an opinion editorial written exclusively for ANZMEX 

6 April 2020
By Chris Sladen

Energy matters – What happens when the price is not right?

What are the consequences of the oil price collapse combined with the fast approaching global economic catastrophe? The oil price has collapsed over 50% since the start of 2020. The price has reached lows not seen since the turn of the century. We are possibly witnessing the world’s worst ever oil crisis with demand collapsing as deep recession begins. How can Mexico’s energy sector best survive? Just how ugly can it get? There are plenty of indicators from previous recessions, price falls and demand shrinkage. Here are some:

1. Many companies will not survive. With lower oil prices, oversupply and less demand, cash flow is evaporating at an alarming rate. Many energy companies will be unable to service debt or pay salaries. Many large companies will have to slash dividend pay-outs and stop share buy backs. Stocks become highly volatile with wild price swings. Many will seek bankruptcy protection and try to renegotiate loans whilst slashing costs. Some will need a restructuring process to continue trading and give them space that could help them avoid insolvency; smaller firms often run out of cash. Mergers and acquisitions activity will become furious. 

2. The industry has to re-value its assets. This is because of the much lower prediction for future energy prices. For many companies revaluing themselves on an oil price of US$ 20 per barrel, it is very different to US$ 60 per barrel. Expect companies to announce huge impairments over the coming months as the financials get re-set. With financials looking ugly, it is also an opportunity to empty the cupboard of those energy projects that were never going to make it but were still on the books, some large write-offs are coming.

3. What can be delayed or deferred, gets delayed or deferred. Non-critical expenditure gets deferred. It all helps slow the pace of capital spend. Many energy companies have already announced 30-50% Capex reductions. Whether it is cancelling rigs to drill exploration wells, pausing commitment wells, or delaying final investment decisions, halting new licence rounds, or a refinery upgrade – if they can be delayed, or put on hold, they typically are. Rig utilisation will fall both offshore and onshore; contracts get terminated if they cannot be renegotiated at much lower day-rates. Some projects will get shut-in, for example in the Canadian oil sands, and it is a good opportunity to bring forward annual field shutdowns for plant maintenance and well workovers.

4. Demand will plunge. There are unprecedented international travel and domestic restrictions. With planes no longer flying, large manufacturing industries shut down or reduced, and the US driving season effectively cancelled, demand for fuels and electricity will fall dramatically. Business activity is collapsing heralding a recession of unprecedented scale. Legal, tax and force majeure issues are starting to emerge. Price cutting amongst fuel retailers will be essential to lure customers.

5. There is so much over-production there is nowhere to put it. When all available storage is full – in fuel tanks, pipelines and ships – deep price cuts are often the only way to shift products. This latest collapse in oil prices has put in play a lucrative trade to store crude at sea, in oil tankers and floating storage vessels. This mimics the Global Financial Crisis and recession of 2008-09 when millions of barrels were kept afloat on the world’s oceans whilst waiting for prices to rise.

6. Companies that existed to explore for new oil & gas reserves are particularly exposed. Often they went exploring using borrowed money. In the success case, they could sell their newly found reserves, avoiding the high costs of developing those reserves, and be able to pay their debts and make a substantial profit. But now heading into a severe economic downturn nobody wants new reserves. The world has far more oil supplies than it needs. Many exploration focussed companies may simply disappear. Their assets cannot be monetised and their value is greatly diminished. Meanwhile, companies that have recently spent heavily to develop high cost barrels that are hard to produce also now face significant problems. Many of their barrels being produced are no longer commercially attractive. Not only are they losing money, they have insufficient profits to pay back debts and borrowing. Their ability to borrow further is often lost.

7. In the past, periods of low oil price and economic downturn have created waves of industry consolidation. This is now likely. Companies either merge or are acquired by others. Merging many companies to create scale makes it much harder to be bought out and taken over and reduces the competition. Merging companies is often a less painful form of survival. But still involves the loss of many thousands of jobs.It is not unusual to see regulators step in with tougher rules to prevent predatory takeovers amid plunging share prices. The low oil prices of the late 1990’s – early 2000’s gave rise to a great wave of industry mergers and acquisitions. (In December 1998, Mexico’s Maya crude oil could be bought for US$ 5.80 per barrel). These mega-mergers included: Exxon-Mobil, Conoco-Phillips, BP-Amoco-Arco-Vastar-Aral-Burmah Castrol, Total-Fina-Elf, Chevron-Texaco-Unocal, Anadarko-Union Pacific and Shell-Enterprise. The rapid speed and large scale of these mergers and acquisitions completely transformed the energy sector at that time.

8. The oilfield service providers, suppliers and energy contractors come under intense pressure to reduce their prices. Currently many are being asked for 30% price cuts. Any equipment on long term hire, perhaps deep water drilling rigs on high day-rates or floating production vessels, need to negotiated down quickly or risk losing the contract altogether. Energy companies struggle to pay their contractors and want to delay payments, heaping more problems onto the service sector. Hundreds of energy service companies are set to become insolvent. In Mexico, as the peso weakens, energy contracts based in US$ become harder to pay.

9. There will be many hundreds of thousands, probably millions, unemployed in the energy sector globally. Early retirement, lay-offs, redundancy, or simply suspension are all options. Some companies may simply adopt a mathematical approach, wasting little time in slashing staff by a certain percentage, sometimes overnight, in attempts to survive. Other companies will take a sophisticated approach – this involves releasing contract staff, consultants, staff in non-core activities, and those in low value added tasks. New business development is often halted and staff currently overseas are repatriated. Pay is frozen or in some cases cut; bonuses may evaporate. These are all attempts to preserve the high value core, with the know-how to keep operations running and manage the finances.

10. We now live in an era of cancelled events. Conferences as well as training courses are always an early casualty. Electronic substitutes – webinars, videoconferencing and e-learning are stepping up and doing well but there is little substitute for generations of relationships built at annual or monthly gatherings and through networking events and technical exchanges & seminars. Events offer participants access to a wide audience of potential customers and partners in an environment that promotes meaningful discussions that are impossible to replicate online.

The points outlined above are all things that can happen when the price is not right. The energy world is no longer in balance. Which companies are best placed to survive? To be well-positioned requires reliable low cost production, a lower operating cost base, access to markets, robust hedging strategies, and fiscal manoeuvres to reduce debt and strengthen the balance sheet, including sound borrowing based on substantial developed reserves. As demand plummets and prices collapse, the relationships of an energy company with its banks and financiers, with governments around the world, regulators and with its stakeholders quickly become crucial to survival.

About the author:

Chris Sladen runs an advisory service offering insights to inform, shape a decision, policy & regulation, and guide the next steps for energy ventures, acquisitions & divestments, energy transition and climate strategies. Chris has a unique global experience having worked in over 40 countries. This is underpinned by extensive knowledge of petroleum systems and where best to find oil and gas, notably in the Gulf of Mexico & nearby areas, Europe and NE & SE Asia, as well as the development of midstream, downstream & renewables investments in many emerging economies. Chris has extensive experience acquired on the Boards of companies, subsidiaries, business chambers & organisations. Chris has a career of over 40 years in the energy sector, living in Mexico (2001-2018), Russia, Vietnam, Mongolia, China & UK. His contributions to the energy and education sectors have been recognised by the UK Government with both an MBE and CBE, and also the Aztec Eagle from the Mexican Government – the first foreigner in the energy sector to achieve this award. Chris has published extensively over five decades. Chris’ articles for Energy Matters reflect his experience and enthusiasm and are not paid for in any way.

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ANZMEX ORG A.C. is a politically neutral business council with no political affiliation. The views expressed in this column are not necessarily representative of the official views of ANZMEX or any of its officers or staff.