New investment is needed in the oil and gas sector. However, shareholders in mid-sized companies are increasingly directing them to focus on returning cash, rather than growth.
The International Energy Forum has said the world would need to invest $4.9 trillion between 2023 and 2030. It has predicted that without new investment, non-OPEC production will decline by 9 million barrels per day by 2026. By 2030, these declines will reach 17mn bpd.
Recent statements from the largest oil and gas companies have rowed back, somewhat, on their energy transition commitments.
ExxonMobil has raised concerns around under investment. CEO Darren Woods, talking in January, said the industry is “not keeping up with that depletion or not offsetting it and covering the growth”, with the potential to drive a tighter market as a result.
Until there are competitive alternatives or additional investments, Woods said, tight markets will continue. What growth there is, seems unlikely to come from the mid-sized independents.
Investors in these companies are flexing their muscles and calling for more thought to be given to returning cash. Given the need for new investments, though, this risks the industry’s longer-term sustainability.
“High commodity prices mean producers are generating large cash positions – which the shareholders are happy to benefit from. However, the industry has had chronic under investment for 10 years, which has an impact on how companies can continue to produce at existing levels,” said Gneiss Energy director Doug Rycroft.
Companies such as BP may be increasing production in the short term, “but it doesn’t address the longer-term reserve replacement issue”.
These high prices also do much to enrage consumers, who take umbrage at record profits for majors. At the same time that government is expressing concerns around energy security, there are also new drives for additional windfall taxes.
“When you are asking an industry that measures investment horizons in years, if not decades, to answer the short-term gaps in supply whilst levying ‘super profit’ taxes – it’s a confusing and complex environment for companies to take investment decisions,” Rycroft said.
“Projects take time and they take investment and that can only be done when businesses have confidence in the stability of the fiscal environments in which they operate.”
Another challenge comes in convincing shareholders about the wisdom of growth.
Capricorn Energy has struggled to make its case about why it wanted to merge. It first made a plan to link up with Tullow Oil and then with NewMed Energy.
The Tullow deal had been seen quite widely as a poor outcome for Capricorn shareholders, Rycroft said. That the NewMed deal should face similar amount of opposition was more of a surprise.
“Shareholder activism is nothing new and it’s been a broad thematic in the market over the last few year but the level of activism that Capricorn faced feels unprecedented in the space. There was complete loss of control of the narrative and even the eventual fig leaves offered up were resoundingly and unequivocally rejected by the shareholders – with blood in the water it was like viewing a corporate feeding frenzy,” he said.
Investors have been more passive in the past. There seems to be a recognition that they have more power than they thought.
“It’s part of a broader statement around activist shareholding, which partly comes out of the ESG movement – and a focus on the G element in particular,” Rycroft said.
Bracewell partner Alastair Young agreed there was an ESG angle to recent shareholder moves.
“There is no one reason for this acceleration in shareholder activism and circumstances vary from situation to situation. That said, reasons sighted for increased shareholder activism over recent years include the increased perception of the importance of ESG matters for value creation and a company’s social licence to operate, a general rise in stakeholder capitalism, and socioeconomic trends.”
One motivating factor is likely to be where such tactics are used successfully. The result is “snowball effect” where more shareholders are emboldened to “to take up their own challenges with company boards”, Young said. He cited the success of Engine No. 1 in securing representation on the board of Exxon, despite having only a small number of shares.
AKap Energy’s Anish Kapadia agreed that shareholders have more power – and that activists might see opportunities emerge in M&A situations.
“They might not be hugely opposed to the deal, but they may see an opportunity to kick up a fuss. It’s going to be harder to get M&A done, everyone will be thinking whether it is worth taking the risk,” Kapadia said. “There’s still a huge number of listed E&P companies, there’s an argument to consolidate and cut costs – that’s not being helped by shareholder activism.”
Faltering support from investors for deals throws up new problems for companies attempting to grow.
“Pricing is not as important as it as in the past,” Kapadia said. Most companies now base their forward projections on the futures curve. “It’s still more of a buyers’ market than a sellers’. That said, it is still hard to assets. With integrated companies pulling out of that market, and private equity pulling out, there’s a smaller buyer set.”
Bracewell’s Young saw majors and the larger private equity houses as driving sales.
“On the buy-side, we are seeing competition for attractive assets mainly from independents of various shapes and sizes but, in part due to the funding challenges faced by smaller independents, we are seeing the growth of a small cadre of very large independents as compared to the picture a few years ago,” he said.
“Deals are being funded by equity and healthy balance sheets, vendor loans, trader-based financings, pre-payments for offtake, as well as traditional bank lending.”
The larger independents can raise debt in the capital markets, Young continued. The “practicalities of deal certainty and execution have meant that bonds have only rarely been part of the specific acquisition finance toolkit. Growth is also increasingly arising by way of corporate consolidation with smaller and medium sized independents merging.”
Kapadia noted the higher cost of capital for hydrocarbon projects, particularly in emerging markets. “The cost of getting things done is astronomically higher for oil and gas than for the greener projects,” he said. “In the longer term it’s bullish for prices, as not enough investment is going into the areas where it should be.”
Some companies, with a wider range of operations, may be struggling to make the case around growth versus dividends. For pure play exploration, the pitch is more straightforward.
“Dividends and exploration don’t go hand in hand,” Kapadia noted. For exploration investors, the appeal is the company will “hit a well and double the share price – or more. To some extent, these independents are shooting themselves in the feet.”
One investor in Namibia-focused frontier explorer Reconnaissance Energy Africa linked dividends from companies with fewer growth prospects.
“When investing in a junior wildcat exploration campaign, I would much rather the company put their limited funds towards finding reserves, which is the best way for a company of this size to create value for shareholders,” said Zach Langille.
The world’s largest companies can go ahead with their megaprojects, while also returning cash to shareholders. Small exploration companies may not directly benefit from a higher price environment. But they can at least try and cash in on interest in the sector through growth at the drillbit.
Caught in the middle, though, independents are going to struggle. Companies such as Tullow and Capricorn face the challenge of how to meet investor expectations. As a result, M&A looks like an increasing pressure point.
The imperative of returning capital acts as a constraint on independents. As a result, longer term growth looks far more challenging.