Bain & Co.: Tough decisions loom on costs, investments

Tentative economic recovery and volatile oil prices will force managers of the oil and gas industry to make tough decisions soon, warns Bain & Co., Boston.

By OGJ editors
HOUSTON, Sept. 8
-- Tentative economic recovery and volatile oil prices will force managers of the oil and gas industry to make tough decisions soon, warns Bain & Co., Boston.

Price gains in the second quarter of 2009 restored oil company profits hurt by the slide in last year’s second half. But they create hazards, the consultancy says: Further price increases might slow the global recovery and hurt efforts to lower costs.

The uncertainty complicates investment decisions by oil company managers.

“On the one hand, they must continue to cut costs without compromising on important areas like maintenance, technology, and people development,” Bain says in its Midyear Review. “On the other, they must invest in large-scale capital projects to replace declining assets and increase future revenue growth.”

Project and exploration delays resulting from the price slump might cut conventional production capacity worldwide from historic highs by 3-5 million b/d by the end of 2010, Bain says, pointing to unusual constraints on exploration and production investment.

In all industry slumps, operators delay or shelve production projects as expected returns fall. To those crimps on production, the current slump adds limits on capital availability and “price deflation after years of inflation.”

Timing crucial
Opportunities exist for solid companies acting at the right time.

“Those companies that have built up reserves and have a strong projects pipeline will be in a prime position to capture new opportunities,” Bain says. “Others will either watch from the sidelines or be swallowed up in the industry churn.”

In the next few months, the consultancy says, industry managers must answer three questions:

-- At what point do we switch the emphasis from cutting costs to ramping up investments for the future?

-- In a volatile price environment, what should we assume about the future of oil prices to make investment decisions?

-- If oil prices settle at $60-70/bbl for the rest of 2009, how should we deploy the additional gross revenues?

Bain estimates the oil and gas industry cut expenses by 20% during the first half of 2009 from their levels of 2008. The cuts came mostly from reducing activity, pressuring suppliers, and squeezing operational costs.

At an oil price of about $65/bbl, the firm says, “the industry’s need to contain costs is overtaken by the desire to expand and grow.”

If oil prices remain above $60/bbl during the next 2 quarters, the industry might have additional cash income exceeding $100 billion. In recent years, the industry has tended to return cash windfalls to shareholders through dividends and buybacks.

“The last 12 months,” Bain says, “have made the decision on how to spend the money much more complex: invest for the long term, invest in a strategic acquisition, or abdicate the decision to shareholders.”

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