Challenges in the Oil & Gas Industry

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Oil & Gas Challenges (1)

The Oil and Gas Industry in the US faces some very tough challenges. Slow economic growth along with the spread of Corona virus in many countries around the world, seems to be the most important factor impacting oil prices and production for US players.

GDP Growth Slows Down

  • According to the latest publications, the US GDP growth will slow in 2020. Deloitte predicts a 25% recession, while the Federal Open Market Committee stated a growth of 2% in 2020, 0.2% less than in 2019. This causes uncertainty for the US fuel market. As growth rates downshift, there is a lower demand for oil, considering that oil is a product used widely in modern life.
  • With other big markets facing economic instability, the demand for oil has been reduced and therefore oil prices have been declined as well. This creates a vicious circle, since the impact to the US companies is massive, with numerous US oil companies going bankrupt in 2019
  • US oil production has not been affected, as the country wants to maintain the same volumes of oil production. On the other hand, due to the economic circumstances and taking into account the declining oil prices, the big challenge is to manage to get the product to the markets, especially abroad as US is a big oil and gas exporter.

Corona Virus Affects Oil Prices And Demand

  • The spread of the virus that started in Asia affects negatively the oil and gas industry in two different ways. First and foremost, people travel less since they are scared of the contagious virus. This means flight cancellations and reduced number of flights, especially to Asia. With a lesser amount of fuel used for aircrafts, demand for oil has declined. Secondly, without knowing how this will end and for how long it will exist, stock markets have been plagued and this has also an impact on oil demand as well.
  • First effect of the corona virus has been the projected oil consumption decline by approximately 600-800,000 barrels per day over Quarter 1, as it was stated from the Barclays' press release.
  • Price of oil falls as the global demand declines. China is the second biggest market for oil consumption globally, after US. The outbreak of the virus had a significant impact on global demand.
  • This concerning health issue had also an impact on the shares of big players. Exxon Mobil experienced the lowest price in the last fifteen years with its share to close at $49.82 within February 2020.
  • Lower oil prices will push back the whole U.S. economy. As fuel prices decline, oil companies tend to reduce investment and cut down jobs. That was the case back in 2016, when there was big decline in gasoline prices that largely contributed to the country’s economic growth slowing from 2.9% in 2015 to 1.6%.
  • In addition, Brent prices were the lowest comparing to the past twelve months. West Texas Intermediate, the most significant oil-price grade, used as a benchmark in oil pricing, stated a fall to $48.73 a barrel in February 2020, recording the lowest price since January 2019.

Limited Access To Financial Help Affects US Oil Players

  • With oil prices declining, there is instability in the cash flow of the oil companies, while at the same time, they face pressures in terms of profitability. As a result, major banks have cut access to oil players in the US market. This has created a massive problem mainly to the smaller oil companies that operate primarily in the US and are struggling to get financial help. This could result to more oil companies crashing financially.
  • Industry experts expect companies operating in natural-gas to be the most threatened.
  • Lower oil prices affect the whole business structure of the companies being present in the sector. With US prices declining both in 2019 and in 2020, this has led to job cuts and reserved debts.
  • For instance, Halliburton stated few months ago in October 2019, that if oil prices remain at a low level, they will implement more cost cuts.
  • Additionally, other big shale producers such as EOG Resources and Pioneer Natural Resources Co, had predicted a share loss by the end of 2019, comparing to the per share earnings in 2018.

IMO 2020 Shakes The Oil And Gas Industry

  • From 1st of January 2020, the International Maritime Organization (IMO) has implemented a new law that forces a 0.50% global sulphur cap for marine fuels, instead of the previous limit of 3.50%S, radically changing the shipping market supply.
  • This will boost costs for consumers' products. In addition, under these conditions, the new demand for a more compliant fuel is expected to increase also ULSD prices and consequently the cost of diesel fuel.
  • There is uncertainty and confusion across the industry, as not all the oil companies were ready for this change, while major oil players such as BP and Shell stated that they have limited production of sulphur fuels that meets the IMO 2020 standards.

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Oil & Gas Challenges (2)

Three specific challenges in the oil and gas industry related to reduced emissions include the distrust of oil and gas companies by Americans who are against fossil fuels and competition from alternative zero-emission energy that affects the competitiveness of oil and gas emission companies. Detailed information is below.

Distrust of Oil and Gas Companies by the Public

  • According to the Atlantic Council, one specific challenge in the oil and gas industry related to reduced emissions is the popular distrust of oil and gas companies by the public. This is because oil and gas companies have a mixed public record on reducing emissions and protecting the environment. The industry has also been inconsistent in successfully framing a successful narrative on the value of reducing emissions.
  • The pressing issue of fighting climate change has grown in the public discourse and renewable alternatives to conventional fossil fuels energy sources made popular. There is a shift towards embracing clean energy transitions. This has resulted in strict environmental protection requirements from Americans who would like to see hydrocarbons completely removed from the energy system. This has minimized the oil and gas industry’s social license to operate.
  • Public opinion in America is against the use of fossil fuels. As stated by a 2019 Gallup poll, "60% of U.S. adults, including the vast majority of Democrats and a large share of Republicans, support policies aimed at reducing the use of fossil fuels. Senators Elizabeth Warren and Bernie Sanders have also promised to ban fracking."
  • According to Forbes, negative perceptions have led to legal challenges. Oil companies have been sued by States, cities and investor groups for "marketing products that, when burned, release greenhouse gases with potential adverse consequences to their citizens."
  • Since oil and gas companies depend on fossil fuels for the majority of their income, increased calls to reduce greenhouse gas emissions and the achievement of the Paris Agreement are likely to jeopardize their long-term profitability and social acceptability.
  • Recent protests in the United States targeting oil and gas companies such as Keystone XL pipeline due to emission concerns is also an example of the distrust by the public towards the oil and gas industry.

Competition From Renewable Energy

  • According to Mckinsey, another challenge in the oil and gas industry related to reduced emissions is that renewable technologies have become cheaper and are providing competition to the oil and gas industry. For example, in the United States, the cost of wind power has fallen by nearly two-thirds, while the cost of solar has fallen by over 70% since 2011. It is also forecast that by 2025, the generation of renewable power could compete with natural gas-based power generation in other regions.
  • This has increased investment in renewable energy. In 2018, wind power capacity in the United States totaled 7,588 MW and represented "$11 billion of investment in new wind power project installations." The introduction of battery electric vehicles which provide a viable and competitive alternative to internal combustion engines also pose a challenge to the oil and gas industry. This is because battery electric vehicles release no emissions into the environment as they are driven. They are putting pressure on oil and gas companies to do more to reduce emissions.
  • Companies like Tesla have been able to manufacture battery electric vehicles that have matched or even exceeded the performance and customer satisfaction of conventional engine vehicles. According to Finance Monthly, the growing sustainable energy market poses a serious challenge to oil companies "in remaining competitively priced and diversifying their services to keep going in the fluctuating market."

Investors and Activist Shareholders Challenge Companies on Emissions-Reduction Plans

  • A third specific challenge in the oil and gas industry related to reduced emissions is pressure from investors and activist shareholders who challenge oil and gas companies on their plans to reduce emissions. The companies are being required to prove that their operations are sustainable and can stand the test of time as energy transitions occur.
  • Investors and activist shareholders challenge oil and gas companies to cut emissions from their products and operations. They also pressure companies to increase investments in cleaner energies. Oil and gas company executives are pushed by investors to "disclose consistent, comparable, and reliable data" while activist shareholders in the U.S. challenge oil companies to reveal climate policies and emissions-reduction plans.
  • Oil and gas companies are being forced to shift their portfolios and start investing in cleaner and renewable energy. There has been a lack of investor confidence that has forced oil and gas companies to prioritize short-term returns. However, the companies must also continue to make profitable dividends and good returns for their shareholders.
  • Institutional shareholders are forcing oil and gas companies to acknowledge the big part they play in greenhouse gas emissions and global warming and set emissions targets. They are also being forced to align their operations with the Paris climate goals.
  • A company that has been affected by shareholder demands is Exxon. In 2019, Exxon successfully requested the Securities and Exchange Commission to allow it to block its shareholders, such as the New York State Common Retirement Fund, from "voting on a proposal calling on the company to set and disclose targets for reducing greenhouse gas emissions."
  • In 2019, Exxon was also investigated by the Massachusetts Attorney General’s office on charges that it deceived its shareholders in Massachusetts by "failing to warn them of potential climate change-related risks to their investments." Shareholder challenges are some reasons why Exxon "dropped out of the index’s top 10 largest companies by market value for the first time in 2019."
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Oil & Gas Challenges (3)

Climate change is the most significant issue facing the oil and gas industry today. Some of the specific challenges related to climate concerns are a drastic reduction in the demand for oil, advancements in alternative energy sources, global pressure for climate policy change, and financial setbacks.

Reduction in Oil Demand

  • According to industry experts, the number one challenge facing oil and gas companies today is a declining need for oil as the electric vehicle continues to rise and remaining gas-powered vehicles become more efficient.
  • In an annual report released in 2018, oil giant BP announced that demand for oil is expected to peak within the next two decades due to the growth of renewable energy sources.
  • Exxon Mobil confirmed BP's projections, stating that they expected demand for gasoline used to fuel passenger vehicles to peak by 2040.
  • However, analysis from sources outside the energy industry suggests that demand for oil could plateau even faster, as soon as 2025.
  • BP also predicted that the number of electric cars could reach 300 million by 2040, which would trigger a significant decrease in fuel consumption. This number is significant considering that almost half of U.S. oil consumption in 2016 was used to create motor gasoline.

Advances in Other Energy Sources

  • Another major challenge facing the oil and gas industry is increased competition from renewable energy sources, including wind and solar power.
  • As the economics of renewable energy become more attractive, there will be an increased focus on potential alternatives to fossil fuels.
  • As of 2018, wind and solar power made up about 7% of the electricity supply in the U.S., whereas BP expects renewable energy to grow to 40% of energy production by 2040.
  • Exxon Mobil projects a 400% growth in wind and solar energies over the next two decades.

Global Pressure for Policy Change

  • Despite the environmental deregulation under the Trump administration, government officials from countries across the world are pushing the energy sector to move away from fossil fuels.
  • As climate change becomes increasingly certain, governments are "increasingly enacting policies to mitigate greenhouse gas emissions" caused by the burning of fossil fuels.
  • In 2015, in order to meet the target set forth by the Paris Agreement, countries around the globe vowed to "aggressively tackle greenhouse-gas emissions", a goal which requires significantly less oil and gas purchase and consumption on a global scale.
  • In 2018, the Intergovernmental Panel on Climate Change (the U.N.'s climate-science body), concluded that in order to keep the planet's temperatures from reaching catastrophic levels, countries must cut their greenhouse-gas emissions in half by 2030 and reach net-zero emissions by 2050. This goal would require not just reducing emissions, but also abandoning plans to drill vast oil reserves that have already been discovered.

Pressure from Investors & Financial Crisis

  • In 2018, Moody's warned that the energy transition away from fossil fuels represents "significant business and credit risk" for oil and gas companies.
  • The Heads of Banks of England and France agreed that any oil company that does not adapt strategically to the new energy transition will not survive.
  • In recent years, powerful investors in Royal Dutch Shell succeeded in coercing company execs into promising to find ways to reduce emissions by as much as 3% by 2021.
  • Although U.S. oil companies enjoy a more conservative political environment, Hague-based Shell has also dealt with protesters swarming their Dutch headquarters and has been sued by advocates representing 17,000 Dutch citizens.
  • In a 2018 report, Exxon Mobil stated that some of the company's assets may no longer be attractive investments in coming years due to the shifting energy market.
  • Markets are already weary of the oil and gas industry, with energy being the lowest performing sector on the S&P 500 index in 2019.
  • According to the Institute for Energy Economics and Financial Analysis (IEEFA), the energy industry has dropped from 28% of the index's value in 1980 to less than 5% in 2019.

How Oil & Gas Companies are Responding

  • In response to these challenges, some oil and gas companies are finally addressing this global energy transition and shifting towards become "energy companies"
  • Some oil companies will likely respond to these challenges by shifting their refineries from those that make gas to those that create other petroleum products, such as jet fuel, petrochemicals and other refined petroleum products.
  • Additionally, natural gas and other renewables are expected to continue to replace coal in the power sector.
  • Shell is one of the companies attempting to adapt to the changing energy reality (by diversifying into electrical power and expanding its plastics business), whereas Exxon Mobil is seen as trying to make the most of the remaining lucrative years of the oil economy.

Research Strategy

Per the client request, we focused our research on the oil and gas industry within the U.S.; however, because oil consumption and climate change is a global crisis, we also thought it beneficial to include some findings about global policy change. We also included some information on Dutch oil giant Shell for the sake of comparison. Finally, as we thought it may be valuable to the client, we also added a brief section on how some oil companies are responding to these various challenges.

From Part 01
  • "Deloitte forecasts that US GDP growth will slow in 2020, with a 25 percent chance of recession and only 10 percent chance that growth in 2020 will match recent years."
  • "The response in oil prices has been significant. Brent prices hit a twelve-month low last week, with the near-term outlook looking grim and the forecast looking increasingly dark for the balance of the year. During that period the forward curve, a marker of expected per-barrel value over the rest of the year, has flattened in the past week, signaling that oil traders see no value in holding or selling off their stocks. At week’s end, Brent was trading at slightly over $50 per barrel with West Texas Intermediate (WTI) prices hanging on at $45.26. "
  • "Oil prices bounced back slightly on February 2, with both Brent and WTI rising by around two dollars on the back of a broader rebound throughout the stock market. However, this bump should be contextualized by volatility due to the uncertain economic forecast, expectations for interest rate cuts in the United States and Canada, and anticipation surrounding a possible production cut by OPEC+ as it meets over the next few days."
  • "The Houston-based analyst team has reduced its U.S. crude supply forecast and expects output to hit 13.1 million b/d by the end of 2020, versus a previous estimate of 13.5 million b/d. The downward revision follows TPH’s adjusted upstream price deck for 2020 to $50/bbl West Texas Intermediate from $53"
  • "As of mid-August, about 26 North American explorers had filed for bankruptcy, according to the law firm, and more have filed since then. Overall, “we do believe U.S. production growth is slowing down to some extent,” the TPH team said. However, “it doesn’t change a broader, bearish crude price thesis,” because absent more production cuts by the Organization of the Petroleum Exporting Countries, other oil producing countries including Brazil, Guyana and Norway “will produce ample volumes to meet global demand next year.”"
  • "U.S. West Texas Intermediate (WTI) crude futures have fallen almost 20% since reaching their 2019 peaks in late April, as oil prices were dragged down by intensifying fears of an economic downturn that’s started to impact oil consumption."
  • "On Wednesday, (June 2019) Brent crude futures were at $61.34 per barrel, and U.S. crude futures were at $52.40 per barrel — off this year’s highs of around $74 and $66 per barrel in April."
  • "Our biggest challenge in the United States is not maintaining production, it’s actually getting the product to market. We are developing infrastructure ... at a rapid pace, but we need to do more. We need more pipeline capacity in order to have the oil and the gas reach these export markets,” he said. In fact, Brouillette said, there will be increased production, not falling output, in the U.S."
  • ""
  • "Oil futures gave up earlier gains to finish with a loss on Tuesday, with U.S. prices below $50 a barrel for the first time in more than a year, as demand worries continue to plague the market. Prices fell even as the Organization of the Petroleum Exporting Countries and its allies considered deeper production cuts to stem a coronavirus-inspired tumble in the commodity that entered a bear market a day ago"
  • "West Texas Intermediate crude for March delivery US:CLH20 lost 50 cents, or 1%, to settle at $49.61 a barrel on the New York Mercantile Exchange, a day after it entered a bear market, down 20.8% from its recent high of $63.27 on Jan. 6, according to Dow Jones Market Data. A decline of at least 20% from a recent peak is the traditional definition of a bear market. Tuesday’s settlement was the lowest since Jan. 7, 2019."
  • "April Brent crude UK:BRNJ20 fell 49 cents, or 0.9%, to $53.96 a barrel on ICE Futures Europe—its lowest settlement since Dec. 31, 2018. The international benchmark entered into a bear market on Monday, down 21% from its recent high of $69.02 from Sept. 16."
  • "As such, it is not surprising that sharp declines in oil prices have been coincident with downturns in economic activity, a drop in inflation, and a subsequent decline in interest rates“ We can also view the impact of oil prices on inflation by looking at breakeven inflation rates as well. As I noted in “Oil Sends A Crude Warning:” “The short version is that oil prices are a reflection of supply and demand. Global demand has already been falling for the last several months and oil prices are now waking up that reality. More importantly, falling oil prices are going to put the Fed in a very tough position in the next couple of months as the expected surge in inflationary pressures, in order to justify higher rates, once again fails to appear. The chart below shows breakeven 5-year and 10-year inflation rates versus oil prices.”"
  • "Major banks including JPMorgan Chase (JPM.N), Wells Fargo (WFC.N), and Royal Bank of Canada (RY.TO) have, as part of regular biannual reviews, cut their estimated values for oil-and-gas companies’ reserves, which serve as the basis for those companies to receive reserve-based loans (RBLs), according to more than a dozen sources familiar with the activity."
  • "Those lenders have marked down the perceived value for both oil and natural gas for the coming five years, with the changes kicking in as early as this month. Expected natural gas prices have been cut by around $0.50 per million British thermal units, about 20% below levels set in the spring. Industry sources are forecasting some firms face a 15% to 30% reduction in loan size as a result. Oil prices are expected to be about $1 to $2 lower than spring estimates."
  • "“Some banks believe they have too much energy exposure and want to reduce some of this risk,” said Ian Rainbolt, vice president of finance at Warwick Energy, a private equity firm with upstream investments in Oklahoma and Texas."
  • "Reduced funding could slow growth in U.S. oil and gas production, and also threaten more bankruptcies in the sector. Bankruptcy filings among U.S. oil and gas producers are at levels not seen since 2016, when U.S. crude slumped to $26 per barrel, according to law firm Haynes and Boone."
  • "“I expect the biggest issues to be with over-leveraged natural gas producers, especially those without firm transportation in geographically-disadvantaged areas,” said Brock Hudson, managing director at investment bank Carl Marks Advisors, who referenced companies in Appalachia, the Rockies and parts of Oklahoma. Smaller RBLs can have huge consequences: Alta Mesa Resources, an Oklahoma-focused producer headed by former Anadarko Petroleum chairman Jim Hackett, filed for bankruptcy a month after its borrowing base was slashed by almost half in mid-August."
  • "Eight sources indicated larger banks have set their price decks, the industry term for the value they will ascribe to hydrocarbons behind the RBLs, with oil between $46 and $51 per barrel for the next five years. There are fewer financing options available to help bridge the gap from lower RBLs. Just one U.S. producer, Contango Oil & Gas (MCF.A), has issued any new equity in 2019, while there has only been one high-yield bond offering by a shale producer since March, according to Refinitiv data."
  • "U.S. oil prices are down 17% and natural gas is down about 31% from a year ago, undercutting production increases. Costs of job cuts and retiring debt also will pressure profit at some companies, analysts said ahead of reports."
  • "“I think we are moving from a growth to a value phase,” said Brad Holly, chief executive at Whiting Petroleum Corp (WLL.N) at a Denver oil conference earlier this month."
  • "With prices in the mid-50s, top shale-service provider Halliburton last week warned U.S. customer activity would continue to decline this year, and outlined plans for a new round of cost cuts"
  • "Among major shale producers, EOG Resources (EOG.N) is forecast to report per share earnings of $1.13, down from $1.75 a year earlier. Pioneer Natural Resources Co (PXD.N) could post earnings of $1.98 per share, down 9 cents, according to Refinitiv IBES."
  • "U.S. GDP growth will slow to 2.0% in 2020 from 2.2% in 2019. It will be 1.9% in 2021 and 1.8% in 2022. That's according to the most recent forecast released at the Federal Open Market Committee meeting on December 11, 2019.1 The projected slowdown in 2019 and beyond is a side effect of the trade war."
  • "According to Energy and Restructuring law firm Hayes and Boone’s, a grand total of 50 energy companies filed for bankruptcy during the first nine months of the year, including 33 oil and gas producers, 15 oilfield services companies and two midstream companies."
  • "As Ken Monaghan, Amundi Pioneer co-director of high yield, has told CNBC: “We’re at the early stages [of the shakeout]. The problem is some of these companies still have a bit of rope to go. they don’t have [debt] maturities that are coming up in 2020 and 2021. They’re going to try to outrun the clock and hope that oil prices move higher.”"
  • "It’s as if the entire Wall Street community has been shell-shocked by the S&P 500 plunging 10% in four sessions last week and the Dow Jones Industrial Average crashing more than 1,000 points in two trading days. Or Apple and Microsoft — two of the hottest trades in the market this past year — being slammed simply because of a tick-up in coronavirus infection totals out of Italy."
  • "The main U.S. oil-price gauge, West Texas Intermediate, fell 2.3% to $48.73 a barrel, its lowest closing price since January 2019"
  • "Marine fuel is a distillate, with the reduction in sulfur placing it in the category of ultralow sulfur diesel fuel, or ULSD,” says Brian Milne, editor, product manager at agriculture and energy analysis provider DTN. With the new rule, demand for compliant marine fuel is expected to boost ULSD prices, lifting the cost of diesel fuel and other distillates, he says (SGR’s San Miguel)."
  • "The US remains the biggest question mark. Export volumes are overly light and sweet, which is optimal for gasoline production, less so for distillate output. Even so, any sweet barrel is preferred to one with more sulphur. With an average API of just 39 and sulphur content at 0.44pc, US exports are likely to be in a middle ground alongside light-sweet Waf barrels and medium/heavy-sour Middle Eastern and Latin American grades. "
  • "Oil majors including BP (BP.L) and Royal Dutch Shell (RDSa.AS) have announced they are producing very low sulphur fuels that meet the 0.5% requirements."
  • "By the numbers: Barclays' note sees global crude oil demand loss related to the virus at around 600,000 to 800,000 barrels per day in Q1 and around 200,000 for the full year, which they note is less than 0.2% of global demand."
  • "On 1 January 2020, the International Maritime Organisation (IMO) will implement a new regulation for a 0.50% global sulphur cap for marine fuels. Under the new global cap, ships will have to use marine fuels with a sulphur content of no more than 0.50%S against the current limit of 3.50%S in an effort to reduce the amount of sulphur oxide. The Emission Control Areas (ECAs) will remain at the 2015 standard of 0.1%S content."
  • "Lower prices at the pump, however, aren’t necessarily good for the U.S. economy overall. When energy prices fall, energy companies tend to cut back on investment and jobs. A freefall in gasoline prices led to a sharp drop in U.S. business investment in 2016, for instance -- one reason the country’s economic growth slowed to 1.6% that year from 2.9% in 2015."
  • "With the viral outbreak spreading to more countries, the price of oil has dropped precipitously as global demand weakens even further."
  • "Meanwhile, shares of Exxon Mobil tumbled to $49.82 on Thursday, reaching a 15-year low"
  • "China is the world’s second-largest consumer of oil after the United States. It is also the world’s largest importer of oil, accounting for a bit more than 20 percent of all global oil exports. No wonder oil prices react to every piece of news coming out of China."