For today’s leaders, energy is at the top of the agenda. There are worries about persistently low oil prices, access to resources, rising petro-nationalism, threats to supply, problems in electricity and gas markets, re-assessment of coal for power generation, the challenges of global warming and renewables, and the re-emergence of nuclear.
The energy industry, from oil and gas to utilities, is going through an unprecedented change. It’s a change similar to when the world moved from wood to coal, with the steam machine, and from coal to oil, when utilities centralized and the car industry took off early last century. Today, the shift is from hydrocarbons to alternative and renewable sources of energy. The change will be gradual from our perspective, but could be completed this century.
The two majors sectors within the oil industry, upstream and downstream, have a long history of adapting to oil prices and fuel-demand evolution. With oil prices at low levels and technology acceleration trends, they are facing new structural challenges:
The financial health of the oil and gas industry has always been set by oil and gas prices, with major price inflections often leading to significant structural changes in the sector. After the price drop of 1986, WTI oil prices remained low for nearly 20 years, at about $30-$40 in 2015.
This low-price environment not only drove a wave of project deferrals, but also triggered a series of consolidations among international oil companies, seeing the demise of Arco, Amoco, Mobil, Fina, Texaco and Phillips, among others.
The much-higher prices of the past 10 years have ushered in an era of greatly accelerated oil and gas exploitation in often much more technically complex, deep-water and remote settings, with many smaller, emergent players now pursuing unconventional hydrocarbons and playing a much more influential role in price setting.
With oil prices again at around $40 per barrel, a price level which increasingly looks as if it may be sustained for many months, if not years, into the future, it is appropriate to ask what alternative structural trends might come to dominate the sector over the next few years.
In this context, international oil companies (the “majors”, or “IOCs”) are facing an increasing reserves replacement challenge, one that is not faced in the same way by many of the largest national oil companies (“NOCs”).
These NOCs not only control over 58% of the world’s current oil production, but also around 90% of global oil reserves, the vast bulk of which comprise relatively low-risk, low-cost volumes, generally in brownfield settings.
While some NOCs remain very dependent on external support, many of the more sophisticated NOCs are increasingly able to access their resources without needing IOC support and participation.
These more capable NOCs have increasing access to all the technologies required – they have been rapidly expanding their R&D budgets, and are building ever-deeper, direct relationships with oil-services companies, without a need for IOC intermediation.
These more advanced NOCs are acquiring ever more effective staff skills and competencies, often without needing to engage with IOCs at all. Further, many NOCs are also now able to raise funds in global capital markets in order to develop their resources.
On their side, IOCs have also recently been challenged by the rise of shale-oil and shale-gas, largely produced by a tier of relatively small, independent US oil and gas companies, having nimble operations and low-cost structures.
These companies have changed the face of the industry, often leaving the IOCs stretching to catch up. In consequence, future access to economically viable resources by the traditional IOCs is becoming increasingly challenging, especially in this relatively low-oil-price environment and uncertain market.
This presents the IOCs with a growing strategic dilemma. What are potential future winning strategies for the IOCs?
What directions are plausible, and how can they either pursue growth or maintain earnings?
Might some or all of them need to rethink their business models?
What types of partnerships or collaboration might be appropriate?
Petroleum downstream has been adapting to increasing competition and challenging regulations, and is suffering from lower returns than those of the upstream segment.
The sector is facing numerous challenges: regional capacity mismatch, margin volatility and market rigidity, diminishing feedstock quality and stricter product specifications, increasing capital-investment requirements, vulnerable or unviable refiners, erosion of margins in fuel distribution, and challenging retail economics.
As new energy sources for mobility will impact the entire fuel value chain, downstream players will need to innovate to protect their shares of the mobility market. In light of this challenging business context, not only will oil downstream players need to excel in the execution of their operational and commercial strategies, but they will also be forced to innovate and transform their business models in order to survive.