Thinking through the downturn

OGFJ: Give us an overview of what KPMG does in the energy sector.

MAYOR: We cover audit, tax and advisory. We're well known for the audit and tax sides. We work with some of the largest oil and gas companies in the US and globally. We provide a lot of tax assistance services associated with that, from compliance around tax returns, assistance with expatriate tax for individuals, or very complex tax-based management programs around international or federal taxes. We have a large and growing advisory business which provides everything from accounting advisory assistance to transactions and corporate finance, all the way through to corporate strategy, technology deployments, and process transformation. It's very full service. I'm always learning of new things that we can do. KPMG has 174,000 employees around the world, operating in 155 countries; it's amazing. Where companies operate, regardless of the type of service that people need, it's likely that there's a way KPMG can serve.

OGFJ: How would you describe the current state of the energy industry? Can we say we're in a rebound stage?

MAYOR: Let me parse those components. The current state of the energy sector: it's tough out there. Really tough. When Alan Mulally, former president and CEO of The Ford Motor Company, gave his keynote speech at the 2016 KPMG Global Energy Conference, he talked about his time at Boeing, serving as a senior executive post 9/11, and how sales of planes went from 690 down to 280 or so. His words were, "I can't think of many businesses who've suffered a 70% revenue decline in a 12-month period." I had several oilfield services CEOs sitting around me. They all turned around and looked at me and said, "We can!" It's traumatic. It's dire. It has lasted longer than anyone would have expected.

And, from what I'm hearing, it's different from what happened in the 80s. It feels different. This downturn is not dissimilar to what we've experienced in the past, but it feels different emotionally. Part of it, I think, is that we got complacent. At the 2014 KPMG Global Energy Conference, we asked people what they thought commodity price would do. Fully 90% of us in 2014 thought the price of Brent would stay above $100 per barrel, on average, through the remainder of 2014. We know now that prices started plummeting shortly after in June of that year. I think that shows where we were as an industry as well as what we're suffering though now. I think the industry has taken some really hard steps to restructure and pull the Band-Aid off as quickly as possible. One of our oilfield services clients, for instance, has dropped headcount 75%. People are really feeling the human cost.

Would I say we're in a rebound? No. I think $50 gives us a tiny bit of breathing room, but I don't think anyone's ready to declare a rebound yet. That being said, I would have expected more bankruptcies than we've seen. We're still seeing leniency on the part of the lenders. I don't think banks are excited about being handed the keys to a bunch of gas production wells, plus, it's still an underlying asset, so provided the loans are so-called "money-good" where the interest payments are made, the banks are stretching it out. The wave was predicted in October and then predicted again in April of this year. Of course, the cost of capital is going up. It's not a rosy picture, but not all companies are going bankrupt. I think the industry is more robust and resilient than a lot of folks gave us credit for.

OGFJ: The economic viability of major oil and gas projects, and even of the companies themselves, is seriously challenged today. How has this impacted what you do? It seems as though your expertise in business transformation, process redesign, organizational design and change management would be especially relevant.

MAYOR: You're spot on with this question. There's a certain group of companies that are using this downturn as a catalyst for change. They're judiciously using outside advisors to challenge their thinking. The way they've done it is the way they've always done it. If they could have built a better mousetrap through their own devices, they would have done it already. That component has been terrific for our strategy services and business process redesign and even our organizational redesign. There is a group of companies that need economic and accounting advice as they go through bankruptcy. There are so many things to consider as you renegotiate debts and try to preserve some tax efficiencies. It's very complicated.

Our business here at KPMG has survived nicely. We're up a bit year over year…single digit growth. Compared to colleagues in high growth sectors like healthcare, life sciences, or government, I'm not doing well, but when you look at commodity price and how it has plummeted by 60-plus percent from its high and I'm flat year over year, I look pretty heroic [laughs]. Part of that is attributed to the portfolio. For our business it's power and utilities, oil and gas, chemicals and mining-and not all of them are having a homogeneous response to commodity prices. For power and utilities and for chemical companies, the current price environment is a good thing. Even in oil and gas it's not homogeneous. Oilfield services and upstream independents are suffering the most and midstream is getting hit pretty hard. Downstream was insulated for a while, but margins are being squeezed and it's becoming a bit harder for them. So given that portfolio and the breadth of services we provide, our business is solid-especially as a fair portion of our services are provided to companies in distress, we get called on to help with bankruptcies, restructurings, and M&A.

OGFJ: What changes do you see in terms of energy investment going forward? What are some of the implications for the businesses?

MAYOR: I think it's going to be limited. I think it goes back to your previous question about the viability of the major oil and gas projects. My personal belief is that the era of the mega project is over. This whole notion that we're going to bite off these projects worth billions and billions of dollars-I don't think we'll see that. As far as offshore, I think companies are going to figure out how to do projects in bite-size pieces. Now I'm not an engineer, so maybe there will be limitations to that, but this idea that you're going to go build out a Gorgon like they did in Australia or you're going to go attack the Arctic with zeal…I just don't see it. I don't see companies, at least in the next decade, willing to take those kinds of risks, especially given the cost of capital.

OGFJ: Managing costs is, of course, an overriding topic right now. In the current market what, if anything, has changed about those discussions? Is data a large component in the short-term?

MAYOR: I don't see data as the savior, I think it's more "back to basics." Going back to Mulally's speech at the KPMG conference and his Boeing example-the CEO of Diamond Offshore, Marc Edwards, was in the audience. He stood up and asked, "What do we do?" Mulally was very blunt: You absolutely have to resize to grow the company. He has a formula called the PGA, Profitable Growth for all Stakeholders. Applying that to Ford, Mulally noted that the company was sized for 28% market share. They actually had 9% of the market share. They had almost 500,000 employees and they took it down by half. Unless you resize yourself to fit the revenue profile then you simply cannot grow again and focus on how you're going to do things differently. In 2015, many of our clients took short-term tactical actions…no more travel, no more training programs, no more conferences. All contractors left the building. They did some headcount reductions. Those changes aren't sustainable for the long term. Now they're asking "How can I really manage this operation with 40% fewer employees?" Data will certainly be a component, but I think companies will need to spend money before they can make money, and in this exact environment, data is still unproven. We see pilots starting, but will that be the savior that'll get them through the downturn? I'm not convinced that it's ready for primetime. I think the benefits of those kinds of investments are still 5-10 years out and you have to survive this year and 2017.

OGFJ: Layoffs in the sector have cut deep-from the field to the corner office. Many companies will be forced to rebuild. What are your thoughts on human capital as the industry emerges from the downturn?

MAYOR: I think that is the $64,000 question. I think companies are really working hard on the human capital management side of the formula. Some are using it as an opportunity. They need folks that are more comfortable in a digital environment because data will be the future, but at the same time, you don't want to lose the expertise that you had. No one has cracked the code. I don't think it's going to be this boom and bust cycle. I think we're going to figure out how to live with fewer employees, whatever that right number is for a particular company, and how to make money and be profitable in a sub-$40, sub-$50 environment. With that headcount, as we grow, we're going to figure out how to use technology better. So it isn't "go find the employees you laid off;" we're going to think differently about how we manage the growth curve in the future. That's how I think it's going to work, and hopefully most of the companies going through it and surviving are the ones being smart about who they're keeping.

OGFJ: Uncertainty with regard to industry regulation is another topic of concern. What are some of the current discussions during this campaign season?

MAYOR: I think we'll continue to see, regardless of who makes it into office, carbon reduction goals/mandates. How it comes out will probably differ based on whether it's a Democrat or a Republican, but overall I'd say carbon reduction will likely be a regulatory desire. At the recent KPMG conference, we talked a little about a carbon tax. There are effective ways to use carbon taxes to reduce emissions and enable the free markets to trade against carbon emission requirements. The industry tends to favor those types of regulations as opposed to absolutes. Regulation continues to be a challenge and an opportunity. The industry in general is incredibly responsive to doing the right thing. Period. Regardless of whether it's a regulatory mandate or not. On top of that, I think it's an industry that's incredibly scrupulous around complying with regulations. The challenge is always understanding the regulations. An example is the Renewable Fuel Standard and the fact that the EPA keeps adjusting the ethanol mandate. These are even backward-looking mandates. For the industry, it's head-scratching. The vagaries are the biggest frustration and challenge for the industry. Having an administration that's not a lame duck and has a process that follows the conventional rule-making system, that isn't reliant on executive orders, could be beneficial for the industry. The current administration hasn't had an energy policy, but it has shown a desire for carbon reduction in advancement of reducing climate change, which is a great and admirable goal, but exactly how that's transpired and become law has been vague and difficult to comply with. I can't predict the election outcome, but I anticipate carbon reduction will continue to be a goal. How much emphasis gets placed on that goal and how rigidly it gets applied will be interesting. You'll continue to see subsidies for renewables and other forms of energy generation.

OGFJ: Thoughts on prices going forward?

MAYOR: We had a group of economists at our conference. Dr. Philip K. Verleger, Jr., an energy economist, had a fascinating prediction that oil will be priced like an agricultural commodity. I don't know, but it was quite interesting. He predicts prices will stay low for long periods of time until there's a major supply disruption, like the price of corn during a drought. He wouldn't say it would never spike above $100, but his point of view would be that it's very low for very long periods of time, and then it might have huge disruptive forces. That was fascinating to me. The belief is that oil is no longer an exhaustible commodity-we'll still have oil in the ground when we're using something fundamentally different, whereas before there was the theory of Peak Oil. The thought that we'd run out made it priced differently. Verleger says there's so much hydrocarbons available that the pricing curve is going to fundamentally change. It seems consistent with how things are starting to happen with prices. A major supply disruption could easily occur, but I do think people are going to have to get comfortable with sub- $50, sub-$60 for very long periods of time. And to think that you could get to $80 or $100 and stay comfortable there-I don't see that through the next decade or more. Moreover, his thought on actions by the Saudis is that they believe oil will be left in the ground. If what you have in the ground isn't worth anything because we'll convert to some other resource...and you can argue about when that happens...but if you ultimately believe that your natural resource is no longer exhaustible then you're going to get out as much as you can, while you can, and while you can still sell it-even if you're selling it at a lower price point. Right now, $50 gives us breathing room. I think companies are sizing themselves to be profitable at $40, but I'm hopeful that we'll get to $60 by the end of the year.

OGFJ: The industry is multi-faceted and ever-changing. Is there anything you'd like to add?

MAYOR: The one thing we haven't touched on that I tend to speak a lot about are social and demographic changes that could translate into different approaches for using energy. For one, ageing is creating a drive toward urbanization. People are downsizing their homes, they're moving closer to cities, and becoming less reliant on owning vehicles. On the other side, millennials are demonstrating behaviors that show that cars are just a means to an end for them. Their freedom comes from their phone and the internet, whereas other generations viewed cars as freedom and a status symbol. So cars are being defined differently. It doesn't mean they'll be used less, but the exact role they play in society is changing. Driverless cars and the ride-sharing economy are also part of the equation. These are conversations we're having on the hydrocarbon side. We're trying to look ahead. Gasoline demand in the US is a low-growth, no-growth demand scenario with fuel efficiency standards. While there could still be demand outside the US, understanding what those social and demographic changes are-because they are big shifts that are coming-starts companies, energy or not, thinking about what these things might mean for the business model and customers' preferences.

OGFJ: It's been a pleasure speaking with you, Regina. Thank you for your time today.