Musings: A Retrospective View of A Restructured Energy Industry



Musings: A Retrospective View of A Restructured Energy Industry
G. Allen Brooks shares his predictions on how the global oil and gas industry will be in 2025.

This opinion piece presents the opinions of the author.
It does not necessarily reflect the views of Rigzone.

Using our time machine, we ventured to 2025 where the global oil and gas industry is enjoying its fifth year of the “new normal” – crude oil prices were settled in the $95 a barrel range. Luckily for the industry, demand for its oil continued to grow, albeit ever so slowly. The steady growth since 2020 of 250,000 barrels a day represented an environment some are starting to call “boring.” That may be a welcome respite for managers following the volatility of the first 20 years of this Century and the toll it took on companies, technology and investment. Countries have become less fearful of oil shortages now that renewable fuels supply a significant share of the world’s energy needs and electric power generation. In developed economies, crude oil is essentially reserved for transportation fuels, but even then, the increased penetration of green fuels, electric vehicles and social attitude changes toward the use of vehicles and mobility in general have limited the growth of hydrocarbon-based transportation fuels.

People contemplating this new petroleum industry environment have been reflecting on how dramatically the industry was restructured as it recovered following the oil price war of 2014-2017. The students of the industry understood that industrial sector restructurings usually don’t occur until after the worst of an industry’s downturn has passed and company management teams can begin to fathom how the underlying structure of the industry was altered by the forces that birthed the downturn. The last downturn was driven by the growth in crude oil and liquids output in response to the successes in harnessing horizontal drilling and hydraulic fracturing technologies to tap hydrocarbons trapped in shale formations all across the United States. The shale revolution slowly expanded from the United States to the rest of North America and then to Europe, Australia/Asia and South America. Global oil supply grew further when Russia embarked on drilling shale formation along with various Middle East countries. The high oil prices that existed during the decade of 2004-2014 were coupled with extraordinarily cheap capital in the last half of that period as central banks globally embarked on huge monetary easing campaigns in an attempt to boost economic growth in the central bank’s countries. The need to flood local markets with cheap money was mandated by the tepid pace of economic recoveries following the 2008 global financial crisis and the recession that followed.

The speed with which oil prices recovered in 2009 after governments around the world injected essentially “free” money into their economies shocked many observers. Those in the industry, however, assumed that 2008-2009 was merely an interruption in the long-term trend in oil prices that would soon take them back to and well above $100 a barrel. Between 2010 and 2014, global oil prices traded within a range of $80 to $107 a barrel, which signaled that the world was desperately short of crude oil supply to meet the projected growth in demand. High oil prices provided the cash flow necessary to explore and develop new supply sources, especially the high-cost ones such as shale, oil sands and offshore/deepwater resources.

One observer commented that if the industry had its own version of Rip Van Winkle who just happened to fall asleep in the summer of 2015 and awoke now in 2025, he wouldn’t recognize the industry today. Forget the days of the Seven Sisters, now the members of the global oil industry could be counted on the fingers on one hand. The last major wave of oil industry consolidation occurred at the end of the 1990s and right after the turn of the current century. In 1998, Exxon bought Mobil Oil while BP plc purchased Amoco (formerly known as Standard Oil of Indiana). Early the following year, BP snapped up ARCO, the former Atlantic Richfield. In 2001, Chevron bought out Texaco following its bankruptcy fiasco fallout from losing its lawsuit with Pennzoil over Texaco’s tortuous interference in merger negotiations between Pennzoil and Getty Oil. The following year, Oklahoma-based Phillips Petroleum merged with Houston’s Conoco and then three years later the combined company acquired Burlington Resources in hopes of becoming the king of the domestic natural gas industry. Unfortunately, the timing of that transaction came as U.S. natural gas prices peaked and fell from double-digit price levels to mid- and then low-single digit prices. Later ExxonMobil became the largest U.S. natural gas producer when it acquired the large independent, XTO Energy, a company almost totally focused on gas.

Now, the international oil industry was finishing digesting its latest merger wave. Royal Dutch Shell had successfully integrated its 2015 purchase of BG Group; originally the UK government’s British Gas Company that helped pioneer the development of the North Sea as a leading oil and gas basin. ConocoPhillips was neatly tucked in under the ExxonMobil wing helping keep its place as the world’s largest oil company.

Musings: A Retrospective View of A Restructured Energy Industry
History of Oil Industry Merger Activity

BP, the product of numerous major oil company acquisitions, after struggling for more than half a decade following the financial burdens from its Macando oil spill in the Gulf of Mexico in 2010, was finally absorbed by Chevron seeking to build its global presence, and especially seeking to enter the Russian market and keep pace with ExxonMobil.

The merger wave wasn’t confined to US-based oil companies as European-based companies Total and ENI forged a global merger. Possibly the strangest developments occurred in the national oil company universe as state oil companies succumbed to the pressure from escalating financial costs and the needs of their host governments for them to become more meaningful contributors to their local economies. Norway’s Statoil, Brazil’s Petrobras, Mexico’s Pemex and Venezuela’s PdVSA helped lead the global oil industry consolidation parade with creative joint venture structures that preserved the illusion that each of these national oil companies remained committed to their host governments while they were actually drifting closer to becoming full-fledged international oil companies. The operational and social issues inherent in making these joint ventures work were significant, but they were slowly overcome as the pressures to make them work intensified. Despite some of the political issues, there were even tie-ups between Asian producers including Chinese oil companies. The one region of the globe where the parade did stop was in the Middle East as the religious nature of the various host governments prevented any ties closer than those for the members of the Organization of Petroleum Exporting Countries (OPEC), which rapidly became an obsolete institution. What did remain and became even stronger, was the Organization of Arab Petroleum Exporting Countries (OAPEC) that provided closer coordination among those state oil companies confined to the Middle East region.

One trend that had become more pronounced in 2020-2025 was how these new mega-oil companies were sucking up many small, independent producers around the globe as the ability for these smaller companies to operate in an industry dominated by giants was limited. Personnel emerged as a managerial challenge. The reality is that the oil and gas industry was starting to confront its early sunset days as the dominant fuel source became an impediment for students to seek to earn degrees in petroleum sciences. Without a steady supply of new petroleum engineers and scientists, the lure of the security of working for the behemoths sapped the strength of the small, independents. In addition, a growing and severe shortage of “grey-haired” oil and gas professionals developed limiting the formation of new independents and even for staffing existing ones. The small producers were further hampered by the explosion in regulations that were the weapon of politicians to punish the industry for past environmental accidents. The attacks by the anti-fossil fuel movement led to some erosion in financial and investment support for the industry. Not only had this regulatory onslaught raised the cost of doing business, but the constant political and social battles had worn down the energy of those managers running the independent companies. It was much easier for large, politically savvy and important petroleum companies to overcome these hurdles, so they devoted a greater share of their cash flows to buying up small producers as an effective way to build reserves and augment production.

Recognizing the impact from the consolidation of the oil and gas producing sector, the oilfield service industry also found it more profitable to become bigger. Back in 2015, the industry was tracking the maneuvers that brought Halliburton Companies and Baker Hughes together and then their saga in seeking approval for the merger from the U.S. and other governments. Once that deal was done, the combined company was forced to sell off a handful of divisions in which the two previously competed, which enabled smaller service companies to not only become larger, but also more diversified. Those desires were part of the rationale for the Halliburton-Baker Hughes merger as the combined company became a true competitor to industry kingpin Schlumberger.

While most observers were fascinated by the Halliburton-Baker Hughes transaction, Schlumberger was further broadening its portfolio enabling it to provide an even more complete range of services to its customers. That broad portfolio had prompted the new Schlumberger CEO to propose modifying the company’s business model in order to not only gain additional market share through providing a true value-added service to customers but also as a way to increase Schlumberger’s profitability.

When Schlumberger introduced the new business approach to investors in 2014, they called it “transformation.” The management said that this new business approach “leverages the drivers of technology innovation, equipment reliability, process efficiency, and system integration, all together delivering better management of costs, better quality of products and service delivery, and better generation of free cash flow.” For the clients and Schlumberger, it meant that while setting “goals for new technologies and increasing elements of service integration, they were also targeting a 10-fold reduction in customer non-productive time, a doubling in asset utilization, a 25% reduction in inventory days, a 20% increase in workforce productivity and a 10% lowering of unit support costs.” The net result of Schlumberger’s new approach to conducting its business and how that approach impacted customers’ work flows was to slowly create a new mindset for operating in the oil patch.

Part of Schlumberger’s long-term business strategy that drove its “transformation” was the formation of a joint venture in a market sector where it had never operated. That was the formation of OneSubsea, a joint venture company Schlumberger formed with Cameron International that focused on providing equipment and services for developing offshore oil and gas fields totally subsea. After the initial successes of the joint venture, to further Schlumberger’s new business model, it used its OneSubsea interest to acquire Cameron. That deal kicked off a service industry merger wave with French service giant Technip picking off FMC Technologies. It had previously tried to acquire French seismic industry leader CGG, which would put it firmly in competition with Schlumberger who has a major seismic player in its WesternGeco subsidiary. The CGG deal was resurrected and eventually completed. Technip and Schlumberger would also battle in the subsea area as Cameron and FMC Technologies have been long-time competitors.

In 2015, GE made the strategic corporate move to exit its financial services businesses, which had propelled the company’s outstanding stock market performance under legendary leader Jack Welch in the late 1990s and early 2000s. That business became an albatross around the neck of GE when the 2008 financial crisis emerged. GE’s strategic move drove the company to emphasize oil and gas equipment that it continued growing through a series of acquisitions. With that new focus, GE felt compelled to acquire businesses in order to broaden its well completion and subsea equipment portfolio, and subsea service provider Oceaneering became its latest acquisition target. The deal was brutal and expensive as the new Halliburton Company battled GE to the end. The two other large oilfield service companies, National Oilwell Varco and Weatherford International, both built by serial acquisitive managements, battled over the Halliburton-Baker Hughes assets that they were forced to sell to complete their merger. As always in the oilfield service industry, the big boys are continually wrestle with the buy/grow decision, especially over unique product lines.

In the new normal world of the petroleum industry, despite moderate  and consistent demand growth, oil prices continue to lag where they had been trading before the last collapse in 2014-2015. That price collapse forced oil and gas operators to cut their exploration and production spending and begin aggressively axing staff and overhead in order to lower E&P costs. The oilfield technologies that were critical for opening shale basins around the world proved capable of enabling operators to increasingly increase their production by extracting a greater percentage of hydrocarbons from shale reservoirs than initially. So, while many observers had expected a “V-shaped” recovery in 2015, much like what occurred in 2009, that didn’t happen. As the resiliency of shale output coupled with healthy volume growth from low-cost conventional reservoirs around the world battled low oil demand growth due to the continuation of the era of historically low economic growth, oil prices failed to rebound quickly.

At the start of the oil price collapse, the debate within the industry was whether companies were looking at a “V-shaped,” “U-shaped” or “L-shaped” recovery. Having quickly dismissed the first choice, the debate then shifted to the remaining options. The problem was that the length of the bottom of the “U” can easily transition into an “L,” and in this case it did, much like what happened in the late 1980s and 1990s. One could say that it was the lack of any oil price improvement for an extended period of time that contributed to the petroleum industry’s merger wave at the end of the 1990s and early 2000s. Based on history, no one was surprised that the petroleum industry would go through another consolidation phase - the surprise was the speed and magnitude once the effort began.

One of the outcomes from the petroleum industry restructuring was the rationalization of E&P activity. Lower oil prices forced the newly combined E&P companies to re-prioritize their exploration prospects and, importantly, their development activity. Managers seemed less troubled with cutting back exploration due to the emergence of shale production as they were able to rapidly respond to changes in supply and demand dynamics by quickly adjusting capital spending. When you needed to boost production you went out and drilled a few more wells. If supply exceeded demand, you just stopped drilling and waited for production to fall-off. Companies with substantial shale operations were blessed with the flexibility to grow their reserves and potentially their production despite the rapid production decline of shale wells. This flexibility was rewarded with investors clamoring to own their shares. The problem was that there weren’t many of these companies.

For those companies that operated primarily in the offshore arena, they found that its cost structure proved to be higher than the breakeven point for most of the shale basins, meaning that offshore, and especially the very high cost deepwater and ultra-deepwater production was a victim of economics. To respond to the growing uneconomic arena producers reacted by embracing standardization of field development. Offshore exploration wasn’t something that allowed standardized actions, but development presented many opportunities to standardize, especially well production equipment and even platforms and floating production facilities. Rejecting the not-invented-here phenomenon was difficult but changing the culture of how to develop offshore fields was critical for the success of their owners.

Re-ordering development work proved more difficult to achieve than anticipated. Many development projects, especially those offshore, were already underway when the oil downturn arrived at the end of 2014. Management teams historically have been reluctant to delay or shut down already approved development projects. But, as one of the petroleum industry’s leading consultants pointed out in mid-2015, the industry at that point had already delayed $200 billion of development projects, which represented about 30% of annual industry spending during the good times. The price for these producers delaying projects was the realization that there would be a delay in a substantial volume of future oil and gas production. For companies worried about their cash flow and profits, enduring these cutbacks was a tough decision.

The industry’s consolidation effort has led to reduced overhead at the oil companies enabling them to lower their well breakeven costs, especially with their onshore properties. At the same time, the consolidation within the oilfield service sector has contributed to improved efficiencies across the range of products and services that are needed to develop new hydrocarbon reserves. The increased efficiencies within the service sector translated into lower service and equipment costs that further helped lower the oil companies’ production break-even costs. But the efficiencies also meant that not as many drilling rigs and other oilfield services were needed to achieve the same level of oil and gas output. That reduced activity became a meaningful hurdle for the service industry to overcome in order to restore the sector’s profitability.

Maybe the petroleum industry has finally arrived at nirvana – a world in which oil price volatility is eliminated, the ability to grow production modestly is assured and the profitability of that output has been stabilized by the reduction in breakeven finding and development costs. In the interim the service industry struggled with reduced profitability due to the increased bargaining power of the larger producing companies. Fewer service providers and a more stable and predictable business level has enabled the service companies to become more efficient, helping to offset some of the downward profit margin pressure. It is too bad these industry developments have arrived as petroleum companies look toward their sunset.

We intend to return to 2025 to explore how the energy business evolved and the challenges faced during that decade-long journey.



WHAT DO YOU THINK?


Generated by readers, the comments included herein do not reflect the views and opinions of Rigzone. All comments are subject to editorial review. Off-topic, inappropriate or insulting comments will be removed.

Dr Satya P.Bindra  |  August 15, 2015
Thanks for a critical review of restructured oil sector that demonstrates that how strength speed and scope of phenomenal transformations due to austerity, consolidation, reduced activities, rationalization of E&P & reordering of offshore development projects are painful decisions. However, it is a bitter pill that is needed for profitability in the long run.