Oil and gas firms need to expand their focus beyond short-term issues such as tumbling oil prices and oversupply if they are to successfully navigate the growing range of disruptive forces that will shape the industry.
In the wake of December’s climate change agreement in Paris, the momentum to replace fossil fuels with cleaner energy sources has been gathering pace and other factors, from low oil prices to geopolitical events, continue to shake the industry.
Viren Doshi, PwC’s Strategy& Oil and Gas Leader, commented:
“While, for understandable reasons, the current depressed oil price dominates the headlines, it is also important to look beyond that to consider what forces are shaping the future of the industry. US shale supply has contributed substantially to the current position – what other disruptors does the sector face?
Global demand for affordable, reliable energy will continue to grow for the foreseeable future, but there is a new longer-term backdrop, as the world transitions to a low carbon system. Momentum to replace fossil fuels with cleaner energy sources is building up, and oil and gas companies need to consider their futures in this context.
Time and again, successful operators have demonstrated the ability to respond to challenges by taking a long term view, innovating, adapting and gauging major trends as they define medium-long term investment plans. And we are convinced that they can do so again.”
A new proposed framework for New Energy Futures could help companies successfully navigate increasingly complex and volatile global market over the next five to fifteen years. The framework evaluates four potential futures, where the level of disruption and the pace of change fluctuate:
- The oil and gas sector evolves along the current lines with limited government intervention. Ongoing price volatility across pricing and demand presents funding challenges, encouraging greater collaboration between operators and service providers to drive efficiency and reduce cost. Gas is increasingly becoming an essential transition fuel.
- Demand from energy consumers (retail & commercial) for cleaner energy drives the transition towards a low carbon world resulting in significant private investments in low carbon technologies. The link between economic growth and energy intensity breaks.
- As governments apply incentives and direct investment regulations, this increases energy efficiency, expansion of renewable energy demand and accelerates development of disruptive technologies. This puts further pressure on fossil fuel providers who need to find new ways of working.
- Supply constraints are inflicted through direct government actions, such as implementing carbon legislation or withholding licenses (e.g. Shale, Arctic), or through geopolitical disruption, which can also contribute to increased volatility on periodic and regional basis.
According to Jan-Willem Velthuijsen, Chief Economist, PwC in Europe, each perspective teases out a range of possible effects on supply, demand, and market dynamics:
“Megatrends are transforming industry, which makes navigating the future increasingly challenging. The oil and gas industry is facing a complex and difficult environment today, with historically low commodity prices, among other factors. The future will likely bring even greater uncertainty, given potential disruptive forces.
While in practice, no single future perspective can be neatly ‘ring fenced’, this framework enables business to consider various tangible scenarios. It allows them to reassess their current strategy and plans, with implications for the operating model, partnering strategy, resourcing and technical capabilities and other areas.”
While various elements may be played out in distinct ways across different regions, it will be increasingly vital that companies are able to demonstrate:
- A clear strategy and alignment with portfolio, decision making processes and capabilities;
- An ability to be agile and resilient in uncertain times;
- An innovative response to disruptive change using existing assets as well as technology, knowledge and capabilities;
- A readiness to form alliances and collaborate across the supply chain, with a growing focus on efficiency gains and reduced emissions rather than cost and risk sharing; and
- Safeguarding social license to operate by sustaining the trust and support of investors and a wider range of stakeholders through increased transparency.
A majority of key oil players view the current situation in a similar fashion – for all the uncertainty that may cloud the industry’s future, one thing is clear – the oil and gas industry has continually demonstrated resilience and innovation to adapt to the dramatically changing world. Whatever the future may hold, the sector will continue to play a vital role in meeting our changing energy needs.
New Energy Futures Framework
New Energy Futures is designed as a foundation document to help frame questions, rather than directly provide answers. This framework also establishes the basis for future collaboration with other industry sectors, such as transportation.
New Energy Futures looks at four perspectives highlighting some of the fundamental trends that will reshapthe oil and gas sector in the medium term of 5 to 15 years. . Some of these trends may take considerably longer period of time before the full effects come into force, but we believe that these trends in the medium term will have significant implications for the sector in its long term prospects. In two of the four perspectives, market forces play a defining role, while the other two perspectives are driven more by government action and geopolitics. Each of them teases out some possible effects on supply, demand, and market dynamics.
These possible future scenarios look very different. Some aspects of each of the four perspectives represent a significant move away from the current position, while others continue observing the current trends. In practice, of course, no single perspective is neatly ‘ring fenced’. Nevertheless, by thinking carefully about and expanding upon these different perspectives, companies will be able to evaluate their current strategies and plans, as well as consider the implications for their operating model, partnering strategies, resourcing and technical capabilities.
Regardless of which perspective resonates most, the future is uncertain. Companies will need to be agile and resilient, underpinned by a fundamentally sustainable business model.
What do the perspectives mean for your organization?
Businesses need to address fundamental challenges over the next five to fifteen years, regardless of which perspective will be adopted or where the business is positioned within the value chain.
For upstream producers, there remain significant opportunities but the perspectives present several distinct types of challenges. Where government-related interventions dominate, upstream companies will need to address whether their portfolio balances different levels of risk involved in the exposure to increased regulation or political instability, and they will face a tough balancing action. In these perspectives, in particular, it will be important to evaluate whether the company is able to generate a risk – commensurate return from specific basins and geographies and even entire resource types, to maintain stakeholders’ support through periods of volatility. Rapid changes in consumer behavior feature in some of the perspectives on the future. In these cases, the share of renewables in the energy mix increases more rapidly and upstream companies will need to take a strategic decision whether to enter these markets, or not. Social media magnify the potential for consumer action to damage a company’s reputation; therefore an active “social listening” is essential for companies to address consumers’ concerns at an early stage. Innovation will be vital for upstream companies in every perspective, but the focus may need to shift over time. If governments impose higher taxes on emissions, technologies to reduce emissions should take priority, while investments in new types of exploration may become somewhat less important. When supply constraints will become predominant, continuation of the current focus on technologies, so that to improve production efficiency, from mobile devices in the field and predictive data analysis (mining ‘big data’) to automated solutions for maintenance, will become even more important. These investments need to become a priority even when prices are low, in order to ensure future competitiveness. Collaboration can help upstream companies to navigate the future, extending beyond the current arrangements, in order to focus more on sector-wide efficiencies and also on innovation. For example, upstream companies may work together to standardize major types of equipment, such as portions of offshore platforms. This could lead to a modular approach that would savesignificant resources. In all the perspectives, there are either periods of, or persistent, low prices and upstream businesses will need to ensure that they manage their financial resources to withstand these challenges.
Midstream and Trading
Midstream and trading businesses will be deeply impacted by the resulting oil and gas flows under the different perspectives. Midstream already plays an important role in bridging demand and supply. With oil and gas produced typically in countries where there is relatively low demand, and larger consuming nations such as in Asia needing this supply, there is a clear strategic opportunity for midstream companies. The capacity utilization through the combination of conversion (liquefaction/gasification), shipping, and pipeline and storage facilities will be directly dependent on the size and direction of these hydrocarbon flows. How these flows evolve in the medium term will dictate the future success of midstream participants. Equally, in each perspective, new midstream projects such as pipelines and LNG terminals may face significant headwinds, either from more strict government regulations or consumer objections to fossil fuel projects. Working to gain trust and support from governments, local communities and the media will be an important prerequisite to any investments. Regulators have tried in the past and will continue in the future to ensure that midstream assets do not become toll gates to swallow extraordinary profits of the owners. It is worth noting that governments are increasingly interested in the activities of traders. Potential market price distortions particularly in mature economies may extend the net of regulators to include control of activities by commodity trading businesses. The traders therefore need to make sure that they are operating on a basis that will withstand this additional scrutiny. Nevertheless, the changing dynamics of supply and demand will continue to present opportunities to profit from bridging over bottlenecks.
Uncertainty as to which perspective is being realized at any point in time leads to volatility in prices. This daily volatility in crude prices has often been higher than the gross margin of the entire downstream value chain during the past five years. It is not surprising that trading companies with capabilities to manage and profit from risks associated with price volatility have emerged as the most profitable players in the sector. These trading companies see value from asset-backed trading and have moved on to integrate refining, logistics and marketing operations across the world. Given price volatility will likely continue in multiple perspectives, trading opportunities will proliferate against this backdrop of uncertainty. For the large oil and gas companies, having trader-like capabilities, albeit in a risk managed way, has become essential. Supply-demand perspectives vary almost daily. As a consequence, much value can be lost through poorly managed inventory holding or pricing arrangements that are misaligned with rapidly moving market indices. These trading capabilities will become even more valuable as uncertainty accompanies the transition to a low carbon economy.
The outlook for downstream companies will hinge on how demand for transport fuel products (mainly gasoline, diesel and jet) will evolve. This will be heavily influenced by ongoing trends in mobility, engine efficiency and substitution of oil-based fuels (such as electric vehicles, biofuels and gas). Flexibility in terms of adjusting to different feedstock sources and also to changes in product demand is critical in an environment of high uncertainty and increasingly stringent compliance requirements. The need for increased efficiency is a constant. Innovation plays a vital role here, as well as in the future development of enhanced products, such as biofuels and lubricants, which contribute to energy efficiency. By incorporating renewable feedstocks into their product mix, downstream companies can seize new opportunities created by concerned consumers. They will need to have access to the market for their refineries or run the risk of losing to competitive intermediaries. Business models may need to change as well. For example, downstream operators may want to consider further enriching or tailoring their offering with post sales value added products or services, including energy efficiency services, to strengthen and retain their trusted relationships with customers. Finally, with a potential shift in value from access to supply (upstream) to access to demand (markets in downstream), companies will need to adapt. In this context for example, a different set of capabilities in fuel marketing will be required in order to succeed. In the same way supermarket chains transformed the landscape in fuel marketing, market players will need to innovate to maintain their competitive edge.
Oilfield Service (OFS) Providers
Oilfield service providers will also need to adapt their businesses to remain competitive. In some of the perspectives, OFS companies may want to consider changing their business model. For example, if governments are taxing carbon emissions at a high rate, some assets may no longer be economically attractive, making the decommissioning market potentially more lucrative. Carbon constraining regulation might also provide impetus to newer technologies around CCS and downhole hydrocarbon separation. Divesting non-core businesses may also help OFS companies manage costs and focus on areas where their core capabilities are making a difference. Where governments’ intervention plays a strong role, OFS companies should assess their portfolio to make sure that clients which are more exposed to potential regulatory interventions are balanced by those in less sensitive regions or resource areas.
The traditional strength of many OFS players in innovation will prove to be a unique factor for winning companies, particularly where demand for oil and gas remains robust, while supplies are constrained by governments’ intervention or other factors. Innovative OFS players can help upstream companies exploit mature basins best through superior enhanced oil recovery (EOR), for example. They can also enhance their position with their customers through improved technology and leading efforts for standardization across the sector. In some regions where NOCs are dominant, they may team up with national governments to develop their own OFS champions to support the localization agenda.
In defining measures to be adopted or developing future business models, companies need to align with several essential strategic questions. These fundamentals, supported by certain necessary characteristics of an organization, can provide a basis to which, in this uncertain future, oil and gas companies are able to adapt, survive, and thrive.
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DR. AHMED RASHWAN
PwC Director- Head of Oil & Gas
PwC Partner- Utility, Mining & Energy Leader
PwC Partner-Assurance Leader
PwC Director, Industry Expert