Attracting investment capital looked like a challenge for the oil and gas industry heading into this year, as investors put increased emphasis on profitability and steady returns.
At first that situation appeared to be an emerging problem. Then prices fell off a cliff, with damaging results for exploration funding.
The worldwide spread of the coronavirus gutted oil demand while a dispute between Saudi Arabia and Russia left both sides threatening to increase crude production. OPEC+ eventually reached a compromise on cutting output, but most analysts felt it was too little, too late, putting oil and gas in a money crunch.
“That is a lot of the conversation: Where is the industry going to get its capital?” said Susan Cunningham.
Cunningham is an adviser for Darcy Partners, an energy technology research company, and a former executive vice president of Noble Energy for global exploration and business innovation.
She was scheduled to participate in the panel discussion “Will Exploration and Production Regain Its Luster for Investors?” at AAPG’s Annual Conference and Exhibition in Houston.
Also scheduled to participate in the special session was Bill Maloney, an adviser for the private equity firm Warburg Pinkus and a former executive vice president of Equinor, the renamed Statoil, serving as its senior executive in North America.
Both agree that the industry faces some serious investment hurdles in a situation without a predictable end date. Exploration could be especially hard hit in the downturn.
“Investors in energy have been and continue to be essentially on strike,” Maloney noted.
“If you see what’s happening now, which usually happens, one of the first things to get cut is the exploration side of the business,” he said.
No Quick Recovery
Going into 2020, it appeared that unconventional resources – especially shale development – would be financially challenged as spending outstripped returns. Now exploration is also looking investment deprived, Maloney observed.
“I don’t see any exploration money coming from private capital. Why do it now? I’m an explorer by background, and I don’t see it,” he said.
“If you’re a private equity firm do you really want to be investing in exploration right now? Well, no. Do you want to be investing in assets that give you cashflow? Yes,” he added.
Cunningham said she’s confident that investors will return to the oil industry when prices climb and results improve, but she doesn’t see any quick resolution to today’s situation.
“If the returns were there, investors would be there. If the returns get there the scenario will change. The question is, when will the returns get there?” she asked.
“Personally, I think it’s going to be at least a year before it gets back,” she said.
Maloney also believes the industry faces a prolonged period of reduced demand and lower spending.
“I think the belt-tightening has happened, and I don’t see it letting loose this year,” he said.
Some economists have forecast a quick upturn in oil prices, a spike when the pandemic spread ends and the industry works through surplus crude in storage. Maloney said he isn’t optimistic about that kind of bounce-back.
“I have a hard time seeing a price spike. Will it get back to 100-percent (demand) quickly? I think probably not. If there is a measured response, I don’t see a big uptick in prices,” he said.
“People aren’t going to take airplanes, people aren’t going to go on family vacations, until the all clear is sounded by multiple sources,” he noted.
Oversupply, Not Renewables
Investors began to drift away from oil and gas in recent years because of comparatively unattractive financial results, not because of a shift away from hydrocarbon fuels, according to Cunningham.
“It’s easy to blame it on public perception of the industry and the energy transition because that’s an easy thing to blame it on, but the real reason is because the returns have not been there,” she said.
“The assumption is that the demand for hydrocarbons is going to decrease,” Cunningham noted. “When you actually have some conversations that are more one-on-one, they say the reason is less the carbon transition and more about the financial returns.”
Maloney, who serves on the board of directors of Trident Energy and holds other positions of leadership in the industry, said his opinions reflect his own views only. Still, the current demand/supply imbalance in world oil presents an obvious and glaring investment obstacle.
“The reason for that is, the market right now by some estimates is at least 20 million barrels a day oversupplied by the decline in demand from COVID-19,” Maloney observed.
“Having filled much of the available storage, how long will it take to work that off? Until you work through that, why invest capital?” he said.
The Storage Problem
Some companies managed to improve efficiencies and strengthen their balance sheets following the last downturn, and that will help them in a depressed investment environment, Maloney said.
“If you go back to 2015 onwards, I think many companies, especially the bigger ones, have come out of that downturn stronger,” he noted.
“The industry was able to overcome the price downturn. However, there’s much less room now for similar improvements from efficiency gains,” he said.
The majors today are generally healthier than independents and better prepared for financial risk, Maloney observed.
Independents “that produce in the 5,000 to 100,000 barrels of oil per day range could be at risk in some form or another. You’ve already seen Whiting Petroleum declare bankruptcy,” he said.
Cunningham thinks many U.S. independents can ride out the demand collapse for a while, with conditions deteriorating the longer the effects of the pandemic go on.
“A lot of them have hedges on, so financially they won’t be in terrible shape for another six months or so. The real problem is storage,” she said.
Hoping for Stability
The outlook for the industry isn’t completely dismal. Maloney said the industry should emerge in good shape when the supply-and-demand picture improves and prices stabilize at a higher level.
“When you have a stable oil price, that’s good for everybody. If it stays at, say, $60 a barrel Brent, companies can plan, governments can plan,” he said.
Whenever oil prices do stabilize, “you should see good returns. The cost structure of the industry has come way down,” he added.
Fortunately, banks have continued to lend to oil and gas operators, Cunningham noted.
“They are working with companies that they like, that they think have a future, and they have a good relationship with,” she said.
And several companies recently tapped into capital markets to arrange financing, Maloney said.
“That kind of money will be out there for some companies. We’ve seen the majors taking advantage of the bond market,” he noted.
According to the Bloomberg news service, Shell signed a $12 billion credit line at the end of March and Equinor sold $5 billion of notes maturing between 2025 and 2050. Total also entered the market with a 3 billion euro ($3.3 billion) bond sale.
Oil companies have already begun to make significant spending reductions in 2020, a worrisome sign for exploration activity. In April, Exxon Mobil announced it would reduce its capital spending budget by about $10 billion, a 30 percent cut.
“The exploration wheel is hardly turning at all. There is still some exploration by large companies, but not a lot,” Maloney noted.
“Will there come a time when the underinvestment we saw in 2015, ’16, ’17, and the underinvestment we see today, will that come to hurt us as an industry in the long run? Will that come back to bite us? Maybe,” he said.
Cunningham described herself as “an optimist at heart” and said today’s challenges for the industry will produce new solutions.
“It’s always times of crisis when the most innovation comes out, in industry, in society, wherever,” she said.
Instead of changing the future course of the oil industry, COVID-19 will more likely accelerate shifts already happening, to automation and smart wells, to different way of working, to using virtual teams and virtual tools, she said.
“That’s so much faster. Those kinds of tools will be picked up – people will be forced to pick up the virtual tools,” Cunningham observed.
And at some point, normal operations will resume. When oil prices rise and demand returns, and if producers don’t increase output to the level of oversupply, the oil industry will stabilize, Maloney predicted.
“It’s not until then that you’ll see investors coming back in,” he said.