How to Survive in a Low Oil Price Era
Blog: Software AG Blog - Reality Check
As crude oil prices break below $30 per barrel after a 1 ½ year slide, it becomes increasingly clear that not every producing company will make it through this year alive. After months of living in denial and burning through output-generated cash to service debt, the handwriting is on the wall: producers will have to stop churning out oil or perish. Some will do both.
Markets go up and markets go down, that is the only certainty in markets. It is typically when they go down that the flaws in business and operational processes are revealed. Low oil prices have exposed this raw nerve in oil producers who, not long ago, believed that modern operational efficiencies would be enough to weather low prices. It is beginning to look like they underestimated the situation.
“The oil market is an unpredictable beast. Could anyone have foreseen two years ago in 2013… that we were going to see a battle for market share that would slash the price of crude by 60 percent?” said Margaret McQuaile, OPEC expert and senior correspondent for Platts, in an article for Insight Magazine.
So what happened? The rout started when U.S. production jumped by 1.2 million barrels per day in 2014, the largest growth seen there since 1940. The U.S., bent on oil “independence,” had jumped into fracking and tight oil production with a vengeance. Construction of new oil pipelines, tankers, rail cars and barges followed as producers started to cash in on their finds.
Then, about 18 months ago, prices began to fall from their $100+ level and have barely taken a breather since. Before we knew it, OPEC was digging its heels in and refusing to cut production. Russia, under international sanctions over its annexation of Crimea and with a sinking ruble, could only raise cash by selling more oil. Iraq started producing again after repairing war-torn infrastructure, and Iran is preparing post-sanctions initial exports of half a million barrels per day. There is already a worldwide glut of 3 billion barrels of oil, said the IEA.
Concurrently, lower demand—including from China, as its economy slows—widened the gap. Yet, even as the price of West Texas Intermediate hovered around $30 per barrel, there was little sign of producers pulling back. As McQuaile asked, who would have predicted this?
Some traders did see the signs before the market crashed, but most analysts, producers and major oil companies missed them. Or, if they saw them, they hoped something would give and prices would begin to rise again. But, as one of my trader friends often says: “Hope is not a good strategy.”
Energy specialist Art Berman has said repeatedly that none of the shale oil producers in the U.S. can be making money. According to Berman, this is the longest oil prices have dropped without intervention from one or more large producers.
There is no overarching cartel, government, or regulator with the authority or the political will to say “Stop! This is hurting us.”
What about OPEC? The cartel – and Saudi Arabia – stopped acting as the “swing producers” of oil back in the mid-1980’s. And, despite the fact that over 40 smaller producers filed for bankruptcy protection in U.S. courts last year, U.S. companies keep producing. The oil still flows and the price continues to drop.
It is time for oil producers to learn how to weather a low-oil-price storm, whether there will be an oil price shock to the upside this year or not (it is looking more like ‘not’).
Oil companies are already taking drastic measures—Shell abandoned exploration in Alaska and in Canada’s oil sands, Chevron cut its workforce by 10 percent, Exxon cut Q3 2015 spending by 22 percent—and there will be a continuous pressure to reduce costs further. Governments, once flush with the tax proceeds from $100 plus oil, have cut budgets. The state of Alaska is considering reinstating income tax for the first time in 35 years.
Saudi Arabia is dipping into its sovereign wealth funds to continue social benefits payments and reducing subsidies on energy. (The kingdom is particularly vulnerable to low oil prices because, after the Arab Spring uprisings in 2011, it boosted spending on social projects, subsidies and entitlements to placate the population.)
As some of the weaker participants disappear or are absorbed by other companies the shape of the industry will change, leaving only the strongest players. Historically, a shakedown in oil prices has often led to some big mergers, such as in the late 1800’s when John D. Rockefeller created the behemoth Standard Oil. Perhaps a new mega-major oil company will arise in 2016.
In the meantime, and in the future, the only way oil companies can survive low price storms is by better use of technology. There are efficiencies out there that have yet to be fully explored.
I spoke with Bart Schouw, director of Internet of Things (IoT), from Software AG, who had a number of relevant observations. His basic premise was that only companies that innovate to prepare for a continued low price environment will survive.
These innovations include:
Automation: low oil prices will force disintermediation in the oil field and this will pave the way for robots or automated operating systems to increasingly replace people. This disintermediation trend will benefit E&P firms, thanks to lower costs and higher safety levels in hazardous environments.
IoT will give oil companies the ability to make exploration and refining environments smarter, thus minimizing costly errors. With added analysis and data enrichment, firms can mimic using new, cost-efficient methods without risk before implementing them in the field.
Moving IT infrastructure into the cloud is another cost-saving innovation; although much highly sensitive IT will need to stay on premise, so there will be continuous need for integration between the two infrastructures.
Finally, siloed business processes and disparate IT systems should be rationalized across corporate boundaries to reduce latency in information flows and, effectively, supply chains.
The above are just some of the solutions that are available to the oil industry which can help them to survive an extended period of low prices. I’m keen to hear other ideas from readers.
The post How to Survive in a Low Oil Price Era appeared first on Reality Check.
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