When future demand becomes more certain, investment plans could change very quickly, but most oil companies do not anticipate any significant or sustained growth in demand in the short term.
The oil and gas sector is accustomed to commodity price fluctuations and the need to respond quickly to changing market conditions. However, the speed and severity of the current downturn took many by surprise.
Long-term investments in doubt
Current oil and gas price volatility and uncertain demand are making it more difficult for oil companies to plan forward investments. Oil companies require security of demand to underpin long-term investments.
Uncommitted spend is being reviewed by most companies, not only in light of lower oil prices but also in the expectation that they can get a better deal in the coming months.
The price of oil has fallen rapidly, but industry costs are moving down much more slowly. When future demand becomes more certain, investment plans could change very quickly, but most oil companies do not anticipate any significant or sustained growth in demand in the short term.
Cost reduction: the primary focus
When oil prices were above US$100 per barrel and demand was outstripping supply, the top priority for most companies was maintaining and increasing production, with cost control taking a secondary role.
A year later, the new market reality is forcing many oil and gas companies to reassess their operating practices, investments and capital allocation. The primary focus for organizations is now on cost reduction and, for many, maintaining capital expenditure on longer-term projects.
Cost management is nothing new in the sector and many, if not all, of the key players have longer-term cost reduction initiatives in place that predate the credit crisis, striving for greater unit efficiency and a competitive cost advantage.
Some players are accelerating these programs and making organizational changes to improve their cost structure. The largest diversified oilfield services companies have also been making job cuts that among them run into the tens of thousands.
Short-term delivery vs. future growth
The need to maintain capital expenditure (capex) on projects that will deliver longer-term growth is understood by all players. Many exploration and production (E&P) projects have a long lead-development time, are very capital-intensive and the costs of mothballing or restarting are substantial. The consequence of a major reduction in capex today could be a major supply shortfall further down the road.
The ability of the leading industry players to maintain their capex through a severe and prolonged downturn varies. International oil companies (IOCs), while all announcing significant reductions in profitability, remain profitable, generally well capitalized and with good access to capital markets for funding.
Small- to midcap companies, especially those without producing assets, are likely to be finding it hard to maintain funding for existing projects and very challenging to gain access to funding for new projects. In addition, many state-owned oil and gas companies are less able to finance projects from cash generated from operations.
However, recent research by Ernst & Young shows that the majority of the NOCs and the largest oil majors are planning to maintain or increase their level of capital investment in real terms through the down cycle. In 2009, the largest NOCs and IOCs collectively plan to invest over US$375b in the development of their businesses at home and abroad.