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It is hard to imagine a more traumatic time for the oil and gas industry. The depth and breadth of the economic crisis has significantly decreased hydrocarbon demand. Notwithstanding actions by OPEC and domestic producers, it remains unclear when supply and demand will regain their balance, especially in the natural gas market. The time for investing in strategic growth is now.
In North America, petroleum products consumption declined by 6% during 2008, marking the first annual decline of more than 1 MMb/d since 1980. In turn, hydrocarbon prices have dropped 60% to 70%.
The industry has faced price declines before but not coupled with a commensurate decline in capital markets liquidity. Despite some improvement since late last fall, capital markets, both debt and equity, remain prohibitively expensive for many companies and completely off limits to others. These factors, combined with the threat of an increased tax burden in the US and further carbon legislation both in North America and Europe, have cast a pall over the oil and gas industry.
To many market participants, the sky is, indeed, falling.
The industry’s initial response has been to retrench, restructure, and “live within its means.” Companies have reduced capital spending budgets and activity levels. Our analysis suggests North American upstream capital expenditures will decline by approximately 30% during 2009. Despite a slightly better picture in other geographies, the global rig count has still fallen by 30% since March 2008.
But is the sky really falling? If the 1973 oil crisis, the energy crisis of the 1980s, the economic downturn in 1990, and the bursting of the tech bubble in 2001 have taught us anything, it is that while restructuring during a recession – by reducing operating costs, managing capital expenditures, and improving working capital – is necessary, it is insufficient for ensuring future success.
Long-term fundamentals of the oil and gas industry remain strong. In fact, many market analysts now worry that under-investment caused by the downturn may actually exacerbate medium-term supply shortages as the global economy is returning to historic growth trends.
The opportunity right now, for oil and gas companies willing to embrace the long term picture, is strategic growth.
Pursue inorganic growth
Relatively well funded players should pursue acquisitions to consolidate existing positions, enter new regions, or expand into adjacent sectors. Premier Oil consolidated its position in the North Sea through the $505 million acquisition of Oilexco North Sea – a producer that was forced into a sale after its creditors refused to advance further funding. BP and Statoil completed transactions with Chesapeake Energy to gain footholds in US natural gas shale basins. Valero Energy moved into the ethanol production sector, based on a belief that increases in Renewable Fuels Standards will continue, through the purchase of eight plants from VeraSun at a price equal to approximately 30% of replacement value. In all of these cases, companies acted on their beliefs with respect to future market conditions in order to increase their potential upside.
Of course, the game isn’t only for the “cash rich.” Suncor’s stock-for-stock merger with PetroCanada demonstrates the potential for such transactions to generate cost synergies, improve capital projects portfolios, and strengthen balance sheets. The combined company expects to save C$300 million in annual operating costs and to realize C$1 billion in annual capital efficiencies through project high grading. Such combinations not only better position companies to sustain themselves during the downturn, but also improve their competitive positioning in the eventual upturn.
Deploy capital now to create long-term advantage
While it is prudent to reconsider capital spending during periods of reduced liquidity, companies should continue to fund projects that capitalize on long-term industry trends, make investments that increase ‘option value,’ and even divest assets in order to re-allocate capital to more attractive opportunities.
Imperial Oil and Exxon Mobil, in contrast to many of their peers, are moving forward with their Kearl oil sands development in order to realize value when commodity prices increase and to capture the benefits of currently available supplier capacity. Noble Energy’s 2009 capital budget purposefully allocates additional capital to its international exploration efforts – at the expense of North American onshore gas assets – in search of long-term reserves growth. Talisman Energy, in order to accelerate its activities in unconventional natural gas plays, divested its non-core Saskatchewan properties, raising C$720 million in proceeds. These companies provide good examples of the organic options available to industry participants.
Build new capabilities
Companies should also exploit current discontinuities to build new capabilities, which means investing in people, processes, and technology. The economic downturn is increasing the availability of human talent – management and skilled labor – as companies announce layoffs.
ConocoPhillips recently cut 4% of its workforce – nearly 1,400 people – and service giant Schlumberger shed 5% of its workforce, or 1,000 jobs, early this year. In addition to increasing the available labor pool, such news increases the anxiety level of employees at under-funded or poorly positioned companies. As a result, experienced technical staff with expertise in particular basins or specific technologies such as horizontal drilling may now be looking to transition to employers that offer more secure long-term opportunities. That company might be yours.
A recession, in effect, represents an excellent time to gain ground in the industry-wide war for talent.
There are many opportunities for the oil and gas industry to improve process capabilities during this period. For example, certain unconventional natural gas producers are leveraging technical staff that are not as busy as they were during last year’s peak to drive improvement initiatives, including the application of LEAN and other manufacturing techniques to reduce well delivery cycle times and related costs.
The high degree of uncertainty currently plaguing the broad markets and the oil and gas sector is unlikely to end soon. Nevertheless, oil and gas sector participants have the opportunity to act boldly – to pursue transactions, invest capital, and build capabilities to help secure a long-term competitive advantage.
You can make the most of these opportunities and benefit as a result. After all, as legendary oilman J. Paul Getty said, “Without the element of uncertainty, the bringing off of even the greatest business triumph would be dull, routine, and eminently unsatisfying.”