Energy and basic materials are the building blocks of society as we know it. They are key constituents of pretty much everything we see around us and are essential for the development of the world. But the world we’re living in now, the post Covid-19 world that is emerging, it's hard to know what it will really look like.
Yes, one could argue that the changes we see and the current slow economic pace are temporary – a return to norm can be evidenced as countries emerge from lockdown and potentially, if found, a vaccine would put an end to the health crisis. If not, then uncertainty continues in an environment of virus recurrence and slow recovery. However, it is the behavioural changes created by this pandemic that may remain with us for years to come and may encourage the push for the reprioritisation of, innovation of and new ways of thinking about the way we live. After all, the transformation of the energy and basic materials industries was already on-going (albeit slowly) before the pandemic, mainly as a result of pressure regarding environmental concerns, among others.
As consumers rethink their behaviours, so do companies. More specifically, so do the companies that contribute to and impact heavily on the global economy, the financial markets and business in general. In this article, we’re going to look back for a moment at the strategies that oil and gas companies have adopted, with a view of exploring potential areas they should be considering to build resilience, transform and thrive in what is defined as the “new normal”.
As of June 2020, FactSet predicts that, at a sub-industry level, all four sub-industries in the oil and gas sector are projected to report a decline in earnings of more than 100%:
- Integrated Oil & Gas (-172%),
- Oil & Gas Exploration & Production (-160%),
- Oil & Gas Refining & Marketing (-143%), and
- Oil & Gas Equipment & Services (-110%).
This is of course not big news, considering the tumultuous (to say the least) start of the year the sector faced.
While oil prices have recovered since their lowest point in April, and OPEC+ came to an agreement on supply levels, explorers and producers of all sizes, shape and form have had to face the consequences of the dramatically low price levels and have had to react quickly in order to stay afloat.
Some of the measures adopted by companies to react to the crisis have included:
- Financial - capex and opex cuts, additional financing to support liquidity, dividend cuts
- Operational - halting of operations, on-site workforce testing and ramping up of existing technology
- Employment/staff-related - job cuts, termination of third party arrangements, realignment of available skilled manpower, and
- Strategic - deferral of high-cost, not critical projects, recruitment freezes, reassessment of portfolios, renegotiation of open deals.
While the future is still unclear, some things are already apparent as fundamental for the future of the industry:
- Focus on long-term, sustainable practices: public views rooted from lessons learnt during the pandemic around the importance of long-term, sustainable practices may bring an even stronger focus on climate change, a cleaner economy and corporate environmental responsibilities. Signs that this is likely to take a bigger focus include events such as the new proposals for climate-related disclosures for premium listed issuers been published by the FCA which, if accepted, should be in place by as early as January 2021; developments such as the EU Marshall Green Deal and Energy Transition Commission’s COVID Recovery Letter which has been signed by a number of corporates, including oil majors and announcements by fund managers such as BlackRock and State Street. In addition, the great work that the agencies like the IEA and IRENA are doing will be instrumental for public policy focus on long-term, sustainable practices.
- Demand levels may never be the same: digital transformation including remote working, distance learning and e-commerce may all form part of the “new normal”, therefore reducing the need for mobility and other related services, which are largely driven by the oil and gas sector.
- Ability of governments to manage the health crisis: the sustainability of economic activity is deeply dependent on governments effectively managing world events.
- Ability to manage geopolitical dynamics: compliance with the recent OPEC+ agreement will be key to maintaining some level of stability in the market.
Time to rethink
While this is of course a time of great challenge for the market and global economies, companies cannot be standing still. Oil and gas companies should take this time as an opportunity to revisit their strategies and practices – rethink their business models, their future plans and their response to the changes we expect to see.
Below are some potential areas for consideration:
- Reshape portfolio – assessing returns from current projects is the first step for a company to Rethink its portfolio. Reallocate capital from low-return assets and operations and align funds to those with greater opportunity for future value creation. The companies that have resources and business models to do so, may choose this moment to accelerate their diversification towards clean energy and the technologies of the future. They may be helped in doing through the support hopefully received by a number of governments reprioritising public spending towards energy efficiency and decarbonisaton.
- Scale up technology and digital investments to improve throughput from existing assets – it’s no news that technology can help increase efficiency and decrease costs in the long term. But this period has been seen as an opportunity by a number of companies in the sector to implement systems and tools such as advanced analytics, robotics process automation, visualisation and integrated planning and scheduling. In addition to efficiency, such systems can help improve KPI tracking, automate processes, deploy cloud cybersecurity, and respond accordingly to emerging regulatory changes. In addition, placing focus on tech may also help the industry attract the new generation of workers, such as data scientists. At a time where the industry is struggling so much to attract new talent into what is seen my GenZ as a “sunset industry”, this may be a good time to whet the appetite of GenZ on how technology can change the way in which the sector operates. We published a report on this just some time ago referred to the mining sector, but very relevant to oil and gas as well - here.
- Prioritise resilience over efficiency in your supply chains (both customers and suppliers) – analyse the financial resilience of existing key suppliers and customers, assess emerging risk profiles and consider alternative options. Understanding your contractual requirements is vital, but good communications and trusted relationships will help avoid adversarial discussions from the outset with both your customers and suppliers. For existing key suppliers, set out contractual levers available to manage fluctuations in demand and any recourse for non-delivery to your customers up-chain. Engage key supplier stakeholders to understand changing supplier capacity and capabilities so you can evaluate what is at risk. Plan for emergency renegotiations with existing suppliers and negotiations with new suppliers. Finally, tailor your contract management approach to the new environment. It will be different going forward.
Take this opportunity to review your risk management strategy:
- Financial management - accurate financial information to support cash flow forecasting models is critical. Models should allow for the ability to flex and sensitise assumptions regularly and easily as new information on scenarios emerges.
- Fraud – opportunities to perpetuate fraud increase not only when operating environments are challenging, but also during times of transition. Business leaders need to consider key risks and vulnerabilities. How can these risks be mitigated, and what is the organisation’s risk appetite? Some controls may not have been fully operational during the height of the COVID-19 outbreak, so it may be necessary to undertake a retrospective review to understand what did or did not happen or whether compensating controls were effective.
- Cyber security - with millions of employees working from home, organisations have had to quickly adapt to keep business critical functions running, while also maintaining adequate security. Security considerations must also be taken into account as business processes change and organisations resume their new normal operations
- Health information and data privacy implication - organisations are collecting and processing new types of information about individuals including health status, household information and the results of any COVID-19 testing. Are your data privacy policies appropriate?
- Regulatory compliance - in the midst of everything that is happening and the daily challenges organisations face, it is important that companies do not take their eyes off the regulatory ball. Regulators will not be tolerant. They’ll in fact be increasingly stricter, particularly around ESG-related issues, as mentioned above about the recent FCA proposals review. There needs to be an ongoing focus on compliance and the continued swift adoption of any regulatory changes that are required.
The world is different now and it will be different going forward. Oil and gas will not disappear but it will continue to have to change, and at an unprecedented pace, if we are to live in a more sustainable world (environmentally and financially). The quicker companies realise and embrace the change and the more companies look to engage with potential future trends, the stronger and more resilient the industry will be to whatever comes next.