Oil Downturn Looks A Bit Like 2008 Financial Meltdown
The present severe oil market downturn bears some resemblance to the 2008 financial crisis, but a fundamental difference between the oil and financial services industries marks a major distinction between the two historic episodes.
So concludes Richard Marshall, head of the Global Oil and Gas Practice with the cloud software firm Nakisa. In a recent conversation with Rigzone, Marshall offered his insights on the events as well as the oil downturn’s likely impact on companies’ supply chain and asset management. Read on for his perspective.
Rigzone: What similarities do you see between the current oil industry downturn and the 2008 financial crisis?
Richard Marshall: Both the oil industry downturn occurring right now and the 2008 financial crisis are representative of imbalances in underlying markets, and both are/were global in scope. In the case of the current situation in oil and gas, an existing oversupply situation driven by increased production was coupled with an unprecedented demand shock from the global pandemic decreasing consumer and industrial consumption.
Both situations are also characterized by uncertainty and the accompanying volatility in asset prices, whether this is share prices, commodity prices, home prices or interest rates. Also, the pricing behavior we have observed has at times been aggravated by financial derivatives, which are contracts written on top of underlying assets like futures contracts for oil prices or mortgage-backed securities for house prices. In both cases the impacts were felt globally, driven by the interdependencies of energy and financial markets.
Rigzone: How are the two events different?
Marshall: Of all the differences, the one I would like to comment on is the characteristics of the major respective industry players. By their nature financial services firms – and especially companies that engage heavily in sales and trading – interact heavily with financial markets on behalf of their customers and on their own behalf, both operationally and to generate a return. The use of financial derivatives – like futures and other forms of hedging – are common in the energy sector, the number of counterparty positions and the daily volume of trades is not fundamental to the liquidity of the oil and gas companies like it is for financial services firms.
This is in stark contrast to the banks in 2008 where debt is part of their operating structures and the settlement of positions on a daily basis can be necessary to stay in business. We should not see a large player like Royal Dutch Shell or Chevron collapse or be forced to merge with a peer in the same manner as household names in banking did in 2008. In addition to the terms and conditions that govern these arrangements, there are fundamental differences in the breakeven costs for different activities in different parts of the world and these activities cannot just move from one financial center to another. They are limited to where the commodities exist and what infrastructure is present and available.
Rigzone: What effect has the oil downturn had on supply chain and asset management?
Marshall: Within the industry cost models exist for different price levels, but implementing those cost models takes time. Many decisions are made with multi-year outlooks and what the price of oil and gas will look like going forward. It is a careful balancing act in order to reduce expenses, preserve future production and perhaps take advantage of dislocation to selectively acquire assets. Announcements on decreasing new CAPEX make headlines and represent part of the picture. This affects the anticipated usage of equipment and staff in oilfield services, as an example. For in-use and operating assets the cost structure is compared to what is outlined in operating agreements and other contractual arrangements and action is taken as quickly as possible to align with what is needed. Both the physical and human capital elements of this decision-making must be considered.
Rigzone: If you’re an oil and gas company trying to navigate these very challenging business conditions, what should your priorities be regarding supply chain and asset management?
Marshall: The priorities of oil and gas companies should be ensuring that decision-makers have access to up-to-date and visualized data to better react to the situation.
For leased assets this downturn represents the first price shock since the new lease accounting standards went into effect for most companies on Jan. 1, 2019. In addition to the hundreds, if not thousands, of new journal entries, company accountants had to deal with the new assets and liabilities dictated by the standards. For upstream assets like rigs that are under lease contract and were operating in hard-hit areas like the Permian Basin, impairment is highly likely and could hit many assets at once. Therefore, from a forward-driving perspective, there’s never been a more pertinent time to leverage lease accounting software. The automated research and reporting tools of a lease accounting software solution allow users to analyze costs versus benefits for informed decision-making.
From the human capital standpoint, there is a similar benefit from being able to visualize and analyze, model scenarios and then act on. This has to be done in a secure fashion with different levels of access and authorization, with outputs transferable to systems of record once approved.
Rigzone: As the economy restarts and demand for oil products such as gasoline, diesel and jet fuel likely rebounds, what impact should this have on oil and gas supply chain and asset management?
Marshall: The most likely scenario is a longer period of depressed prices, but increased demand will start to consume the pent-up storage.
Under this scenario, production efficiencies will be key and therefore the emphasis will be on focusing and increasing operations in areas with lower production/refining/distribution costs. There is a certain amount of fear and speculation that higher-cost production areas for heavier oil like shale and oil sands will be more permanently impacted and will affect the markets for those physical assets and the people that work on them. However, digital technologies like machine learning and blockchain have already been helping with production efficiencies. This rebound will affect decision-making and what terms and conditions are written into contractual agreements – ultimately the surviving companies will continue to operate in a new, leader model that remains economically viable.
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