Do Oil Drillers Need A New Business Model?

Exploration and production (E&P) companies are set to face one of the biggest challenges - if not the biggest challenge ever - to their business models. 

This challenge is a combination of investor and society concerns about the oil industry’s contribution to climate change and concerns about global oil demand peaking in just a decade or two. And this challenge could result in too few new good opportunities for project development for just a few oil explorers, IHS Markit says.  

“[T]here may well be too few ‘quality,’ competitive investment opportunities for the E&P industry as a whole; parts of the industry will not be able to attract investment capital,” Jerry Kepes, Keith King, and Siddhartha Sen of IHS Markit write. 

The exploration and production sector is indeed facing many dilemmas. 

First, analysts expect global oil demand to peak at some point over the next two decades - there’s the concern that oil and gas assets could remain stranded, especially if policies support the transition to low-carbon energy sources.    

Then, investors and money managers are jittery about continuing to plow money into oil and gas amid growing concern from their clients and the society as a whole about the oil industry’s environmental, social, and governance (ESG) credentials. Those investors who are still betting on the oil industry are demanding returns, and they are demanding that those returns start flowing more quickly than they did before the 2014-2015 oil price crash. 

Big Oil has to find a way to reconcile the need to keep dividends (and growing them) with the growing need to not fall entirely out of favor with investors as it faces the backlash from society and activists who criticize oil companies for continuing to produce energy from fossil fuels. Related: Oil Bulls Are In For A Bitter Disappointment

Then there’s the pure financial consideration of the business models of E&P companies. 

After the oil price collapse, the quicker returns were perceived to be in the shorter-cycle U.S. shale. But the meager returns disappointed investors, who continue to punish oil stocks, while capital markets are largely closed for many U.S. producers who have accumulated too much debt while they “drilled themselves into oblivion,” as Harold Hamm had warned in the middle of 2017. 

Shale production growth has been slowing down for months, and peak shale could be just years away. 

Companies with strained capital and stretched debt would suffer, while the biggest firms, who have also boosted their exposure to U.S. shale, could focus on exploration in prolific low-cost basins outside the U.S. 

Exxon’s Guyana adventure is already paying off, with first oil achieved five years after discovery. Equinor managed to slash costs for its huge Johan Sverdrup oilfield in Norway’s North Sea, which already pumps 350,000 bpd, with break-even price for the full-field development below US$20 per barrel, as per Equinor’s estimates. 

But again, these are too few examples for too few oil firms striking big new resources and making them profitable in a highly volatile oil price environment. 

“But how many Guyana Basins or Johan Sverdrup's (in offshore Norway) are there? There may be other new sizeable crude streams that are highly competitive, with break-evens at $25 to $45 per bbl. However, even if volumes are 300,000 to 500,000 bbls/ day, this does not make up for overall industry trends,” IHS Markit’s analysts say. 

In short, the exploration business is set to become even more competitive in the future as too many oil and gas firms would have to compete for a few highly attractive new resource prospects. And those who will win the competition will be the ones with the deepest pockets and most experience. 

“The Majors are focusing on asset types or geographies where they have competitive strengths and competencies,” Simon Flowers, Chairman and Chief Analyst at Wood Mackenzie, said in October. Related: Oil Traders Could Lose Big On Coronavirus Panic

But then, the majors - more than others because of their prominence and scale of operations - face the existential threat of being stripped of their ‘social license’ to operate. 

The oil and gas industry’s ‘social license to operate’ “is under serious threat and there is no scope of a second chance,” Tim Eggar, chairman of the UK’s Oil and Gas Authority (OGA), said last month, calling on the industry to do more to help the fight with climate change. 

The majors, at least those based in Europe, respond to those calls with pledges for ‘net zero’ carbon emissions in operations, BP being the latest, but environmentalists accuse Big Oil of greenwashing as it continues to invest in oil and gas production. 

Climate concerns and increased competition for profitable resource development amid looming peak oil demand will profoundly change the E&P industry. 

By Tsvetana Paraskova for Oilprice.com

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