History Doesn’t Exactly Repeat, But It Does Rhyme

By Allen Brooks, PPHB

“Lower for longer” was former BP CEO Robert Dudley’s description of his management team’s frame of mind as they plotted the company’s future.

That was back in 2015, when oil prices were falling after Saudi Arabia abandoned its role of supporting the organization’s official price and targeting the recapture of its lost market share.

Petroleum industry executives recalled when Saudi Arabia made a similar move – 1985 – and what resulted. It was an ugly decade marked by energy company bankruptcies, reduced drilling and completion work, and hundreds of thousands of jobs lost. But consumers were smiling as they filled up on cheap gasoline.

Fast forward to 2021 and the oilfield service world is as challenging and uncertain as it was in the 1980s. Today, traditional producing company activity drivers are no longer as compelling, upsetting the dynamics of planning for well service companies. The priorities of E&P customers are different from those in 2015 and for decades prior. Then cash flow was important, but growing oil and gas production was key because it drove company valuations and executive compensation.

Today, there is a new hierarchy of industry activity drivers. Financial discipline and environmental, social and governance (ESG) metrics are at the top of the list. Growing production and reserves ranks lower. Will this new industry DNA survive the pressure for expanded output in a recovering economy and an emerging global energy crisis? Or will managers embrace their old impulse for unrestrained and profitless growth?

Despite the ongoing pandemic, economic activity is recovering, which is driving forecasters to raise their oil consumption projections. Since the spring 2020 collapse, we are enjoying a sustained recovery in demand. Projections by OPEC, the IEA, and the EIA call for oil consumption surpassing 2019 pre-pandemic levels sometime in 2022. They also see demand continuing to increase in the years ahead.

Weighing on executive thinking is the regulatory push to reach a fossil fuel-free world within the next 25-30 years. As a result, many forecasters project global oil consumption peaking in the mid-2030s, a decade away. The rush for a clean energy world is running into technological and financial challenges – issues never fully explained to a public forced to pay escalating power bills and having their lives disrupted by policies and mandates.

Oil and gas executives are watching the news and seeing renewable energy facing greater challenges than ever envisioned. Increasing numbers of electricity blackouts are forcing utilities globally to turn to fossil fuels to keep the lights on. At the same time, utilities are abandoning coal, the cheapest and most prolific power source in the world, due to its high carbon emissions. Many utilities worry about greater reliance on intermittent renewable power, so they are turning to natural gas, and in some cases oil, for backup supplies.

This suggests those peak oil consumption dates may be pushed out further into the future. Importantly, even if oil consumption peaks, oil use will not drop to zero. Energy forecasts for 2050 see fossil fuels — oil, gas and coal — still involved in powering the world’s economy. The EIA envisions oil and gas consumption growing beyond 2050, if the funding is available.

Belief in the long-term future of fossil fuels is driving transactions in the petroleum world. The decision by Shell to sell its Permian acreage to ConocoPhillips reflected a strategic effort to leverage the core strengths of each company. Shell held a small asset base in the Permian relative to its worldwide holdings. Selling those oil wells will barely impact Shell’s long-term prospects. For ConocoPhillips, the acquisition expands its acreage in the basin, allowing it to leverage existing staff and logistics infrastructure, key to increasing profitability.

With financial discipline at the top of the strategy list, petroleum companies have been reluctant to step up drilling new wells, despite higher commodity prices. New wells are highly visible and could draw critical attention. Less visible, but potentially more profitable, are new well completions and sustaining well output. E&P company spending is directed that way. Drilled but uncompleted well counts are falling from their June 2020 peak. Without an acceleration of new well drilling, the U.S. may be on the cusp of a peak in domestic oil output. If that happens, oil prices will go higher to stimulate more drilling, or we will begin importing more oil, increasing the country’s dependency on foreigners for our energy, and lifting global prices.

For the oilfield service industry, pricing struggles to advance in a lower activity environment. The increase in OFS bankruptcies over the past several years reflects the weak pricing and depressed activity that followed the 2014 oil price collapse. This led to fewer service companies operating, however, OFS capacity did not shrink enough to restore profitability throughout the sector. The lack of pricing power set the stage for mergers and acquisitions to consolidate capacity, strengthen survivor balance sheets and begin restoring OFS pricing power. This ongoing process will continue if the history of oilfield business cycles is any guide.

Despite the elevated roles of financial discipline and ESG, oil and gas consumption will continue to grow. The need for petroleum products will extend for decades, regardless of the push for a net zero carbon emissions world. That need will drive the petroleum industry and its OFS companies to strategize how best to grow. Climate activists’ pressure on lenders and providers of capital will create challenges for funding corporate growth, but improved profitability will help provide the necessary funds.

Petroleum company executives looking to the future and concerned about the myriad of challenges they face should reflect on the past and remember that their predecessors also faced daunting challenges, which they subsequently managed. There is no reason to believe today’s leaders cannot successfully navigate the future.

Allen Brooks has spent 40-plus years in the energy and investment industries as an energy securities analyst, an oilfield service company manager, a consultant to energy company managements and a member of the board of directors of oilfield service companies. Since 2005, Mr. Brooks has been an adviser to PPHB LP, a boutique oilfield service investment banking firm with offices in Houston and Calgary. There he publishes his highly regarded energy newsletter, Musings From the Oil Patch, and provides proprietary research for the firm’s partners.