January 2016 /// Vol 237 No. 1


Executive viewpoint

Looking back at 2015: What happened, what didn’t, and hope for the future

John England, Deloitte LLP

Looking back, I am struck by what a unique year 2015 was, even in the dynamic world of oil and gas. To be sure, 2014 was marked by a price shock that rapidly brought us from $90-$100/bbl down to around $60/bbl. In 2015, oil prices continued to decline, down to below $40/bbl. So in little more than a year, upstream companies faced a more-than-50% drop in revenues. The industry responded with the “five stages of grief.”

There was denial—“This is just a blip, and it won’t last”—a view that died by March. Next was anger—“It’s OPEC’s fault” for producing as much as they can, a lot like U.S. producers. Once anger subsided, it was followed by bargaining—“If only we had invested for returns, not growth.” Eventually depression set in with operators saying, “Our cash flows continue to diminish, and balance sheets continue to weaken.” And, finally, there was acceptance—“I guess we’d better prepare to ride this out,” which is the current view of most players today.

Last year saw the E&P sector pull out the 1980s playbook for a severe price decline. First, cut capital expenditures and defer major capital projects, then cut operating expenditures and headcount. Next, push suppliers for better pricing. Lastly, hope for better prices. The first three have been effective at reducing costs and preserving cash. The fourth one is still in progress and, although hope is not a strategy, it sure beats no hope when it comes to morale.

Through the course of the year, the industry continued to deploy new technologies and saw per-unit costs go down dramatically. In fact, despite much lower capital expenditures and rig counts, U.S. production did not start to fall until early-summer 2015, as output efficiency gains offset rig count reductions. With the end of 2015, and “lower for longer” becoming the new mantra, let us reflect on what did happen, and what did not.

So what did happen? Global oil supply increased throughout 2015, led by OPEC nations and the U.S., although U.S. production began to decline during the second half. Earnings and stock prices dropped dramatically for many IOCs, independents, OFS companies, and, to a lesser degree, midstream companies. Downstream has continued to shine, as crack spreads stay strong.

With declining revenue, companies pivoted their focus from expanding to cost-cutting. Upstream and OFS companies reduced headcounts, and a significant number of projects were deferred or canceled. A few large M&A deals were announced (Shell-BG, Halliburton-Baker Hughes, Schlumberger-Cameron, ETP-Williams).

As companies adapted, markets continued to shift. A deal with Iran was reached, which puts them back in the global oil market. The Chinese stock market went crazy for a few days and made everyone very nervous, giving the Fed more reasons to wait until December for a rate hike.

And what didn’t? We ended the year like we started it: prices were low, cost-cutting was top-of-mind, and we still waited for the big M&A wave to happen. So, what’s different in 2016? No one believes prices are going up anytime soon, so people are battening down the hatches like a hurricane is coming.

One bright spot is the industry’s resilience on the natural gas side. Despite moderate gas prices since late 2011, production continues to grow. The largest driver is world-class U.S. basins like the Marcellus shale, with production growing from 1.0 Bcfgd to about 16.0 Bcfgd in the span of five years.

Demand is growing too, including all the traditional sectors—residential, commercial, industrial and power. With high energy density and low emissions, this is good for both the business and the environment. And it’s not only the traditional markets, with huge gas-based investments underway in chemicals. Not to mention, gas is well-positioned to penetrate heavy truck and marine fuel markets. We also have seen the opening-up of new markets with the first LNG cargoes, expected in first-quarter 2016 from Sabine Pass.

Bottom line, the natural gas value chain, from wellhead to burner tip, is thriving in a moderate price environment. So, are there lessons learned to draw from for oil?

Hope for the future. Some positive developments should improve the price environment, as outlined below:

Demand. U.S. consumers are responding to lower oil prices in the usual let’s-go-buy-a-new-large-vehicle kind of way. As auto sales go up, expect to see increased U.S. demand. More broadly, Asian demand, beyond just China, is showing growth, too.

  1. Natural reservoir production decline has, historically, been 4%-5% globally. That means the industry must produce another 4.0 MMbopd, every year, just to keep up, even without demand growth. This puts upward pressure on pricing.

Production. Total U.S. production finally started to decline. That trend should continue in 2016. Billions of dollars of investments have been deferred, which translates to millions of barrels that will not be produced in the years to come. This sets the stage for a price rally.

A leaner, stronger industry. More than anything, I believe in free markets. Just as high prices were critical for shale gas, today’s low crude prices are forcing innovation in oil development and production. We are still in the early stages of what can be achieved in terms of reducing unit costs and, ultimately, increasing unit margin and return on capital employed. The upshot is an industry that will be stronger, leaner, and built to last. wo-box_blue.gif 

The Authors ///

John England serves as vice chairman and Oil & Gas Sector leader for Deloitte LLP. He has almost two decades of experience at Deloitte, during which he has served as audit and enterprise risk services industry leader for U.S. energy. He also has held a similar global role. In addition, he has led Deloitte’s global capital markets team for energy. Mr. England’s expertise includes regulatory compliance, oil and gas issues (supply, demand and prices), upstream and midstream, and financial structuring.

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