The oil price collapse triggered by the demand shock created by COVID 19 and exacerbated by the price war between Saudi Arabia and Russia, has led to a global oil and gas (O&G) industry-wide downturn. This has left companies wondering about the duration of and severity of the shock and the subsequent shape of the industry. Russia’s refusal to curb oil production at the OPEC+ meeting held early in March 2020 led to an oil price below $25 per barrel, its lowest level since 2003 (see Figure 1).
Ending the weeks-long war for market share, OPEC+ agreed on a historic cut of 9.7 million bpd; although expecting a major rebound in the price, this cut impact was limited to reducing further price degradation. Concurrent to the oil political disputes, the governments have rolled-out a set of radical ‘stay-at-home’ and social distancing measures to tackle the highly contagious COVID-19 virus, these measures led to a drastic effect on the oil demand and the larger global economy (see Figure 2).
The O&G industry has been exposed to several downturns in the recent past, and businesses have demonstrated adaptation and resilience. Oil prices are rarely stable for extended periods of time, and the industry has shown a remarkable ability to adapt and thrive as cycles change. Several price shocks have occurred over the past 50 years with major drops in the 1980s, 2008-09, and 2014-16, driven either by demand or supply shocks, however for the first time in the history of the O&G industry, the market has been impacted by both simultaneously. These unique circumstances have resulted in O&G companies experiencing a period of acute uncertainty threatening their profitability, with disruption to operations, and supply chains coming under pressure. In light of macroeconomic forces and an uncertain future, leaders are faced with the urgent need to respond and build resilience for their businesses. The question that remains centers on the specific actions to take in a crisis in the short term, and on the measures to future-proof organizations from further uncertainty impacting the industry in the long run.
In the short term, O&G companies must maintain their focus on liquidity, cash preservation, continuity of operations, be proactive in assessing their risk and vulnerability from both an operational and a financial standpoint. Instituting a framework that identifies priorities, defines accountability, specifies timeframes, followed by decisive action will provide a basis for controlling and mitigate issues.
The practical immediate response measures to stabilize the business should involve liquidity management through robust short-term cash flow forecasting, reduction in discretionary capex, optimization of working capital, ensuring continued availability of funding lines, and supply chain stabilization through active management and contingency planning. Heavily impacted businesses without adequate headroom or shareholder support will need to approach their lenders to arrange financing solutions, covenant resets/waivers or seek consensual restructuring solutions with their stakeholders to avoid insolvency by demonstrating robust financial discipline and mitigating actions.
Going forward, different scenarios should be considered. While a possible best-case scenario may be the quick recovery of oil demand and supply (Figure 3, Scenario B), O&G organizations must respond by taking further measures to prepare for a possible worst-case scenario, in which demand recovery is slow and a low oil price level will continue for a longer period of time (Figure 3, Scenario C). According to many experts, it is possible that the COVID-19 pandemic may have a prolonged impact on the recovery in oil demand as international travel and road transport restrictions may continue for longer than currently anticipated, and as companies adapt successfully to home working arrangements.
In response, besides addressing the short-term future (coming weeks to 6 months), O&G companies must gear towards medium-term (2-3 years) tactical responses and longer-term (5-10 years) strategic options to accommodate for any future scenario. For the O&G industry, these strategic options become particularly important as oilfields cannot be turned on and off overnight. That is due to the costs and risks associated with shutting down production, and the relatively long-term nature of agreements.
In the medium term, emphasis will be placed on profitability, in particular through savings on low-yield projects capital expenditure and maintaining flat dividends. This is also important for the medium-and longer-term as decisions today will have a longer-term impact given the nature of the O&G industry. For longer-term success, organizations will identify robust yet flexible strategic options in line with the value maximization. This is achieved by anticipating the future business environment, assessing areas to focus their investment plans on (i.e. horizontal and/or integration across the value chain, renewable energy, chemicals, and retail), evaluating the lasting impact on areas such as the workforce, supply chains and innovation and identifying new skills needed to fulfill new strategies.
Many measures for future-proofing organizations derail as leaders tend to extrapolate from the current context. In order to build a more resilient long-term approach, leaders need to detach themselves from the status quo. During troublesome times, leaders should not only focus on the core portfolios, but also use the momentum of the crisis as a catalyst for designing strategies that are in the adjacent and transformational space. These measures could help their organization thrive in the future.
O&G companies must seek to future-proof their organizations by building resilience, and placing it at the core of their portfolio (see Figure 4). Ultimately, it boils down to addressing strategic drivers of various market environments, determining implications for industry dynamics, building optionality to gain flexibility and thus being able to change strategic course depending on how critical near-term events unfold. More importantly, building resilience is required for the appropriate weighing of feasibility and risk against the long-term upside potential, and against the risk tolerance of the organization.
While designing a corporate portfolio resiliently may come at a certain price, portfolios that are future-proofed offer inherent value to businesses. To maximize return on investment and minimize external interference from macroeconomic forces, leaders should not only develop portfolio optionality to deal with different scenarios, but also identify the highest performing option and the risks in your portfolio (see Figure 5).
The question remains: how should organizations be future-proofed to achieve portfolio resilience? It begins with the evaluation of the market and the O&G industry trends and drivers. Thus, understanding what the market and the landscape of the industry will look like in the next two decades, and identifying the main elements that have the potential to impact the future (e.g. price volatility, competition for talent, political disputes, oil reserves depletion, and the energy transition). Evaluating the possible direction of the market and the industry, and providing narratives to assess the respective implications on development, investment plans, supply chains, capabilities, geographical footprint, etc., further facilitates the understanding of strategic responses from consumers, market conditions and players.
A wider lens perspective of the industry must then be followed by zooming-in on the organization’s internal portfolio through a structured process of twelve stages (see Figure 6). This process will enable decision makers to determine the internal portfolio vulnerability and the exposure of its exploration, development, and production business units among others on the critical uncertainties impacting the business. The success rates of all portfolio components across scenarios must be assessed, and synergies between business units should be considered to identify spillover effects, and value-adding components.
Non-core portfolio components should be identified and divested to free-up capital for deployment on value-accretive projects. A projection into the future can ultimately be determined by deciding on offerings that are mandatory for success, and options dynamic in nature; offerings that are defined as “no-regrets” qualify as part of the future-proof of the portfolio.
In the face of certain challenges and perceived risks, resilience must start with leadership, who are rightly concerned about how their companies will be affected and what measures they have to take next. There are fundamental qualities of resilient leadership that distinguish successful executives as they guide their enterprises through crises. Leaders should simultaneously design from the heart and the head by empathizing with their employees, customers and their broader ecosystems, yet simultaneously adopting a rational line to protect financial performance from disruptions. They should typically be able to stabilize their organizations to meet the crisis at hand, while finding opportunities amid difficult constraints, and painting a compelling picture of the future that inspires others to persevere. Resilient leaders should remain focused on the longer-term horizon, anticipating the new business models that are likely to emerge and sparking the innovations of tomorrow.
Crises with deeply intertwined challenges offer learning opportunities and increased trust among all stakeholders involved, particularly as more value is created for society as a whole. It equips organizations to adapt quickly in the midst of an ever-changing global economy. Players in the O&G industry now have the opportunity to, not only address today’s challenges, but to address future ones by taking the right approach today.
Authored by: Bart Cornelissen, Energy, Resources, & Industrials Leader and Managing Partner, Monitor Deloitte Middle East & Adnan Fazli, Energy, Resources & Industrials Partner, Financial Advisory, Deloitte Middle East
Yasmin Fansa, Manager at Monitor Deloitte Middle East
Yousef Iskandarani, Manager at Monitor Deloitte Middle East
Evgeniya Vlasova, Assistance Director at Deloitte Financial Advisory Middle East