Looking past the short-term

TOM ELDER: My interest in natural resources came early in my life, when I came close to completing a geology degree during my undergraduate studies. However, when the 1980s oil bust occurred, I decided to transition into the accounting program instead. After graduating with an accounting degree, I went to work for a major global accounting firm as an auditor in their energy practice, eventually becoming a senior manager. I then joined UHY LLP as a partner in 2002, where I significantly expanded the firm's energy practice over the next decade. UHY's Texas practice merged with BDO in late 2014, and I became the co-leader of BDO's US Natural Resources practice with Charles in 2016. In my role, I am responsible for driving revenue growth for the practice, employee training, and thought leadership.

OGFJ: How may the Saudi-led diplomatic freeze of Qatar impact the global LNG market? What about the impact on the US market? Could US LNG companies benefit from this development?

DEWHURST: Qatar is currently ranked as the world's largest LNG exporter-and thus, we can expect far-reaching consequences resulting from the diplomatic freeze, one of which includes increased barriers to LNG shipping. Before the block, Qatar's LNG vessels have typically refueled at the United Arab Emirates' (UAE) port of Fujairah. This port, however, is now off-limits, greatly limiting Qatar's ability to ship LNG to its major customers in China, India, and Japan. If Egypt follows suit and restricts access to the Suez Canal, Qatar will also be unable to reach its European customers. While the latter development is still mostly speculation, any changes in shipping arrangements could easily lead to a falloff in LNG supply to Asia and Europe.

As a result, many Asian and European countries are scrambling to find alternative suppliers of LNG-presenting a significant opportunity for US, Australian, and Russian LNG producers to ramp up production. While boosting LNG supply in the short-term is difficult due to the amount of time it takes to construct an LNG plant, the long-term opportunities are boundless. In the US, we can expect to see a renewed focus on expanding natural gas production, especially along the Gulf Coast.

Until companies have the LNG infrastructure they need in place, restricted LNG supply could carry environmental consequences. Many Asian and European countries will most likely fall back on coal for their energy source, which, ironically, is what many nations are trying to move away from.

OGFJ: What impact could the May 11 US-China Comprehensive Economic Dialogue trade agreement have on the US's overall global positioning as an LNG exporter?

DEWHURST: Anytime the leaders of the two largest global economies reach an economic agreement, it's a good thing-and it appears that both President Trump and President Xi of China are personally vested in the agreement's success. As a result of the agreement, which opens the US and Chinese markets to trade in certain key areas-including US exports of LNG to China-the US will now treat China no less favorably than its other non-Free Trade Agreement (FTA) partners in regard to LNG exports. This opens the door to allowing Chinese companies to negotiate all types of agreements with US LNG exporters, including long-term contracts. As recently as two months ago, the US Department of Energy authorized 19.2 billion cubic feet per day (Bcf/d) of LNG exports to non-FTA countries.

The agreement has opened up another lucrative and profitable Asian market for US LNG-exporting companies. There is a greater positive price differential for LNG in Asia versus the US compared to the price differential between Europe and the US, which makes exports to China more profitable than shipments to the EU.

OGFJ: What do these developments imply for oil and gas companies with investments or presences in Qatar or the Middle East?

DEWHURST: The Qatar crisis brings with it several implications for US oil and gas companies invested in Qatar and the Middle East. The US, for example, has a major airbase at al-Udeid in Qatar, which is used for strikes against ISIS in Iraq and Syria. The airbase, together with the US Naval Forces Central Command and the home port of the US 5th Fleet in Bahrain, also serves to protect the interests of the US oil industry in the region. Unfortunately, because Qatar and Bahrain are on opposing sides of this crisis, the US finds itself in a precarious position. How the crisis plays out for these two strategic bases will have significant consequences for US interests in the region.

Many US companies have significant investments in Qatar, as well. Qatar's LNG industrial complex, for example, currently exists as a partnership between ExxonMobil and Qatar Petroleum, the state-owned oil company. The Dolphin pipeline that supplies Qatar's natural gas to the UAE, as another example, is a joint venture between Houston-based Occidental Petroleum (harboring a 24.5% ownership stake), Total of France (24.5%) and Mubadala (51%), the UAE's Sovereign Wealth Fund. The American companies with significant interests in Qatar and the broader region can expect to be strongly affected by the instability brought on by the crisis.

OGFJ: Will the surprise appointment of Mohammed bin Salman bin Abdulaziz-known for his charge to wean Saudi Arabia off oil as part of a new economic strategy-as the new deputy prime minister and first in line to succeed King Salman affect markets?

DEWHURST: Mohammed bin Salman bin Abdulaziz's appointment as the new deputy prime minister will affect markets-but not to a huge degree, since his plan to move Saudi Arabia away from its total dependence on oil and gas is well known and has already been factored into the global oil price, as well as his plan to sell 10% of Saudi Aramco following its IPO. While he is known for his hawkish views on foreign policy and the use of military force in Yemen, which has caused some concern regarding his handling of the Qatar crisis, the Crown Prince-at 31 years of age, 50 years younger than his father-is also known as the face of a younger, more liberal Saudi Arabian leader.

In fact, Mohammed bin Salman bin Abdulaziz is the primary architect of good Saudi Arabian relations with Russia, which have enabled the two countries to agree on production quotas that have, so far, stabilized global oil prices. The most likely adverse impact on global oil markets from his appointment as Crown Prince will probably come from a hardening of the country's position with respect to Qatar and Iran, which may concern global investors in the industry.

OGFJ: ExxonMobil recently made a final investment decision to proceed with the first phase of development for the Liza oilfield located offshore Guyana. With Phase I development expected to cost more than $4.4 billion, and production slated to begin by 2020, what are the implications for the discovery and its impact on the offshore industry-hit especially hard by the industry downturn?

DEWHURST: The offshore sector was picked as an early loser in the natural resources industry, as oil prices tumbled from $100 per barrel to $20 per barrel, before stabilizing in the $45 to $55 per barrel range. The deepwater offshore sector, which includes the discoveries in Guyana, tends to be the domain of the energy supermajors and the local national oil companies (NOC) because of the large expenses involved and long exploration-to-production timeline. The larger energy companies are usually able to take a much longer and more strategic view of potential assets than the smaller independents because of their deeper financial pockets.

Interest in deepwater exploration in the Americas region has continued despite the global downturn in oil prices. One notable example is BP's massive Mad Dog 2 project in the US' Gulf of Mexico. Another can be seen from the success Mexico has gleaned from opening its oil industry to foreign companies-exemplified in the successful auction late last year of the deepwater blocks in offshore Mexican Gulf waters, which saw major investments from BHP Billiton, China National Offshore Oil Corporation (CNOOC), Total, Chevron and ExxonMobil.

The huge discovery by ExxonMobil, Hess, and CNOOC in deepwater Guyana reflects the supermajors' commitment to the deepwater sector. This discovery of the Liza field will be one of the larger discoveries in South America, with estimated recoverable oil reserves of 1.4 billion barrels. As production is not predicted before 2020, the impact on global pricing from the Liza field is not likely to be significant. Rather, it serves as an incentive for other players to invest in other regions with potential major deepwater fields.

OGFJ: In BDO's 2017 Energy Outlook Survey released in January, fewer CFOs cited low oil and gas prices as their greatest financial challenge this year compared to last year (62% versus 85%), and fewer expected decreasing prices to inhibit growth (49% versus 55%). To what do you attribute the increased optimism, and do you think, halfway through the year, the cautious optimism still holds true?

ELDER: The cautious optimism in late 2016, seen in our Energy Outlook survey, was due, in part, to OPEC's agreement in November 2016 to cut production by about 1.2 million barrels per day (plus another 0.6 million bbl/d by certain large non-OPEC producers) beginning in January 2017. The combination of these production cuts, coupled with expectations of high global demand for oil, was viewed positively by many as factors that could help bring the supply and demand cycle back into balance.

As the production cuts began to take place and oil prices began to rise, US shale producers began to put their drill bits back to work again. This resulted in an increase in crude oil inventories, which sent oil prices south again. Because of this, we are seeing the optimism for higher sustained oil prices over the last half of 2017 soften, largely due to the glut in US shale production that's causing supply to outpace demand.

OGFJ: BDO advises on M&A, cost management strategies, and risk management. All seem especially relevant given the tremendous volatility in the oil and gas sector in recent years. How has this downturn impacted what you do?

ELDER: Throughout the downturn, BDO's Restructuring & Turnaround practice and Valuation & Business Analytics services experienced the greatest increase in demand. The many restructurings and bankruptcies that resulted from the downturn touch on every service line that BDO provides, including audit, tax, consulting and compliance services for companies that have filed for bankruptcy. BDO professionals in the Restructuring & Turnaround practice offer advisory services to both energy debtors and creditors to help companies implement strategic changes in challenging financial circumstances. They also offer valuation services, including the application of fresh start accounting, which is typically required upon a company's emergence from bankruptcy to record the fair values of the company's remaining assets and liabilities.

From an M&A perspective, there was a considerable slowdown in deal-making activity as investors chose to keep their cash on the sidelines until they could get more clarity on the expected magnitude and duration of the downturn. Private equity (PE) firms that dabbled in energy during the years of $100/bbl oil were no longer active in the deal flow when prices dropped. PE firms with a strict focus on energy continued to play ball, recognizing that downturns can, in fact, bring some good opportunities for certain investors. Along with BDO's Private Equity and Transaction Advisory Services practices, we worked closely to support both buyers and sellers in the energy industry.

OGFJ: Technology has played a huge role in the resilience of US E&Ps during the downturn. What trends do you see in the continuation to advance efficiencies and lower cost applications?

ELDER: Over the past few years, we've seen the oil and gas industry adopt a plethora of innovative technologies in an effort to advance efficiencies and lower costs-particularly in the technical and engineering applications used in the drilling and production of oil and gas. However, during the periods of peak oil pricing (i.e. $100 per barrel), we have ironically also seen the adoption of new technology slow down, due to the pressure on companies to drill and complete wells as fast as possible. This need for speed makes it challenging for companies to experiment with new technologies that have not yet been proven in live operations. It is actually during the downturns when energy companies have time to focus on trying and testing out new technologies-as well as the incentive to produce as efficiently and cost-effectively as possible.

Currently, the biggest technology trends sweeping the energy sector are the same ones impacting other industries: data analytics, digital systems, drones, and more. Many companies use data analytics, for example, to better determine when critical equipment may need to undergo maintenance or repair to operate at the most efficient capacity. Companies also use analytics to make smarter decisions on what drilling programs they should focus on to maximize production. Companies can use digital technology in the oilfield to better monitor the thousands of sensors on wellheads, pumps and other oilfield equipment from one central location onshore (versus from multiple platforms) in real-time. Drone technology, in the meantime, is largely still in the testing phase. In the future, drones could be used to monitor operations and explore and develop reserves in more remote locations and harsh environments. As less human resources are needed, drones could minimize safety concerns and translate to significant cost savings.

OGFJ: What are the biggest investment considerations for US oil and gas companies? Can companies look past the short-term with sub-$45 oil prices, and what is your outlook for capital availability in 2H17 and 2018?

ELDER: All oil and gas companies need to examine reserves' rates of return and determine which reserves to replace and grow, but investment considerations vary widely depending on the size and scope of the company. Large integrated oil and gas companies have more investment options at any one time and can wait much longer for those investments to pay off. For example, there may be a deepwater play with humongous reserves but no existing infrastructure that could bring those reserves to production. In this scenario, large integrated companies have the luxury of being able to allocate significant amounts of time and investment in building the infrastructure required, while also benefitting from the lower costs during the downturn.

Smaller independent energy companies require more flexibility in their capital expenditure programs since they need to be able to quickly react to changing markets and put their capital to its best use at all times. During major downturns, small and mid-sized independents are often forced to reduce their capital budgets to bare minimums, using their capital primarily to maintain production and/or drill any properties where drilling may be required to maintain the lease. While many small independents are still trying to straighten up their balance sheets, they are limiting investments to only their operating cash flows.

OGFJ: Thank you both for your time.