Courtesy of Oil and Gas IQ
Major Issues Upstream Will Face in 2020
Published Mar 17 2020
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Mike Wiseman
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In this article we collected the biggest challenges Upstream will face in 2020. 

 

Chinese demand at the wake of economic growth reduction

With 15% of the global GDP, China is the second largest crude oil consumer in the world. Its demand is currently standing at 13-14 thousand barrels a day, which is approximately 15% of the global oil production. 

According to IHS Markit, Chinese gross crude demand, including refinery throughputs and operational and strategic inventory fill, expanded by a stunning 1.3 million barrels a day on average over fourth quarter 2018 to third quarter 2019 - double China’s crude demand growth rate of 2017-18. Excluding China, over this period, global crude demand actually contracted by 580 thousand barrels a day on average. Considering that global supply/demand balances barely tightened in 2019 despite major losses of supply, China’s countercyclical buying surge may have saved oil prices from a demand-induced reduction.

"Due to geopolitical uncertainties in the Middle East, China might want to continue building up oil reserves" 

Since 2017, Chinese economic growth has slowed down and will continue this trend in the foreseeable future. The slowing economic growth will slow the growing demand for oil. Due to geopolitical uncertainties in the Middle East, China might want to continue building up oil reserves. If not, the oil price will be affected by China’s reducing demand.

 

Oil price war Saudi Arabia - Russia
Starting from 2017, the alliance of OPEC and non-OPEC countries, mainly Russia, agreed to cooperate on production restraint to support oil prices. Saudi Arabia cuts its output disproportionately: Saudi Arabia has pledged to produce 400 thousand barrels a day below its target, subject to a review in March where the intention was to review whether perennial “quota busters” Iraq and Nigeria have curbed their output. 

According to Foreign Policy, on the eve of the Friday meeting, however, Saudi Arabia surprised its partners by publicly pushing for steeper and longer production cuts than had been expected. Moscow felt Saudi Arabia was trying to jawbone it into agreeing to larger production cuts - by putting Russia in the position of either acquiescing or watching oil prices collapse. Russia called Saudi Arabia’s bluff. After hours of fruitless negotiations, ministers left Vienna without a deal, oil prices dropped.

How long this “war” will last is not clear. Some predict it will last several months or longer.

"After hours of fruitless negotiations, ministers left Vienna without a deal, oil prices dropped" 

 

Economic recession that would lead to the same demand reduction

Global economic growth weakened considerably in 2019 - to 2.6% from 3.2% in 2018. Oil demand has barely increased in 2019. With the outbreak of coronavirus, oil demand is reducing while supply increases compared to the previous years. Even though IMF’s January 2020 predictions of GDP growth for 2020 and 2021 were positively standing at 3.3% and 3.4%, some analysts seriously consider recession to take place in the summer of 2020, pushing demand further down. 

The Vienna Alliance’s aggressive supply and overall energy market management prevented a further deterioration in global balances in 2019, but the challenge is expected to grow in 2020-21 as supply growth recovers.

Courtesy of IMG Blogs 

 

Smart CAPEX and spending discipline

Around the world, and specifically in North America, capital discipline has been improving in recent years and its impact can already be felt by service providers. Production growth slows down as companies reduce rig count. Most E&Ps are committing to focusing on shareholder returns, and capital discipline. IHS Markit has been assuming an average WTI price of $53 and a 12% capex cut across the sector in 2020, which results in “entry-to-exit” production growth of 420,000 b/d in 2020, with 2021 production flat. With higher prices, operators would be able to grow while returning cash to investors. Supermajors will continue to grow, while those with bigger shares in the Permian basin, such as Exxon and Chevron with, might be exceptions.

Independent E&P companies continue and make it even a stricter rule to allocate their capex to the projects that can provide the biggest return to shareholders. They do not invest much in exploration but rather produce in factory mode, limiting their drilling and completion costs. 

 

More bankruptcies and M&A

The majority of the biggest mergers and acquisitions in the oil and gas industry in the last ten years took place between US-based companies looking to expand their asset portfolio. Top 10 M&A were worth $485 billion.

This story is different when it comes to smaller E&P and service companies that mainly operate in North America. Since the oil and gas prices started dropping in 2014, more companies went underwater and mergers and acquisitions were the only solutions to survive. Banks and investors are willing to invest and support oil and gas companies less and less, putting even bigger pressure on those that survived so far. This capital pressure will force more companies to go bankrupt, be acquired by other more successful peers and merge with others. 

 

Investor sentiment towards oil/gas

In the last 10 years, energy was the worst performing sector in the S&P 500. Every $1 invested in energy in 2010 grew to $1.06 at the end of 2019. In contrast, $1 invested in information technology - to $4.35.

Weak and volatile oil and gas prices and poor returns were behind the industry’s poor financial performance. Before the energy recession that started in 2014, energy stocks were often performing above several other sectors. There is a societal pressure to go greener in the western countries, especially in northern Europe and Canada. These countries introduce more stringent regulatory requirements that make the upstream sector even costlier. These, together with low returns and supply/demand volatility, increase the risk profile of the investment. According to IHS Markit interviews with institutional and private equity investors, more than 60% view the oil and gas sector as undervalued. The market is waiting to see companies convert capital efficiencies into better returns. Similar results were obtained by other research companies. Clearer timing and components of the “energy transition” as well as increased oil and gas pricing could improve investment sentiment. 

"In the last 10 years, energy was the worst performing sector in the S&P 500. Every $1 invested in energy in 2010 grew to $1.06 at the end of 2019. In contrast, $1 invested in information technology - to $4.35"
 

Coronavirus reduces oil/gas demand

The last - and maybe the biggest - concern for 2020 is the novel coronavirus that invaded more than 100 countries as of mid March. Quarantines, self-isolations, limited social interactions will all affect local businesses, disrupt supply chains, travels for business or pleasure. This will reduce the demand for oil and with the recovering oil supply, the prices will plummet, or stay low - which is a more correct definition considering the current oil prices. This is the immediate impact of the spreading virus.

Various analysts predict economic recessions in the US, Canada and the rest of the world by the summer of 2020, which affect the demand in the longer term. Companies need to find new ways of delivering services and goods to people, and Central banks need to focus on regulating interest rates to maintain inflation to keep up the economic growth.

Picture courtesy of Life Sciences

Mike Wiseman
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