The expression ‘cautious optimism’ continues to dominate the oil and gas sector, and over the course of the past 12 months the pendulum has swung back and forth between these two words.
To encourage the optimists we have seen the brent prices break through $60 a barrel for the first time since 2015. There have been a number of deals in UK Continental Shelf (UKCS) assets, such as Chrysaor’s acquisition of Shell’s package of assets, Ineos’s acquisition of BP’s Forties Pipeline System, Oranje-Nassau’s acquisition of Sterling Resources, and Enquest’s acquisition of Magnus and other infrastructure. There have also been deals where the UKCS assets have been a material part, such as Ineos’s acquisition of Dong E&P, and Total’s yet to be completed acquisition of Maersk Oil and Gas; plus, generally, the upstream sector has returned to positive cash flows.
Equally, there have been reasons to temper any exuberance from the optimists. Confidence in the global economy remains moderate; capital rationing and cost control remain foremost in the minds of oil & gas CEO’s; and fundamental uncertainty on future commodity price remains. Concerns as to the speed of transition away from fossil fuels has also increased, creating more demand uncertainty.
Against that backdrop, the supermajors are rethinking their strategy with regard to investment in renewables and the speed of change to a low carbon economy. The independents continue to focus on cost reduction, production efficiency and how both of these can be improved through the adoption of new technology. However, companies focused on exploration continue to face very challenging capital markets despite increasing concerns that the lack of investment in finding and developing new resources could result in a commodity price spike in the early 2020’s.
Where does that leave the oilfield service companies? In summary, not much further forward than this time last year. The oil and gas supply chain remains firmly focused on cost discipline, including managing headcount; creating more integrated offerings as evidenced by the mergers of Technip and FMC, Baker Hughes and GE Oil and Gas, and Wood Group and Amec; and innovating both in technology and commercial arrangements. The ongoing pressure on Oilfield Services (OFS) companies maintains the threat of significant cost escalation arising on any material upturn in demand as the supply chain is pared back to a minimum, with little capacity to meet increased demand.
In the UK, the sector has benefited from the focus on maximising economic recovery with HM Treasury responding to concerns that the fiscal regime was creating an obstacle to late life asset transfer by announcing further changes to the relevant tax legislation. These changes, effective from November 1 2018, alongside the rate reductions and introduction of investment allowance in 2015 and 2016, should produce one of the most competitive oil and gas fiscal regimes in the world.
Therefore, the ball remains in industry’s court to transform the UKCS into a basin that competes as far as possible with other basins on costs of extraction, and innovates and collaborates to create value for all stakeholders.
Some excellent first steps have been taken in reducing costs, increasing production efficiency, creating the oil and gas technology centre and placing more of a focus on commercial innovation.
2017 is the year that the oil & gas and the OFS sectors came back from the brink.
The OFS market is likely to remain challenging for the foreseeable future but those who can build and defend competitive advantages are the most likely to deliver the returns their stakeholders expect.
Cautious optimism remains.
Derek Leith is EY’s UK head of Oil & Gas Tax