At the recent ONS (Offshore Northern Seas) conference in Stavanger, the largest annual gathering of the oil and gas industry in Europe, debate on the energy transition took centre stage. Some major oil companies are expanding into renewables, but there was a lot of skepticism among the attendants about this strategy, writes independent energy analyst Jilles van den Beukel, who attended the event. He also noted that in project financing there is a shift from banks to private equity – and geopolitics is back as an important factor in the oil market. A report from Norway.
The 2018 edition of the ONS (Offshore Northern Seas) took place in Stavanger from August 27 to 29. What once started as a small conference aimed at the offshore industry in the North Sea has now become the largest oil and gas conference in Europe. Over 3,600 people attended the conference; about 70,000 people visited the exhibition.
Eldar Saetre from Equinor announced Phase 2 of “Johan Sverdrup” which will take production of Europe’s largest new oil field to 660,000 barrels per day (b/d). Patrick Pouyanné confirmed that Total would not be investing in US shale. Scott Sheffield from Pioneer Oil Company (“I started this company at 30 million, I am leaving it at 30 billion”) boasted that his company still had an inventory of tier 1 well locations in the Permian for the next 20 years. All business as usual – but the oil executives were also preoccupied with the energy transition.
The energy transition: skepticism on the attractiveness of renewables
Very few people in Stavanger doubted that the transition to a low carbon world will come and will fundamentally change the world of oil and gas. But how soon – and how to react? So far the demand for oil is still growing at about 1.5% per year (for gas this is about 3%).
Valentina Kretzschmar from consultancy WoodMackenzie showed that there is a wide range of strategies that oil and gas companies have adopted so far in response to the energy transition. Some smaller players like Engie and Ørsted are making a complete and rapid transition to low carbon fuels. For the majors oil and gas has so far remained their core business.
In a WoodMackenzie study, rates of return for recent conventional oil and gas projects were found to be substantially higher than those of recent projects in renewables
But some of them are exploring new energy frontiers. Front runners in this space, Total, Shell and Equinor, are investing a few percent of their total investments into renewables and the electricity value chain. Equinor stated that by 2020 25% of their research budget is expected to go into renewables. The company, formerly called Statoil, is aiming to build a profitable and substantial renewables business. US oil majors Chevron and ExxonMobil, however, have not followed suit and are limiting their efforts to reducing costs and reducing the environmental footprint of their core oil and gas business.
Likewise, Saudi Aramco and Russian producers Lukoil and Rosneft are assuming that oil and gas remain their core business in the long term. Their response to the energy transition has been to diversify by increasing their activities in refining and petrochemicals. For Saudi Arabia and Russia as a whole this is accompanied by a larger focus on energy intensive industries like metal processing and airlines.
Throughout the discussions considerable skepticism emerged about the attractiveness of renewables to oil and gas companies. In a WoodMackenzie study, rates of return for recent conventional oil and gas projects were found to be substantially higher than those of recent projects in renewables.
Oil and gas companies are relatively small players in renewables (owning less than 2% of global wind and solar capacity) and do not seem to have a competitive edge on other players. Many feel that the investments in renewables by the European majors are basically greenwashing; required to keep their investors and stakeholders happy. It was also felt that this strategy is only feasible as long as these investments remain a relatively small fraction of total investments. It was suggested that some oil and gas companies may at some stage split into a part focusing on renewables (attractive to ethical investors) and a part focusing on oil and gas only.
Financing: a shift from banks to private equity
Financing for small niche companies that specialize in exploration has become extremely difficult according to Jeremy Low from investment banker BMO Capital Markets. The old model of funding 10 exploration companies in the hope of 1 big discovery and 2 or 3 smaller ones is no longer a tenable strategy. Investors have become more risk averse and want short term returns.
Banks (and in particular European banks) have become more reluctant to invest in oil and gas in general (due to pressure from shareholders and other stakeholders). Private equity is more forthcoming but has a clear preference for financing companies with a lower risk profile that specialize in buying and operating producing fields. Should oil prices continue to rise then IPO’s for some of the recently established North Sea companies like Chrysaor become a distinct possibility.
There is a mismatch between the time horizon of investors and that of oil and gas companies
In general there is a mismatch between the time horizon of investors (a few years) and that of oil and gas companies (at least a decade). Investors want high dividends, share buybacks ánd limited investments. But how sustainable are the production and dividends of the majors in the long term, given their current low investments, wondered Ben Monaghan from investment bank PJT Partners? That proved reserves over production ratios for the majors have been falling and are near historic lows is currently ignored by the markets. ExxonMobil, the major with the highest reserves over production ratio that is making relatively large investments to secure future production, is currently distinctly out of favor with investors.
There was amazement among the financing panel members on the willingness to invest so much money in US shale. US investors in shale are risk on and have a high belief in technological progress in the industry – in marked contrast to investors in oil and gas in other parts of the world.
Exploration: deepwater is back
Over the last two years the attractiveness of deepwater with respect to US shale has improved. Break even costs of new deepwater developments are now substantially below those of US shale. The conventional and deepwater service industry still has significant overcapacity and is not yet in a position to start raising prices. The service industry for US shale, on the other hand, is operating close to capacity and has regained pricing power.
With its longer cycle time, it has taken more time for new deepwater developments to reach lower cost levels. Deepwater is also high grading, with new developments focusing on the most attractive areas from a geological, cost and regulation (e.g. local content measures) point of view. This currently implies a greater focus on the Americas (Gulf of Mexico, Guyana and Brazil) and a reduced focus on West Africa (Nigeria and Angola).
The subsalt play in deepwater Brazil will be a hotspot for exploration over the coming years. All majors have acquired licenses here since Brazil opened up and Petrobras operatorship is no longer required by law. Over the past year they have done their homework and worked up the best drillworthy prospects. In the global ranking of their prospects shown by Equinor (not something that major oil companies often show in public) the Brazil deepwater prospects stood head and shoulders above all other prospects. “Drilling those prospects will be the most exciting time of my career” said Tim Dodson, Equinor’s head of Exploration.
“Geopolitics is back as a major force for oil markets”
So said Helima Croft from RBC Capital Markets. The session on geopolitics started with a presentation by Sir John Scarlett, a former head of MI-6. Venezuela’s oil production continues to be in a downward spiral. Production from Libya and Nigeria is relatively uncertain. But the more fundamental and long term issues are the rising tension in the Middle East and the more limited capability and willingness of the western world to play a stabilizing role in global affairs. Who could have imagined Brexit and the presidency of Donald Trump even five years ago?
“Iran is out to dominate the region” said Ibrahim al Muhanna, adviser to three Saudi oil ministers. “Just like Saddam but with different methods”. It illustrates the high level of distrust between the two major forces in the region. And yet, part of the rising tension is related to internal issues in Saudi Arabia. The new crown prince’s position is not yet fully secured. His bold initiatives (whether externally in Yemen or internally with Vision2030 and the arrest of many business people and princes) do not inspire confidence. A rapidly growing population and rising youth unemployment present a major challenge.
President Trump is a major uncertain factor. The renewed Iran sanctions could result in higher oil prices. A further escalation of the trade conflict with China could have a significant impact on the global economy and oil demand, thus lowering prices. What will he do next? Whether a potential impeachment (or removal by the 25th amendment) would unhinge stock markets and the economy is at yet completely unclear.
The more fundamental and long term issues are the rising tension in the Middle East and the more limited capability and willingness of the western world to play a stabilizing role in global affairs
Fu Chengyu, a former chairman of CNOOC and Sinopec stated that “the environmental situation in China is terrible.” The determination of the Chinese government to reduce pollution and improve air quality should not be underestimated. If the share of coal in the primary energy consumption is indeed lowered to 47% in 2030, as per plan, this implies major growth for renewables ánd gas. China was the major force behind the rapid growth of oil demand in 2000-2010. It may well play the same role for the growth of gas demand in the coming decennium (and again as a result of government policies).
Tighter oil markets due to Iran sanctions
When president Trump announced the Iran sanctions it was still relatively unclear to what extent this would influence Iranian oil exports. Recent signals point to a relatively large drop in exports by the end of the year.
Waivers from the US government, needed in order to continue oil imports from Iran, have not been forthcoming. Western companies like Shell or Total can no longer buy oil from Iran now that the country has effectively been placed outside the western financial system. But also Indian refiners cannot buy Iranian oil as they are unable to insure the oil transport from Iran. Chinese companies continue to import oil from Iran but China is not willing to increase these imports in order not to give the US a pretext for further escalation of the trade conflict.
The drop in Iranian oil exports will be as large as 1.5-1.7 mb/d (million barrels per day) by the end of the year according to the well-known analyst Amrita Sen from Energy Aspects in the session on oil markets. It could be compensated by an increase in Saudi and Russian oil production. This would result in a drop of global spare capacity to unprecedented low levels, however, which could easily give rise to oil price spikes in the case of any other supply disruptions.
Jilles van den Beukel is an independent energy analyst (formerly a principal geoscientist at Shell). His recent report on oil markets for HCSS (the Hague Centre for Strategic Studies), with Lucia van Geuns,can be found here.