapse in 12 years, the oil and gas industry may be facing a period of transformation. The industry managed to recover from the previous two downturns and continue with business as usual, but this time it seems the recovery might look a bit different from the ones before.

With the combined negative effects brought on by the coronavirus pandemic and the subsequent oil price collapse and the addition of energy transition knocking on the world’s door, some might say a permanent transformation in the oil and gas industry has been a long time coming.

Wood Mackenzie, an energy intelligence firm, said in late June that the oil price crash and pandemic had already wiped $1.6 trillion off its valuation of the global upstream sector.

On the other hand, the oil and gas industry has always been cyclical and defined by shifting supply and demand and it has endured and survived for so long by changing and adapting to the new environment.

The question arises if this time the drastic changes in the business environment will lead to a more permanent transformation of the sector’s modus operandi or if the industry will return to the same agenda once these hurdles have been overcome.

Will this shape up to be the industry’s most defining moment for years to come or will it remain business as usual once again? There are arguments to be made for either side.

In a webinar hosted by Oil & Gas Council last week, speakers gathered in what is now a new normal, a Zoom meeting, to debate whether the changes seen to the O&G industry in 2020 will lead to permanent transformation.

Arguing that these changes will lead to a permanent transformation, Iman Hill, a Petroleum Engineer with over 25 years of global experience in the oil and gas industry and a COO at Energean Oil and Gas, said that the previous price collapse brought about a real change in the industry’s approach to cost and that has endured.

“This time there is even more interest for a lasting and transformative change”, Hill said.

“We face a combination of a supplier overbalance coupled with a sharp and unforeseen drop in demand and a global humanitarian and economic crisis”.

Hill also emphasized that the health of the industry is not as strong as it was in the previous downturn and added energy transition as an additional factor which will drive the industry towards a more permanent change.

“If we layer on top of that the fact that the health of the industry is not as strong as it was in the last downturn and the additional imperative for the industry to play a leading role in the energy transition and a journey towards decarbonization, I would put it to you that sustainable change is a must”, Hill said.

Noting that the Covid-19 pandemic has just accelerated the industry’s most transformative time, Hill believes that without fundamental change it will be difficult to repeat attractive performance that the industry has historically delivered.

According to Hill, the next decade or decades will be characterized by intense competition for profitable resources, technology application to accelerate speed to market supply and to flatten the declining demand curve and weaning investor confidence and belief in the industry as an attractive proposition.

“That together with increasing public and government pressure on the industry to look at the impact it has on the climate and the environment means that the change that is going to happen will be transformative and will be sustainable”, Hill said.

Hill also acknowledged the fact that oil and gas will continue to be a multi-trillion-dollar industry for the coming decades and with an important role in providing affordable energy and a central role in the energy transition.

“Those that will come out ahead this time will be companies that use this crisis to optimize their portfolios and transform their operating models.

“I believe that financial discipline, measured capital allocation, management and good governance will be even more key as we go forward”, Hill said.

While energy transition talks and efforts have been around for a while now, the pandemic has further emphasized the world’s capability as well as a need for a more sustainable world leaving many wondering whether it will accelerate the world’s transition to more sustainable energy sources.

In addition, the negative public sentiment towards fossil fuel sources of energy seems to be gaining further momentum as the world is becoming more connected and as the urgency of preventing more disastrous effects of climate change is becoming ever more evident. This also affects investor confidence and the attractiveness of the sector, which means it is becoming harder to find suitable investors for fossil fuels developments.

“The negative public sentiment and more vocal pressure from investors and lenders mean that oil and gas companies will have to demonstrate credibility in the energy transition space. Solid, implementable plans will have to underpin the net-zero promises that are being made”, Hill said.

However, Hill pointed out that the oil and gas industry will have to demonstrate that it can be a leading player in energy transition and renewable businesses which will continue to appear.

Hill stated: “I believe that carbon capture, utilization, and storage will continue to develop and will be increasingly important for the industry”.

In Hill’s opinion, the lack of credibility with investors and the growing public and government pressure to reduce the impact on climate and environment means that the industry has no choice but to transform itself and Covid-19 has just put this into further focus and accelerated the need for a sustainable change.

Hill concluded that “the transformation will happen and will last.”

Further adding to the arguments for the permanent transformation of the oil and gas industry, Francisco Ortigosa, Repsol’s Director Innovation Technology noted that following the oil price crash and the pandemic, capex reductions have affected the oil companies and it is his belief that the exploration is not going to recover to prior levels.

Ortigosa also noted that we are already living in a more sustainable way and that the current environment will accelerate the energy transition.

Offering a different perspective to the issue of potential transformation in the oil and gas industry, Julio Dal Poz, a Senior Strategy Advisor at Equinor, argued that the industry is far more resilient than we give it credit and that the companies have been adapting their business models to navigate the market cycles almost since the inception.

“So that, in reality, is not necessarily a transformation, it is not necessarily a one-off process; that is something that is an ongoing process for those companies”, Dal Poz said.

Further explaining his viewpoint, he underlined the fact that even the companies that are going bust in this downcycle are leaving behind assets that are being picked up by other players.

“If we look at some of those changes that happened in the past in terms of value creation, we could also have concluded that they have been transformational.

“Changes like putting more focus on Upstream or Downstream, or becoming more integrated or becoming more decentralized except that those changes and those cycles kept going on”.

Some of the ways that the companies are creating more value and addressing the market challenges these days include creating specialized late-life units, decommissioning units, onshore and shale operations and so on.

“Even if the big debate is about diversification or transition to renewables and low carbon energy versus maintaining focus on oil and gas, even in this debate we can see that for the oil and gas part of the business the strategy has remained the same.

“It is still the strategy of value over volume. It is still the same logic and only the most valuable oil and gas fields are going to be developed and produced”.

In terms of changes to business models, Dal Poz thinks that the Covid-19 pandemic has brought a preview of the future and that those are not necessarily completely new trends.

“It hasn’t changed the agenda, that agenda was already there”, he said.

He pointed out that the companies have had a preview of a world where a peak demand would happen and, as a result, they were forced to think hard about high grading their portfolios. These days that means that only the lowest carbon fields will be produced.

Furthermore, companies will still use the same tools they have so far in exploration and business development, but the peak oil demand will also mean consolidation and specialization.

“Low-cost producers like some NOCs will benefit and capture the market share, high-cost producers will have to re-think.

“But again, this is not something new. Value over volume all over again”.

He also pointed out that the pandemic brought a good preview of what the fully decentralized and fully digitalized workforce will look like but that these efforts to digitalize the work environment are something that is not new to the oil and gas industry and they have been on their agenda for at least 10-15 years, if not longer.

“Capturing efficiency gains, tapping into a digitalized and decentralized workforce has already been there”.

Finally, underlining it as the most striking aspect of what the pandemic has brought, Dal Poz said it has clearly shown what kind of measures and improvements are possible when companies feel threatened and when they need to protect their core business; aggressively cutting costs, tapping into the expertise of the marketing teams, being creative with the risk capital or renegotiating their debts.

This, according to Dal Poz, clearly shows the potential for additional value creation from the core oil and gas business after the pandemic.

Other important aspects of this discussion include long-term trends like the need to decarbonize, the need to engage with society and the broader range of stakeholders, use of technology, and innovation.

Dal Poz concluded that permanent transformation might be the wrong way to think about this: “Maybe we should think about this as value creation and continuous adaptation. Each company will find its own way to create value and this is not a one-off process. The point is that adaptation is what companies in this industry do”.

Cornelia Meyer, a business consultant, macro-economist, and energy expert, turned to the demand and supply side of things pointing out how quickly demand came back in China, the first country to go into the pandemic.

Meyer suggests that we will see similar things happening across the board but the speed of demand recovery will depend on how we are going to deal with antiviral drugs or vaccines or tests because one of the things that keep the demand down is that there is very little need for kerosene and very little need for jet fuel because people do not fly that much.

Meyer believes that the demand will change, but we will also see it come back.

On the supply side of the picture, Meyer said that we have seen how oversupplied we are and that is nothing new, but what will remain the same is that OPEC and its allies will work together to try and manage that and a lot will depend on how the demand side develops.

When it comes to transition to green energy sources, Meyer said this will not happen overnight, noticing that oil companies are working very hard to go into that brave new space of renewables.

“Oil companies will adjust, they will remain players”, Meyer said.

When you go through these transition periods it is the lowest cost-producer that will always benefit so expect the Aramcos, expect the ADNOCs to do very well because they’re low-cost producers and they’re very good at harnessing technology, Meyer explained.

She also believes that oil companies in Europe and those in the U.S. will differ in their approaches and transition to renewables in that the European companies will adjust faster.

“In other words, yes we will have a change over time but in the meantime, we need the oil companies and they’re there to supply us with the energy we need”, Meyer concluded.

Whether the current market developments lead to a more permanent transformation in the oil and gas industry or not, it is evident that the winners will be those who manage to use this crisis to their advantage, reposition themselves, and adapt to the new environment.

Header photo by SP Mac