HOUSTON, TX--(Marketwired - January 26, 2017) -
- A $43 billion cash-flow gap still remains in the E&P sector, the equivalent of $80-per-barrel sustained crude prices or an additional 40% cut in CAPEX
- A 'snap-back' in equipment and services costs is likely, outpacing benefits from rising oil prices; e.g., a 10% increase in costs in the Permian negate a 10% increase in crude prices
- The onshore OSFE sector has endured a 68% drop in operating profitability since 2014, with 2017 shaping up to be at best a transition year
- The downstream sector, for the first time in this cycle, is likely to experience significant stress; 70% of independent US refiners now face moderate to severe financial risk
- Not-yet-restructured companies face a special challenge; e.g., E&P companies that haven't already fixed their balance sheets have more than twice as much leverage ($26,000 BOEPD) as their competitors
- Look for 'peak-oil' concerns to continue to evolve into 'peak oil-demand' concerns, as China's economy continues to cool among other macro factors
- AlixPartners' industry-wide recommendation: Set 'base-case' planning levels based as if crude prices were $45 per barrel -- to keep any surprises on the upside, not the downside
Though the overall outlook for the oil and gas industry doesn't seem to be quite as dire as it was a year ago, 2017 is likely to be a year of "3 R's" for industry players -- a year of more restructurings, more realignment via mergers and acquisitions, and, for some players that take the right actions, finally a year of rebuilding. That's according to a new study released today by AlixPartners, the global business-advisory firm.
The study begins by noting that in its recent severe downturn the industry suffered staggering wounds -- including 134 corporate bankruptcies, more than 350,000 job losses, annual reductions in capital spending (CAPEX) of more than $100 billion since 2014 and cuts in operating costs (OPEX) of more than $15 billion a year.
Given those body blows, and despite recent announcements by OPEC that many see as helping drive crude-oil prices back above $50 per barrel of late, the study asserts that the core of the industry still faces a $43 billion cash-flow gap, the equivalent of oil prices rising, and staying at, $80 per barrel -- or of an additional 40% cut in CAPEX vs. year-end 2016 levels.
Even as parts of the exploration and production (E&P) sector start to recover, the study also warns of a sharp "snap-back" in equipment and services costs for upstream companies, as well as a special competitive challenge for players in that sector that have not yet restructured themselves. It also forecasts continued restructuring and realignment for the already-beleaguered oilfield services and equipment (OFSE) sector, and greater stress, for the first time in this cycle, for the downstream sector (refiners), due mostly to high debt loads taken on in recent years and shrinking crack spreads (the differential between the price of crude and the petroleum products extracted, or "cracked," from it).
E&P: A $30-per-barrel Liquidity Gap Remains
In the E&P sector, the study finds that even with the draconian cuts much of the industry has already made and even at today's somewhat-higher oil prices, a cash-flow deficit equaling about $30-per-barrel -- the difference between today's prices and $80 per barrel -- remains for upstream companies, based on current CAPEX spending and expected interest payments on debt. At the same time, says the study, upstream players, which in North America are sitting on an inventory of a whopping 4,902 drilled-but-uncompleted wells, are likely to encounter a higher-cost environment as they complete wells and in other ways move to restore production. As one example, the study calculates that a 10% increase in equipment and services costs in the Permian Basin, the area with the most uncompleted wells in the lower 48 states of the US, would wipe out the profitability benefits of a 10% increase in crude prices -- illustrating the importance of upstream players working closely with suppliers and continuing to focus on efficiency improvements.
OFSE: A 68% Drop in Onshore Profitability Since 2014
The also-long-beleaguered OSFE sector, says the study, has endured a 56% drop in operating profitability since 2014 through year-end 2016 plus the largest share of any sector in job losses globally since 2014 (70% of industry job losses, or almost 250,000 jobs). Particularly hard-hit, it notes, has been onshore operations, where profitability is down 68% since 2014, as nimble shale-oil clients moved quickly to shut down drilling programs during the downturn. Looking forward, the study states that perhaps the best strategy for many OFSE players is to use the year ahead to position themselves for a greater recovery in demand in 2018, with the hope that North American shale producers will gradually return drilling rigs to service and whittle down their backlog of drilled-but-uncompleted wells.
Downstream: High Debt Loads Put More than Half of the Sector at Risk
The downstream sector, which to date in this cycle has been relatively unscathed -- as lower oil and gas prices translated into lower input costs for its players -- is likely in for a for its own set of challenges this year, says the study. It notes that although North American and European refiners enjoyed a combined $10 billion increase in profit margins in 2015 vs. 2014, the sector has borrowed heavily in recent years, largely for mergers and acquisitions as the sector consolidated, and many players are now saddled with large interest payments and deceasing earnings. In fact, the study finds that the combined debt load at publicly-traded refiners globally a year ago stood at $96 billion, including $67 billion held by North American companies. Added to that is the fact that as product supply has grown greatly since 2015, crack spreads throughout the world have been shrinking, most dramatically in Asia but also down 8% in the US through July 2016, says the study. As a result, using an Altman-Z Score analysis of financial stress, the study finds that 70% of the independent refining companies in the US are in at least some risk of distress, up to and including bankruptcy, in the next two years if their debt loads aren't addressed.
A Special Concern for Unrestructured Companies
In addition, according to the study, companies in all sectors that have not yet restructured their balance sheets, either internally or through bankruptcy, will likely be facing an added competitive challenge going forward against companies that have. For instance, it finds that E&P companies in the US that have not already addressed balance-sheet issues have more than twice as much leverage as their competitors -- an average of $26,000 per barrels-of-oil-equivalent-per-day (BOEPD) of debt vs. just $12,000 BOEPD of debt. The study also notes that while some companies may hope to simply "grow" their way out of their debt problems, such a strategy is likely unrealistic, especially given oversupply issues that already plague the industry globally -- plus the fact that even the best mergers and acquisitions usually add to overall debt loads.
"Peak Oil" to "Peak Oil-Demand"?
The study also takes a look at structural changes in supply and demand throughout the industry, including suggesting that such factors as China's cooling economy and other factors could lead to the "peak-oil" concerns of the past in the industry evolving into "peak oil-demand" concerns in the not-too-distant future -- at the same time that the shale-oil revolution continues to open up all new levels of supply. At the same time, notes the study, the recent downturn has galvanized many NOCs, especially in the Persian Gulf, to sharpen their focus on profitability, driven by a new generation of leaders there and characterized by virtually unprecedented actions such as slashes in employee headcount and other administrative costs. At the same time, says the study, rising nationalism around the world, from Brexit in the UK to the election of Donald Trump in the US, could lead to trade-policy and other changes furthering affecting the industry.
Plan as if Oil Were at $45, So No Downside Surprises
The AlixPartners study concludes with specific "playbooks" for each of the industry's three major sectors and recommends that companies industrywide set their "base-case" planning levels for the year ahead as if crude prices were around $45 per barrel, rather than actual levels -- "to keep any surprises on the upside, not the downside."
Bill Ebanks, managing director in AlixPartners' oil, gas and chemicals practice, said, "Though there's certainly more optimism in the industry today than there was a year ago, the year ahead is still likely to be one characterized by three words starting with 'R': more restructurings, including more in the upstream and oilfield-services sectors as well as in the downstream sector for the first time in this cycle; more realignment, including more mergers and acquisitions throughout the industry; and, for those companies that take requisite actions, at long last 2017 could be a year of rebuilding. However, which of the three categories individual companies fall into depends on how aggressive they are on everything from repairing balance sheets to offsetting what are likely to be higher services and other costs in the year ahead."
Bob Sullivan, managing director in AlixPartners' oil, gas and chemicals practice, said, "Companies throughout the industry would be smart to 'base-case' their planning this year as if crude prices were going to be around just $45 per barrel, to keep any surprises on the upside, not the downside. For one thing, there's likely to be a significant 'snap-back' in equipment and services costs this year. Meanwhile, the downstream sector, initially the beneficiary of low crude prices, also is likely to face significant pressure of its own this year. All in all, this is a year for the entire industry to double-down on its focus and determination across the board, so as not to moot all the hard-won gains made thus far."
John Castellano, managing director in AlixPartners' oil, gas and chemicals practice, said, "The fact is, despite the whopping 134 bankruptcies and all the other restructurings that have taken place, many companies in this industry have yet to address their balance-sheet issues. For those that haven't, 2017 could well wind up being a very tough year -- unless they take action quickly. The clock is very much ticking for those companies."
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