Nick Butler in the FT: “Energy executives returning from their summer holidays face some hard choices. I know of at least three major oil and gas companies that have ordered full scale strategic reviews.”
“The problem, for the companies and for investors, is that prices are falling. The Brent oil price is down 15 per cent since June and by the time you read this could have slipped below $100 [Update: this morning, Brent fell 87 cents to $99.95 a barrel – a 14-month low.] Natural gas and coal prices are also down.
Those falls come despite:
— serious civil conflict in Iraq and Libya
— the continuing tension in Ukraine
— the persistence of sanctions against Iran
— and the continued relatively strong economic performance in China and India, the great growth markets for the sector
….The current downturn could last a long time. The “optimists” forget that technology — on both the supply and demand side — is driving down per capita consumption across much of the world, while politics is driving up the supply of alternative, subsidised fuels. So what can a prudent company do? There are four key steps which apply in different ways to companies across the sector, from Gazprom to Total; from Exxon to the smallest new start up in the North Sea.
1) Cut costs. In most companies, the current cost structures are fit for a world of $125 oil, and similarly high gas prices. The cuts have to be direct: goodbye once again to the corporate jets, the lavish expenses and the padded leather of town centre offices. They also have to be indirect: confronting the cost creep of the service sector. There is scope for radical simplification and restructuring.
2) Cut assumptions about future price rises from the corporate planning process. The idea that prices would continue to rise in real terms is described as “forecasting”, but is really a dressed-up version of wishful thinking.
3) That next adjustment is the third step – drop projects which can’t fly on the lower scenario. There will be squealing as the sacred cows are sacrificed but life will go on.
4) The fourth step, to be taken precisely because life does go on, is to increase the targeted budget for research, focused on technology which will lower costs. The corporate world has tended to neglect this option and to see R&D as a cost which can easily be cut. In fact it is a crucial investment, essential for long term survival. Those who can apply technology to reduce exploration, development and production costs will be the winners as the cycle plays out.
For companies which are already relatively efficient and in control of their costs the ice bucket will be relatively painless. The best CEOs and finance directors will have a list of the cuts which can be made in their back pocket. For others the process will be difficult and for some, deeply destabilising. Projections of future price rises can become embedded in corporate culture to the point where executives believe that they can’t be wrong and that it is the “market” which is making the mistake. But the pain is necessary and much better for the company than relying on optimism and a faith-based analysis.
Future Today
