Busting Myths of Oil’s Demise

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The resiliency of the oil and gas industry has never been more apparent than it has over the past 20 years. While it’s likely that the market growth the industry has enjoyed in the past is over, and that investment sentiment has severely waned, the prospects for hydrocarbon development remain strong.

Still, the energy transition away from fossil fuels is forcing companies to re-examine their operations and even the types of energy they develop. Supermajors, whether by sheer force of outside influence (Exxon Mobil Corp.), legal mandates (Royal Dutch Shell Plc) or self-imposed emission reductions (Equinor, BP Plc), are embracing new methods of producing ESG friendly sources of energy.

But mid-majors, North American large- and small-caps and the variety of producers in between are holding their ground on oil and gas while also making moves to cut emissions. For the foreseeable future, oil and gas development will remain a crucial part of providing the world energy.

But how do those same companies position themselves for the future? How much and how quickly should they adjust their capex toward green energy? In a recent study, Deloitte LLP analysts examined energy transition trends. Their findings revealed that, among other trends, the demise of oil is a “myth.”

Hart Energy recently visited with Amy Chronis, U.S. oil, gas and chemicals leader at Deloitte, and an author of the report, “Portfolio Transformation in Oil and Gas.” Chronis discussed what those myths are, how companies should be viewing their operations as the energy transition evolves and why shale development still remains a highly valuable industry.

Deloitte recently published a report on oil and gas portfolio optimization and whether or not companies should continue to capture value in hydrocarbons or embrace green energy more. What did Deloitte discover during its research?

This is another really pivotal moment in the industry. Oil and gas companies are essentially running out of time to pick a side or a team now that the transition is already moving quickly. Now on the one hand, the value propositions in oil and gas versus green energy are very different, and executives are grappling with how much to invest and in which green technologies.

And then on the other hand, although the high gross growth phase of the oil market may have come to an end, oil demand is still projected to remain.

So our report looked at helping companies assess which team to pick and how to plan the new bid. We forecast that for 2020 through 2030, just to give us the size of the capital redeployment opportunity available to oil and gas companies. We looked at it and assumed an oil price of $55 per barrel.

And the staggering finding is that over the next 10 years, the global oil and gas industry has a huge opportunity to redeploy about $838 billion to right-sizing current oil and gas businesses or pursuing new growth energy areas, like new ventures and new technologies. And so that $838 billion is about 20%—and that’s very conservative—of future capex over the next 10 years. So whether a company remains focused on oil and gas or diversifies as an integrated energy provider or chooses to become a green company, it has to establish its competitive position in the portfolio frontier. Those choices are going to determine the company’s position and the new energy order.

This report cites five myths, one of which is that oil has lost its luster. Can you explain why the study felt it was a myth?

Oil may be down, but it’s definitely not out, and that’s a win-win. Although the high-growth phase, as I mentioned, has come to an end, the reality is that oil demand will remain for the foreseeable future. And it still delivers significant value and is critical to powering the world. In fact, some accelerated energy transition scenarios still project oil demand of about $85 to $90 per barrel by 2030.

In today’s price environment, even by 2030, oil will still be a trillion-dollar industry in revenue terms. So our financial benchmarking analysis showed that about 66% of oil-heavy portfolios delivered above average returns— not often mentioned in the media these days.

You may be surprised to know that a few oil companies have delivered average returns on capital of over 20% over the past five years. That’s higher than many companies and nonservice industries such as utilities and capital goods.

So the important point here is that the energy transition is happening regardless of oil price movements or the economics of green businesses. And counterintuitively, the strength of oil demand is to everyone’s advantage. In fact, a strong oil price has helped companies do both things simultaneously: capturing highest value from the remaining hydrocarbon value and redeploying significant portions of that money toward green energy businesses and solutions.

Another myth explained in the report is that shale’s pain makes other portfolio options an obvious choice. Can you elaborate on that?

High level, it’s all relative. The going has certainly been tough for shale companies—low natural gas prices, WTI to discounted brand, repeated capex cuts and mass bankruptcies. But that’s led to transactions, and even then the pain in shale doesn’t make other resources an obvious investment choice.

So in our analysis, between 18% and 45% of non-shale portfolios delivered below-average performance. The underperformance among offshore deep water and diversified portfolios is high with 39% to 45% of them featuring in the bottom two quartiles.

So we would go back to the foundation. The oil and gas industry is all about engineering operational excellence. It’s less about where one drills and more about how one drills, and that is going to continue. Companies can create a differentiated value irrespective of the resource, including shale, if they have the right set of excellence.

“Whether a company remains focused on oil and gas or diversifies as an integrated energy provider or chooses to become a green company, it has to establish its competitive position in the portfolio frontier. And those choices are going to determine the company’s position and the new energy order.”

We have heard a lot about natural gas serving as a transition fuel in the energy transition. Can you talk about the challenges companies that focus almost exclusively in producing oil will face in the coming years?

You’ve nailed it in terms of the home has changed or in terms of where things are going. We really think that oil specialists with the most efficient and lowest cost of operations, those with the best balance sheets, those with undisputed access to markets and those with the best operating technologies and marketing platforms, for instance, offering carbon-neutral oil, those are the ones that will likely be able to sustain and even grow their share in the shrinking hydrocarbon businesses.

Natural gas is slightly more resilient than oil in that it’s underpinned by its role in supporting developing economies as they decarbonize and reduce the resilience of coal and is a source of near carbon energy when combined.

In Deloitte’s opinion, where should companies be allocating their capital right now?

Each company will have its strategy. A winning capital allocation strategy is four things. I would say that it sustains cash generators that, for instance, have projects that generate cash with the least risk and capital intensity. Secondly, it invests in future growth engines, projects that replace lost fossil fuel-related growth. Thirdly, that it maximizes profit when an opportunity arises, like having projects that are fast scalable for any price upside. And lastly, that it chops value strains, that it rigorously identifies projects that can be targeted for capital reallocation. So those are our four tenants around allocating capital right now.

For companies looking to diversify, which green projects should they prioritize?

Our analysis of the media showed that solar and wind are ruling the day in terms of media attention and notice. According to our analysis of news articles, renewable power, solar and wind energy are grabbing the highest media share, about 47% among all green energy models with sentiment turning toward green hydrogen and CCUS [carbon capture, utilization and storage].

On the other hand, interest in more established gas-based opportunities, including gas power generation, LNG processing, retailing, natural gas conversion, seem to be falling in the analysis yet rising in technological innovation and focus on our future R&D.

Overall, we see companies likely benefiting from spreading the risk and choosing a combination of clean energy capabilities. Based on those text analytics over the last two to three years, renewables, maneuverability and storage and green hydrogen emerges the most frequently mentioned. But it is really a new frontier, and it’s critical that the world recognizes that this business is the frontier and must be essential to the new solutions of tomorrow.