Lower oil prices pose the biggest threat to oil and gas industry earnings and financial solidity since the financial crash of 2008. Brent is now 50% below the 2014 average of $99 a barrel ($/bbl).
More evidence of how this is affecting performance and strategy will appear in the Q4 results and further pared-back 2015 investment plans. The financial performance in Q1 will deteriorate, as the impact of a full quarter of low price realisations flows through to earnings.
Crude hedging programmes will provide temporary protection for some for a quarter or two; as will lagged oil index LNG and European gas contracts which will start to adjust to December/January crude prices by Q3.
The fall in revenue for the oil and gas sector will be exacerbated by higher net debt across much of the sector. Total net debt for the 46 IOCs in Wood Mackenzie’s Corporate Service has risen by 20% ($53 billion) since 2010 (excluding conglomerates). The cost of new capital for smaller companies will rise sharply in 2015.
Asset write-downs will lead to higher leverage ratios and increased financial stretch for some companies. Refinancing could prove difficult in certain cases and covenants based on reserves, cash flow and market cap ratios could come into play.
In December, the research firm said an estimated 37% drop in spend will be needed relative to 2014 to maintain current debt levels if Brent stays at US$60/bbl. This is in addition to the $9 billion cuts announced by companies during thre last weeks of December last year.
Operators in an intensive development phase have the least optionality to respond. Most other IOCs have flexibility to rein in spend to keep finances on an even keel but shareholder dividends and distributions – currently 25% of total spend in the sector – are likely to be a significant part of the cuts for some companies.
“Operators in an intensive development phase have the least opportunity to respond,” said Fraser McKay, principal analyst for Wood Mackenzie’s corporate analysis. “Most other IOCs have flexibility to rein in spend to keep finances on an even keel. But shareholder dividends and distributions are likely to be a significant part of the spend cuts for some companies.”
The oil and gas industry will plunge into full-on capital discipline after dipping its toes in 2014. We estimate companies need to cut costs by $170 billion or 37% to maintain net debt at 2014 levels at a Brent oil price of $60 a barrel. Cuts will be spread across: investment in new projects; exploration budgets; operating costs; and shareholder distributions.
In 2013/2014 companies were making strategic choices related to messaging around value versus volume as they tried to increase their appeal to investors; capital discipline in 2015 will be less about choice and more about survival for some players. The effects could last well beyond 2015.
Distressed sales – asset and corporate – could precipitate the emergence of a true buyers’ market in 2015. Selling assets into a market with few buyers will be a last resort. Financially strong players will put rationalisation programmes on hold but some companies will find themselves with little choice, unable to achieve the cuts in discretionary spend required to balance the books.
Large-scale corporate consolidation is more likely than at any point since the late-1990s. History shows that value creation through M&A is largely driven by commodity prices: for buyers that believe in long-term oil above US$80-90/bbl, 2015 will be a year to “go long,” said the industry paper.
In its December forecast, Woods Mackenzie said that the collapsing price of oil was “throttling the M&A market, with deals being shelved, and potential buyers taking a step back from the market. “Weak oil prices through 2015 will ratchet up the pressure on the most financially stretched in the sector. Expect to see falling deals valuations and the emergence of a true buyers’ market,” commented Luke Parker, principal analyst for Wood Mackenzie’s M&A Analysis.
It is unlikely to be a vintage year for exploration, but a window of opportunity will open to capture high-impact acreage and discovered resource opportunities. Play-opening discoveries will be few and far between as scarcer capital is reallocated towards appraisal and higher returning incremental prospects. Exploration budgets will fall sharply, although lower costs will be an offsetting factor.
But a big unknown is how much and for how long costs will fall – many companies will hold fire on expensive frontier drilling in anticipation that lower drilling and appraisal costs could materially improve full cycle economics.
The opening up of Mexico will also herald a new wave of resource access and an opportunity for financially strong Majors, Large Caps and NOCs to establish new growth platforms for the next up-cycle.
Facts:
– 50% The price of oil per barrel has fallen below the 2014 average.
– $53bn Net debt of IOCs has increased markedly since 2010.
– $100 is an unrealistic long-term target for oil producing countries. Prices are expected to hover around the $50-$60 barrel mark.
