Deloitte launches Upstream Diversification Index

HOUSTON -- Deloitte has launched the Upstream Diversification Index (UDI), a five-factor analytical tool to ascertain the level of diversification and evaluate relative risks and rewards in the oil and gas portfolios of E&P companies.

The goal of the index is to help E&Ps benchmark their portfolio and seek balance in this lower-for-longer price environment, which is marked with uncertainty and volatility. Deloitte’s new report, Seeking balance in the new normal: Portfolio positioning with the Deloitte Upstream Diversification Index, provides new insights into successful strategies of companies which have outperformed over the past 10 years.

Trends

Diversification activity, according to Deloitte’s UDI, grew rapidly until 2011, driven by significant production coming from new resources like shales and LNG. However, over the past few years diversification activity has been flattening out and showing signs of divergence in companies’ portfolio strategies.

Pure-play E&Ps have become less diversified as many have exited resources and regions to concentrate on a few, while supermajors and integrated oil companies have extended their already diversified upstream portfolio across resources, fuels, investment cycle and basins to spread risks. For both groups, however, balancing investments, production and returns has become a major challenge.

“When oil was trading above $100/bbl, this balance could be achieved with any single resource type or upstream portfolio. But with oil staying below $50/bbl for an extended period, and the newly significant and variable role of short-cycle resources like shale plays, almost every portfolio mix or investment strategy is struggling to provide the desired balance,” says John England, vice chairman, Deloitte LLP and U.S. energy and resources leader. “The upstream industry is at a cross-roads when it comes to the question of which portfolio—diversified or concentrated—would deliver the best in this new normal of lower and volatile prices.”

Performance

An analysis of E&P companies’ financial performance and business strategies over the past 10 years using a combination of key financial parameters, such as relative total shareholder returns, upstream profitability and stability, asset efficiency, and more, suggests that companies that remained either strategically concentrated or moved toward diversification outperformed those that frequently shuffled their portfolios or remained in the “middle” of the diversification spectrum.

Underperformance was largely reported by medium- to large-sized pure-play E&Ps (production of more than 250,000 boed) where there is high indecisiveness on the question of portfolio mix. Weak performance was attributed to one or more of the following aspects: inconsistent strategy; weak position in top markets and quality basins; a lower long-lived asset base; limited infrastructure advantages; moderating production growth rates; or limited financial and investment flexibility.

Future

The report notes that the pressure to perform and the need to come out of this downturn successfully will likely push these E&Ps to either side of the spectrum and thus lead to greater exchange of assets, mergers, and reprioritization of capital in the industry. The case for concentration is strong due to the growing need to sell non-core operations to reduce the pressure on cash flows, but so is the need for them to focus on meaningful diversification given the competition and margin pressure in the U.S. shale market.

Many of the medium- to large-sized E&Ps in the U.S. market will likely face intense competition on both ends of the curve, especially where small and already concentrated companies continue to benefit from their focus on a few, best rocks while supermajors solidify their presence in the U.S. shale market by unlocking their “real options” in short-cycled shales, primarily in Permian and Appalachia. The report notes that the investment decision making and portfolio management was likely never more complicated than it is now.

“We believe situational awareness and a strong internal portfolio analysis will be key for companies that want to thrive in the current environment and position themselves for the upturn,” says Andrew Slaughter, managing director of the Deloitte Center for Energy Solutions, Deloitte Services LP. “The more a team knows about itself, its peers and the industry as a whole, the better strategic choices it can make to sustainably grow shareholder value for the long term.”