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Challenges ahead for the oil and gas sector

Barry Fraser Barry Fraser

A collapse in demand due to the current circumstances has fuelled an oil price crash. Barry Fraser and Stuart Preston consider a market outlook that presents a challenge for the oil and gas sector.

The continued spread of coronavirus has shocked global markets and, with supply outstripping demand, Brent prices have dropped to between $30 and $40/bbl at the time of writing. The world is now facing a recession and the negative impact is already being felt by the oil and gas sector.

Demand for oil has slumped as countries have implemented travel bans, social restrictions and factories remain closed around the world. This, combined with limited storage capacity, has resulted in a steep downward curve in WTI prices, which became negative for the first time in history in April 2020, and concerns over potential production shut-ins. While an OPEC+ agreement will be in place from May to reduce production by almost 10 million barrels per day, oil and gas markets do not think that this will be sufficient to counteract the significantly reduced global demand, resulting in depressed oil prices.

Significant liquidity pressures for the oil and gas industry

In response, oil and gas exploration and production companies have reacted quickly, slashing investment, delaying or cancelling projects and cutting costs and jobs across the board. This, in turn, has severely impacted the oilfield services sector, which has still not recovered from the previous downturn and, with already-thin margins and weak balance sheets, companies are now facing significant liquidity pressures.

The outlook for the remainder of this year and next is challenging and, if there is a prolonged period of low-commodity prices and reduced activity, then there is a serious risk of failure for many companies and the potential loss of many thousands of jobs. There are concerns around the failure of certain individual UK oil and gas players causing a domino effect that could jeopardise the viability of critical oil and gas infrastructure and key elements of the supply chain where there are already only a very small number of credible players. Cost cutting, headcount reductions and realising efficiencies will be crucial in preserving cash flows and protecting balance sheets.

What are the key risks and implications for the oil and gas sector?

A number of oil and gas exploration and production companies have hedges in place, partly protecting income in the short term. However, once these hedges expire and with depressed reserve asset values, many assets and businesses will not be viable at the current oil price, affecting their ability to renew reserve-based lending facilities and satisfy decommissioning security agreements. This could have a ripple effect on fellow field participants and suppliers, as well as impacting the on-going viability of strategically important infrastructure. The exploration and production companies have slashed investment, cut costs and stretched payment terms to mitigate the oil price fall and protect cash flows as much as possible and this is putting extreme pressure on the supply chain.

Although some businesses in the supply chain are partly protected due to previously contracted revenues and the delivery of existing projects, a number of customers are reviewing contracts to see how they can be terminated, and some on-going projects have been stopped. Oilfield services companies are reacting to reduced activity, pricing pressure and working capital strain by pushing these onto their own supply chains, zero-based budgeting to eliminate all truly non-essential spend and reducing staff costs. 

Government support and cashflow management

Oil and gas companies are also seeking help with available finance and liquidity from their banks and equity providers while taking advantage of government support schemes, although these have been slow, at best.

Oil and gas companies who have previously reduced leverage and conserved cash are more protected, as are those in areas of the supply chain that have typically been more robust through a downturn, such as supporting ongoing production and essential maintenance. However, even these areas, at least in the short term, are experiencing operational difficulties due to COVID-19, which is seriously affecting the ability to work effectively both on-shore and off-shore. 

Furthermore, if oil price continued at levels below $30/bbl, a number of UK-based producing assets will not be viable. The essential fire-fighting actions being taken by companies have resulted in the focus on energy transition taking a back seat for many players with potential serious repercussions for the future.

Key focus areas for oil and gas businesses

Financial stability for oil and gas companies will be critical in sustaining business operations and, in order to preserve cash and ensure future success, business leaders should consider the following:

Effective cash management

Put in place effective cashflow measures and integrating short- and medium-term forecasting to enable closer analysis of cash and runway time to implement other actions. Forecasts should be stress-tested for different impact scenarios to provide a clear understanding of liquidity and this will also build confidence with shareholders and lenders.

Business planning

Prepare a well thought through and credible business plan to stand their business in the best stead with its stakeholders. Pro-active and early engagement with shareholders and lenders is a priority. The quicker oil and gas companies can clearly inform stakeholders on the impact of current trading and potential liquidity issues, the more chance there is of getting the flexibility and support required.

Stripping back operations

Review business operations and identifying non-core areas. If there is a loss-making part of the business, steps should be taken to consider the impact of this on the wider business. Taking steps to rationalise, sell or wind down certain operations could go a long way to ensuring that the wider business is sustainable in the long term.

Opportunities

There is likely to be a fundamental change in the oil and gas market and its participants and companies need to assess how their markets will change. Those businesses with more-robust balance sheets, efficient operations and relevant service offerings who can retain their technical capability through this period will emerge stronger and accelerate out of this downturn to gain market share and re-build lost value. 

The current situation will also present opportunities for better-capitalised oil and gas companies to expand their capability, geographical reach and scale through acquisitions. There will be potential to buy sensibly at low valuations and do creative deals, such as acquiring trade and assets rather than full companies, ensuring that unwanted baggage is left behind. There is also likely to be an increase in merger-related activity where deals can be done to consolidate and strengthen through scale, without the need to raise external finance, which will be in short supply.

Effective and decisive leadership will be crucial to guide oil and gas businesses through the challenges, sustain operations and seize the opportunities. Support from government, finance providers and industry bodies will also be vital to ensure that companies can sustain their operations and secure the future of the industry for years to come.

To discuss the situation for the oil and gas industry, contact Barry Fraser or Stuart Preston.

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