The Future of the Energy Industry

March 14, 2017

On March 30, the Energy Institute at Price College of Business is hosting the Fifth Annual Energy Symposium in Oklahoma City. This year’s theme is “Preparing for the Future of Energy – Thriving in Complex and Uncertain Times.”

Ahead of the Energy Symposium and its focus on the future, it is important to consider where we are and to briefly review some of the actions that have been taken in response to the low oil price environment. I am a great believer in competitive markets leading to the best allocation of scarce resources and that participants in these markets, whether producers or consumers, will be driven to make choices that are both innovative and efficient.

Below, I will briefly review some of the effects of the low oil price environment, the impact it has had on the industry and where the industry can go from here.


The Effects of Low Oil Prices
A recent report focusing on deals greater than USD$100 billion determined that despite low oil prices causing an ample supply of oil and gas assets on the market, the overall merger and acquisition deal count in the upstream energy sector plunged in 2015. The weakness and volatility in oil prices made it difficult for buyers and sellers to achieve consensus on value and outlook.

The low price environment coupled with expiring hedges and a major drop in revenues has led to rating downgrades for many U.S. producers. These facts along with lower reserve based borrowing limits have resulted in reduced cash flow and reduced liquidity. 

The response of E&P companies was to:

  • Reduce capital spending and defer projects.
  • Reduce operating expenditures (increase efficiency).
  • Renegotiate with suppliers for the best pricing (including service providers).

The low oil price has been a motivating factor driving increased efficiency and cost control. For instance, advances in technology have increased drilling efficiency. The average number of days from spud to release has fallen consistently since 2012 and dramatically in many regions since 2014. We have also seen significant decreases in rig count and this lower demand has manifested itself in lower rig rental rates. IHS reports the onshore quarterly average day rate fell from its peak of roughly $19,000 in the fourth quarter of 2014 to roughly $15,000 in 2016.

 

A Leaner, More Resilient Industry

A low price environment and a competitive market require producers to be lean and efficient. In addition to most large oil companies who continue to decrease costs, survivors will be low-cost efficient producers who:

  • Strategically manage cash flow hedging to ensure they can meet both fixed debt and operating cash requirements.
  • Finance the capital expenditure program without forgoing totally the upside if oil prices rebound.

Companies that didn’t over-leverage and built up cash reserves when oil prices were high are positioned nicely to acquire companies that did over extend. These companies now find themselves unable to service fixed debt obligations or for that matter, obtain new loan commitments.

 

Efficiency Equals Survival

Tighter margins will drive companies to become more efficient if they hope to survive, and this should be transmitted through the entire supply chain. There is no easy way to recover this loss in value. However, from a decision-making perspective, companies have the option to expend resources, to complete wells, to develop unproven reserves or explore.

Companies also have the choice to develop at current prices (which may lead to net negative cash flows) or to defer development to a future date. As oil prices are variable, there is the prospect that oil prices may rise, making the decision to develop a profitable endeavor at a future date.

On the positive side, oil prices have risen but resilience will depend upon the supply-demand balance. The rig count has also begun to rise and a recent report issued by Barclays projects that U.S. E&P companies will increase spending by as much as 27% during 2017 and that global E&P spending will rise by 7%.  

 

Find more information at the below resources:

Register for the Energy Symposium: “Preparing for the Future of Energy – Thriving in Complex and Uncertain Times” on March 30 in Oklahoma City.