The oil and gas industry’s long march to recovery has created a big imbalance across the oil and gas ecosystem and performance gains of companies continue to be discounted by investors, according to a recent Deloitte report.
The report, "Decoding the oil and gas downturn," is a health report on the overall industry, based on an analysis of around 850 global oil and gas companies 5 years after the oil price crash. The series looks at the upstream, OFS, midstream, and downstream sectors.
“Today’s investors in oil and gas aren’t buying into the industry just to play price and margin cycles in pure-play businesses or to park money in the safety of integrated structures, and rightfully so. Oil and gas strategists need to accept the fact that today even a strong performance needs a ‘compelling narrative on the future’ that is based on a wider set of disruptive opportunities across the time frames,” the report said.
Divergence and imbalance
Wall Street and its global equivalents remain unkind to the oil and gas industry despite it paying dividends of $720 billion between 2014 and 2018, the second highest after the financial services industry, and generating more free cash flows in 2018 than it did in 2013. The oil and gas industry’s relative attractiveness is still at an all-time low, despite it being in its best era of productivity gains and cost controls, according to the report.
“The migration of value and margins across the oil and gas ecosystem has been highly skewed and unhealthy for the most part in this downturn. The entire size of the oilfield service segment (market cap. of $262 billion), for example, is now less than the size of the biggest supermajor. This growing imbalance in the industry is our biggest worry.”
The oil and gas employment numbers doing rounds in the media give an incomplete view and only put out huge layoffs in the upstream and OFS segments. However, about 300,000 layoffs in OFS, pure-play E&Ps, and IOCs were largely offset by a hiring of 255,000 employees by NOCs and pure-play downstream and midstream companies worldwide. Net-net, current oil and gas employment numbers are only 1% below the pre-downturn levels.
Exploration & production
Underperformance even in an improved oil price environment is puzzling, especially when the worst seems to have passed.
Current stock prices of 30% of pure-play E&Ps and integrated companies worldwide with a combined market capitalization of more than $550 billion are still trading below their early 2016 levels, when oil hit a historic low of $26/bbl.
Only a handful of upstream companies have been able to attain a balance: growth without impacting leverage, payouts, and free cash flows. But those who have, most of them (85%) have significantly outperformed. High payouts aren’t enough to win back investors’ interest.
According to Deloitte strategists, the obsession of achieving double-digit growth rate at any expense (mostly in shales), growing shareholder returns primarily through dividends (supermajors), making piecemeal situational adjustments in a portfolio must make way for the complete “balancing of books” and active management of the entire portfolio of assets.
Oilfield services
The OFS segment, despite its super critical role, is struggling to recover from the downturn, and is witnessing the highest disconnect with the ongoing supply boom.
“From one of the most heavily owned and highly valued segments in the run-up to shale boom, OFS has turned into a liability for its investors as they have lost $300 billion of their invested capital.”
Productivity gains of operators are growing losses of OFS companies. Shales has broken the linear relation between oil and gas production and OFS growth, leading to four consecutive years of negative income with a cumulative loss of about $100 billion.
The OFS segment has never been so fragmented than today with more than 1,000 listed and private companies worldwide and only six companies have a market capitalization of more than $10 billion. Large OFS companies seems to have missed the opportunity of expanding their scale and broadening their scope.
According to Deloitte, large OFS companies need to play a pivotal role in bringing a balance to today’s lopsided contractual relationships and fragmented state of the industry.
Midstream
Although midstream investments self-balance over a period of time, the lag or lead in infrastructure growth is intrinsic to this business.
Proactive investments by US midstream are coming at a negative return of capital of 1% while reactive investments are leading to bottlenecks and loss of business for midstream.
Midstream investments are miniscule (less than $10 billion in 2018) and lagging on last-mile connectivity outside North America, posing a big threat to the anticipated natural gas and LNG growth worldwide.
The sentiment on the shipping industry has turned very negative due to high variability in oil and gas markets, altered trade flows and shipping routes, and excess build up capacity in the past. The entire size of the non-US shipping segment (transporting energy products) has reduced to less than $40 billion, less than the size of many pure-play exploration and production companies.
According to Deloitte, the ongoing energy transition requires a closer alignment of upstream growth and infrastructure planning worldwide. Midstream strategists need to change the return philosophy from yearly yields to total returns in the long term.
Refining
Surplus crude, midstream bottlenecks, and strong products demand have changed the texture of the entire downstream industry. Refining broke its longstanding perception of it being a “disadvantaged” oil and gas business in the downturn—in fact, its market cap share in the industry is at its highest level of about 12%.
Simple refiners have outperformed complex refiners in this downturn, with operating margins to the tune of 7% (higher than even what many oilfield service companies are making). The benefits of abundant shale supply however, are not evenly spread and are having significant regional-level implications.
Independent refiners with associated midstream and chemical businesses seem to have outperformed their counterparts in the pure-play refining business by 10-15% in margins and investors’ attention.
The report notes that, with challenges on the horizon, a molecular management strategy and proactive investments to outdo regulations have become bare minimums.