As the Budget is announced this week, Derek Leith, UK head of oil and gas taxation at EY, has taken up the role of Energy Voice’s guest editor. Follow along each day as he spells out the challenges and triumphs the industry faces.
Following the slide in oil price, which commenced in earnest in July 2014 and by 31 December had fallen by more than 40% in 6 months, alarm signals have been sounding loud and clear throughout the sector.
Collectively industry drew a deep breath on the 1 January 2015 as it pondered what the year would bring. Could the price go lower than the $57 recorded on the 31 December and how soon would the price rebound?
Well the answer to the first question has been yes, to just over $45 on January 13, and the answer to the second is anyone’s guess but looks increasingly like a slow recovery with many predicting an average Brent price of $75 for 2016.
The reaction from oil and gas companies is purely market driven: make some quick adjustments to headcount; cut back on capital expenditure, focus on projects which offer the best return and put pressure on the supply chain. In turn the supply chain has also made some immediate headcount reductions, cut contractor rates, warned of pay freezes and rapidly adjusted their forecasts.
With no immediate recovery in sight the more difficult decisions are only starting to be considered by both the upstream and the supply chain. Do I have a strong enough cash flow to weather the storm, how can I make my balance sheet more resilient, do I need to restructure borrowings, how can I drive real changes of culture and practice to radically improve efficiency and rebase costs?
Without a doubt towards the end of 2015 we will see some level of consolidation in the sector, and some over-leveraged companies will be in serious difficulties or out of business entirely. Oil capitals will have lost some of their swagger, and some of the banks, perhaps heavily exposed to US shale will have learned a painful lesson.
In one sense none of this should really be a surprise. The industry is cyclical so why did we delude ourselves into thinking we were in a new paradigm of ever-rising oil prices? Perhaps Friedrich Hegel was correct, “The only thing we learn from history is that we never learn from history”.
However, I feel more optimistic that the current slump in oil price is an opportunity for industry to reinvent itself and deliver a lower-cost, more efficient model for the exploitation of hydrocarbons. That is an enormous challenge but perhaps the external price environment will be the bitter medicine that needs to be swallowed to cure the patient.
The Chancellor also has a role to play. I’ll be discussing that tomorrow.