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As oilfield services and equipment (OFSE) companies seek new ways to generate value, they must address the fundamental shifts taking place in the industry, including slowing demand, improving economics for renewables, an evolving customer base, and changing expectations from capital markets, investors and other stakeholders.
To truly appreciate this challenge, companies need a thorough understanding of the implications of these trends. McKinsey has outlined the five most significant shifts and their implications for the OFSE sector.
1. Flattening demand growth
According to McKinsey’s Global Energy Perspective 2021, growth in energy demand is likely to flatten as the energy intensity of GDP continues to decline. Projections show demand may peak before 2030 for oil and 2037 for gas. Although oil and gas still account for a sizable portion of the total energy mix, this plateauing, then declining, demand limits the growth potential of traditional OFSE value pools. A more aggressive accelerated transition, as indicated by recent electric vehicle announcements and rapid hydrogen development, would hasten OFSE sector decline. As OFSE companies pursue new avenues of growth, emerging energy segments will be prime candidates.
2. Renewables moving down the cost curve
Renewable energy technologies including solar photovoltaics and onshore wind are becoming competitive with traditional energy sources around the world. New renewables will become cheaper than existing coal and gas in many global power markets over the next decade. The levelized cost of electricity from solar has dropped by more than 85% over the past decade and is expected to decline further. Expectations are similar for offshore wind and electricity storage.
Meanwhile, the regulatory environment is becoming more favorable to renewables, and public pressure to reduce greenhouse-gas emissions is intensifying. However, significant uncertainty about total demand potential and the pace of adoption of renewable energy sources persists. Market uncertainty not only affects OFSE valuations but also makes it challenging to identify opportunities in core and adjacent markets, to design a superior strategy and to accurately time investments. An agile and proactive approach has never been more important.
3. Evolving customer base
Three important market shifts are driving the evolution of the customer base for OFSE companies. First, independents have tripled their share of global production of liquid fuels, from 5% in 1970 to 15% in 2020, with a business model that emphasizes low-cost and lean operations. Second, industry consolidation is increasing, with operational excellence as the key value driver. Third, national oil companies (NOCs) are continuing to develop internal capabilities and are facing increased cash-generation demands from governments.
In aggregate, these drivers are diverting demand from OFSE premium products to unbundled (particularly in areas of low integration risk, such as shale or conventional onshore) and commoditized solutions.
4. Investments in new energy segments
Oil and gas companies are increasingly looking for growth outside of core markets—diversifying their investments into new energy segments—in response to pressure from investors to increase their terminal growth rates, and from stakeholders broadly to combat climate change.
European majors have led the way: Shell plans to increase its renewable energy capex to 25% of its total capex by 2025, and bp and Total, respectively, aim to invest about $5 billion and $3 billion per year by 2030.
Recent activity also suggests a diversification in the focus of U.S. majors and NOCs beyond their core businesses. In July 2021, Chevron announced the formation of a new business unit to manage its low-carbon investments, and in September it pledged to triple its investments aimed at reducing its carbon emissions footprint through 2028. A renewed global commitment to combat climate change will likely lead these and other companies to allocate more of their capital to new energy segments.
OFSE companies have an opportunity to make up for the decline in spending in traditional markets; they can follow their core customers into new and rapidly growing markets. Although they would be targeting new business units, they may have an advantaged position, given their corporate-level relationships and reputations for delivering high-quality products and services. Companies will need to reallocate capital and build new capabilities to make this strategic shift successful.
5. Changing investor and capital market expectations
Capital markets and investors are adapting to climate risk and the accelerating energy transition by fundamentally shifting expectations for their portfolios. First, they have increased their focus on immediate cash generation by OFSE companies—a trend that has only intensified as many emerge from bankruptcy. Second, they are discounting terminal value from traditional oil and gas operations.
In this environment, companies will need to strive for operational excellence and maintain healthy cash positions while simultaneously decarbonizing their operations. It is imperative that their strategies, value creation philosophies and activities reflect the energy transition and are clearly communicated to all stakeholders. Indeed, these emerging energy segments represent attractive new value pools that could provide the OFSE industry with its biggest growth opportunity going forward.
There is no doubt that OFSE companies will face a daunting challenge. Not all will succeed. But a strategic shift in response to these trends can unlock significant value. The key lies in arming themselves with the insights required to face these shifts head on and making deliberate strategic choices.
About the authors: Nikhil Ati and Spandan are partners in McKinsey’s Houston office, Dimitar Kostadinov is an associate partner in the Miami office and Diederik Nelissen is a partner in the Amsterdam office.
Acknowledgment: The authors wish to thank Bill Ambrose, Ricky Bureau, Harshvardhan Sanghi and Jake Wilk for their contributions to this article.
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