Confronting Energy Market Realities Forces Strategy Changes
“The Schlumberger of tomorrow will not be the Schlumberger of today.” That declarative statement by Schlumberger NV’s new Chief Executive Officer Olivier Le Peuch at a recent investor conference in New York set the stage for a raft of energy company presentations about how they are resetting their strategies to deal with the reality of current energy markets.
The realities are that global oil supply continues exceeding demand, forcing governments and producers from North America to the Middle East to adjust their output as technology boosts output at progressively lower breakeven prices. This view is not altered by the attacks on Saudi Arabian oil production and processing facilities, although the events have boosted the oil price risk premium that was introduced to the market earlier this summer when oil tanker attacks in the Strait of Hormuz occurred. As terrible as this attack was, geopolitical events are always in the back of the minds of energy executives when setting their strategies, although one cannot plan for Black Swan events.
Amazingly, we are approaching the five-year anniversary of the infamous OPEC meeting on America’s Thanksgiving Day in 2014 that saw the organization shift from defending oil prices to fighting to preserve its market share. That event pushed global oil prices off the edge of the table, although they had already slid 20 percent during the previous six months. From that meeting date forward, the energy market has never been the same, let alone perform as people had anticipated and planned for. Today, the new market reality calls for more moderate oil prices, not $100 a barrel such as had dominated the world’s commodity market in the prior decade, with the exception of the Great Recession.
While BP plc CEO Bob Dudley’s “Lower for longer” mantra was the first dictum about how the industry needed to operate, it has taken years for that view to become ingrained in the DNA of energy company managers. “Living within cash flow” and “capital discipline” are popular themes for E&P management presentations to investors, although the phrases have yet to ease the negative investment sentiment that has embraced energy stocks like a dense fog. Figuring out how to navigate through this fog, in a way that will please shareholders and boost share prices, while still meeting the needs of customers, is the challenge Le Peuch, and his fellow energy company CEOs, addressed at the New York energy investment conflab.
The oil Majors are implementing their new strategies. Almost every one of them has announced the sale of core assets – ranging from properties in Alaska to those in the North Sea. These are assets that previously were the core of company strategies for decades. As historically happens, producing assets move into the hands of smaller, more nimble companies with lower overheads, suggesting the fields will be revitalized before ultimately ending their production lives. These asset sales may lead to more oilfield activity. A good thing for the industry.
The money raised from these sales is targeted for increased shale activity and selective international and offshore projects. The overarching philosophy governing the sales and reinvestments remains avoiding overspending – the historical tendency of energy managers. Now, they must generate free cash flows, and, importantly, return a portion to shareholders, while also deleveraging balance sheets.
For service companies, the moves by their customers are also forcing strategy adjustments, which means exiting unprofitable businesses, investing in new technologies, and determining how to deliver improved efficiencies for customers. Digital technologies and their application to the processes that are core to the operations of the oil and gas business will receive greater investment and management focus. As a result, managers will resize their North American operations as customers are likely to more strictly control their capital spending and drilling activity. Any changes in spending and drilling will have to await a sustained higher oil price following the weekend’s developments, and that may only begin to impact the business in 2020, In the interim, downsizing business lines is not good news for the workforces of service companies, but it reflects the reality of changes that must occur for the companies to earn higher returns and meet the demands of shareholders. Never forget that managers earn a substantial amount of their compensation from stock options and restricted shares, meaning that they are highly sensitive to share prices.
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Managing Director, PPHB LP