Portfolio management provides oil and gas companies with a bridge between corporate strategy and operational planning. It allows companies to be more proactive and responsive to changing market and operational realities at each stage in the asset life cycle and at every level in the organization, from corporate planners to asset teams.

Portfolio management is particularly important when contending with the challenges posed by operating in emerging markets such as East and West Africa. Here opportunities come with additional risk in the form of political instability and a lack of transparency and infrastructure. It also is important when looking to achieve an optimal balance across exploration, development, production, and geographic spread and in better managing price fluctuations and risk.

Portfolio management enables oil and gas companies to mitigate the myriad forms of uncertainty (and thus risk) they face – from gaining access to new reserves, technology development, and financing to commodity price volatility, increased regulation, and stricter environmental policies. All of these factors present a barrier to monetization of resources and company growth and consolidation, making an accurate and rigorous approach to portfolio management essential.

Financing challenges

Despite the fact that oil prices remain at record highs and well beyond the US $100/bbl mark, the main problem for the oil and gas industry over the last 12 to 18 months has been that financial markets have been almost closed. The equity markets proved particularly difficult in 2012. Reserves-based lending, a commonly used technique for financing assets that are already in production or where production is expected to commence shortly, has been hit hard because European banks have continued to struggle amid concerns over the Euro and the sovereign debt crisis.

This has proved problematic for small-cap players such as those listed on the London Stock Exchange’s AIM because they do not have production or cash flow. They are therefore heavily reliant on the equity markets and, in the current climate, have had to finance off their own balance sheet or asset base – i.e., they have either had to sell assets, farm them down, or seek to merge and become bigger entities to make themselves more attractive to investors.

In addition, equity fund managers have been much more selective because they have been suffering from redemption calls from their investors. They have been putting their money into what they perceive as safer investments, namely the corporate bond market, which has experienced a huge rise in activity over the last 12 months. Nevertheless, there has been an uptick in activity in the equity markets since the beginning of the year.

Unlike small caps, the majors and midcap companies have remained relatively unscathed by the fallout from the financial crisis. Typically they finance from their own balance sheets and production and have been acquiring assets and driving a lot of the activity in the oil and gas industry. The offshore drilling sector has remained particularly buoyant.

As a result, the service companies operating the drilling rigs and other service equipment have yet to see any significant impact on their utilization rates. However, this sector tends to lag behind any drop in activity overall. One region where there has been a discernible slowdown is North America, where low gas prices have impacted utilization rates.

Shifting investment flows

Overall, the high price of oil has to some extent compensated for the lack of external funding available for exploration and drilling activity and ensured that investment continues to flow within the oil and gas industry.

At the same time, upstream technologies are unlocking light tight oil and shale gas resources in the US and Canada and are altering the dynamics of the global energy market. By around 2020, the US is projected to become the largest global oil producer, accelerating the switch in direction of international oil trade toward Asia. It also may become an exporter of LNG if the gas surplus from shale gas development is sustained.

This likely will drive a shift in investment from traditional regional hubs for natural gas such as Australia to North America. The International Energy Agency (IEA) predicts a surge in unconventional supplies, mainly from tight gas and light tight oil in the US, oil sands in Canada, and NGL as well as a jump in deepwater production in Brazil. According to the IEA, almost 30% of the $15 trillion in upstream oil and gas investment that is required over the period up to 2035 will be in North America.

From a portfolio management perspective, the rise of unconventional plays also presents new challenges around estimating quantities of reserves and resources. Gaining an accurate understanding of a reservoir’s reserves and resources using subsurface characterization is a key challenge, especially with the advent of so many different types of reservoirs that must be produced in different ways – tight gas, shale gas, tight oil, and heavy oil, both onshore and offshore, as well as conventional resources in extremely hostile environments.

Looking further afield

In the current market investors are now looking to tick a lot more boxes before they make an investment decision. They want companies that have more liquidity and that offer the potential for a high near-term return. Oil and gas companies therefore need to spread risk and capital across more assets. They also should be continually looking for ways to rationalize their portfolio, ensuring that attractive acreage and geology are included in their asset base.

For example, tapping into North Sea opportunities is expensive as it entails offshore and sometimes deepwater operations. The region has seen some high-profile failures in recent years, resulting in a pullback from North American investors. It also is extremely competitive and heavily explored, making further discoveries of large oil and gas fields less likely. Investors are therefore looking for higher potential returns from regions like Africa and the Middle East, where there have been some excellent exploration successes recently.

West Africa in particular continues to attract a great deal of exploration interest as it is seen to be relatively underexplored compared to some of the mature basins in the world (e.g., relative to the North Sea). Nigeria has seen a dramatic increase in activity, especially in the Niger Delta, where the majors have been forced to sell assets that are now being rejuvenated by indigenous companies and small independents. Angola also is seeing increased activity. However, both Nigeria and Angola have regulatory challenges as well as numerous other issues that can make doing business difficult.

In contrast, most of the basins in East Africa (comprising Mozambique, Tanzania, Kenya, and Uganda) are seeing the first wave of serious exploration. These were led by the larger independents, but the size of the discoveries and the need to monetize the gas has brought in the majors and supermajors. Currently, the infrastructure, both legal and physical, is still taking shape, and the main challenge will be the first serious attempt to monetize the discovered gas.

Optimizing portfolios

As technology advances, new geographies open up, and new data are recorded, oil and gas companies must continually be looking to rebalance their portfolios toward the type of asset base that is attractive to investors.

Many are already doing so, with small-cap players acquiring acreage with large-equity positions that they can subsequently farm down to finance. Should seismic data confirm prospectivity, this then entices midcaps and majors to either farm in or acquire the small caps in order to progress with development/drilling. Tight equity markets combined with growth in the number of small caps exploring (with Africa a particular focus) have resulted in an increase in mergers and acquisition activity.

Regardless of region, however, oil and gas firms always should be looking to manage their portfolio creatively to ensure it remains attractive to potential investors. Asset sales and farm-outs should be considered alternatives and should offer a lower cost of financing than issuing equity.

It also is essential to have financing in place to be ready to undertake activities that have been committed to. The secret is to have a solution in place well in advance of an obligation to drill.

Renu Gupta is chair of the SPE London 2013 Conference and Exhibition, held May 22 to 23. Majid Shafiq was scheduled to present on the issue of raising capital under constraint market conditions.