Wary oil and gas executives prepare for a recession as they grapple with inflation and struggle to hire. They hold firm to capital discipline despite the siren call for growth emanating from the triple-digit price of WTI. And they navigate a rocky M&A terrain with more deals of lesser value, steering away from blockbusters.
Welcome to midyear 2022 in the age of contradictions.
There’s plenty of data, but no certain knowledge about what is to come; high oil prices that bring the industry grief may not be high enough to balance the market; and energy investors are finally getting their paydays in the midst of an equity market downturn.
Could oil reach $145/bbl again, as it did in July 2008? Sure, and it could close at -$37/bbl again, as it did in April 2020. The -$37/bbl close was a one-time affair, but miserable-for-longer is always a possibility.
For example, the $145.31/bbl close just before the July 4, 2008, holiday morphed into a price of $30.28/bbl just two days before Christmas 2008. Another example: the tumble from a peak of $108.23 in September 2013 to $44.08/bbl in January 2015. And another example … well, best not to dwell.
But keep this in mind: 2022 is not 2008. A lot has changed.
Recession forecasts: It was the winter of despair…
It’s unclear whether the world is headed toward a recession. As defined by the National Bureau of Economic Research, a recession is “a significant decline in economic activity spread across the economy, lasting more than a few months.”
“The CEOs, the executives that I talk to within the oil and gas industry are reasonably pessimistic and they do believe that there will be a recession. I don’t know that I necessarily hold that view. I try to be a little more optimistic, but the resounding sentiment across the industry is that a recession is coming.”—Regina Mayor, KPMG
The impact is seen in:
- Real GDP;
- Real income;
- Industrial production; and
- wholesale-retail sales.
David Rodeck, in a piece for Forbes Advisor, lists several catalysts for a recession, including a sudden economic shock, such as the COVID-19 pandemic, and excessive inflation. Another is technological change, such as artificial intelligence and robots eliminating categories of jobs.
The near-term worry is that the economic recovery from the pandemic has sparked excessive inflation. The Consumer Price Index for June showed a 9.0% annualized increase in prices over the previous 12 months. To control these hikes and cool the economy, the Federal Reserve has already raised interest rates three times this year for a total of 1.5 percentage points. Depending on economic indicators, the fed has signaled it may raise the cost of borrowing yet again.
But back to our wary oil and gas executives.
“The CEOs, the executives that I talk to within the oil and gas industry are reasonably pessimistic and they do believe that there will be a recession,” Regina Mayor, global head of energy and natural resources at KPMG, told Hart Energy. “I don’t know that I necessarily hold that view. I try to be a little more optimistic, but the resounding sentiment across the industry is that a recession is coming.”
Mayor is not alone in doubting the inevitability of a recession. The International Monetary Fund (IMF) is not convinced, either.
“Based on the median projection for the policy rate published at the June FOMC (Federal Open Market Committee) meeting, we expect the U.S. economy will slow in 2022-23 but narrowly avoid a recession,” the IMF said in a statement in late June.
The organization’s forecast is based on the fed continuing to use sound judgement, in its view, and clearly communicating its strategy to the public. Otherwise, things could go sideways.
“The stakes are clearly high,” the IMF said in its statement. “Misjudging the policy mix—in either direction—will result in sizable economic costs at home and negative outward spillovers to the global economy. An overly forceful policy response runs the risk of triggering an abrupt tightening in financial conditions and a U.S. recession, creating negative spillovers to the global economy. An insufficient shift in policies, though, would risk creating a prolonged period of high inflation that will necessitate even stronger—and more economically costly—measures in the future.”
“What our clients feel right now is the heightened impact of inflation,” Mayor said. “That’s what’s in their face—the cost of pipe, the cost of field workers, the cost of services, the lack of resources to get things done. So, while the price environment ordinarily would spur a lot more development, the inflationary pressures and the lack of resources are minimizing their ability to ‘drill, baby, drill’ as they might have wanted to in the past.”
Cliff Vrielink, global leader of Sidley Austin’s energy and infrastructure practice, acknowledged that some type of global economic slowdown is likely, but ups and downs are normal. What might set this one apart is that the oil and gas sector is ready for it.
“I think that’s going to be buffered a little bit by somewhat of a return of capital and attention to this sector,” he told Hart Energy. “I think that will make the downturn not as sharp or as dramatic as it otherwise would be. I think people are returning with a bit of a long-term perspective.”
If there is a recession, at least one economic forecasting team predicts it will resemble a pasta bowl—wide, low and shallow.
“We have or will shortly slip gradually into this recession,” wrote authors of the forecast at the Institute for Economic Forecasting at the University of Central Florida. “It will not be a deep recession, but it will likely last four quarters—the wide part of the pasta bowl. When we emerge from this recession, there will not be a rocket-propelled recovery as we experienced in 2020. We will emerge slowly out of the pasta bowl, in the same manner, we went into it.
“This recession will begin and end with a whimper. It may also be just the cure that heals what ails our economy.”
Price outlook: It was the epoch of belief…
A global economic downturn will reduce demand for energy, the Energy Information Administration (EIA) predicts, resulting in declines of 18.2% in the price of WTI and 54.2% in the Henry Hub price for natural gas over the next 18 months. That would take WTI down to $92/bbl from June’s $112.50/bbl. It would also pull natural gas below $4/Mcf.
KPMG is more bullish.
“We don’t see the supply/demand fundamentals changing substantially to warrant the decrease in price that we’ve seen,” Mayor said. “I think we stay in the triple-digit territory through the rest of the year, at least—high $90s, low $100s. Hopefully, not $120, but I don’t see how what others are saying could happen. Our analysts are actually saying it’s going to be higher for longer, not dip, and that this current dip is temporary. I subscribe more to that point of view than some of the other points of view.”
Higher prices also make sense to Goldman Sachs analysts.
“We continue to see the oil market in a structural deficit that requires still higher prices to rebalance,” they wrote in a July 7 research note. Much higher, in fact. For supply and demand to balance by late 2023, Goldman Sachs said, Brent needs to average about $135/bbl in second-half 2022 and first-half 2023.
In natural gas, Goldman Sachs projections match up with EIA’s. Limited growth in LNG exports will not keep up with supply increases, pulling the price down to about $3.80.
But even if oil prices do fall, that’s not necessarily a bad thing, Vrielink said.
“The reality is, I’ve heard a number of people say, ‘for the health of the oil and gas industry, we’d rather have $60-$70 oil than $100-$110 oil,’” he said. “It’s efficient for people to run their businesses and plan for the future, and earn a decent return. And, it doesn’t provide the same kind of shock and pain across the economy that these higher prices do.”
M&A: It was the season of light…
Even in the best of times, big mergers are hard to put together, Vrielink said. It’s not just whether the deal makes economic sense, but a number of complex elements, including the different financial perspectives of the stakeholders, can be difficult to align. But not all deals need to be blockbusters.
“We’re actually seeing quite a bit of M&A activity,” he said, “more in bite-size chunks, where they really make a lot of strategic sense. You’re still seeing consolidation plays. I think those will continue to occur from time to time when the various complex elements of any kind of a merger come together.”
“The reality is, I’ve heard a number of people say, ‘for the health of the oil and gas industry, we’d rather have $60-$70 oil than $100-$110 oil.’ It’s efficient for people to run their businesses and plan for the future, and earn a decent return. And, it doesn’t provide the same kind of shock and pain across the economy that these higher prices do.”—Cliff Vrielink, Sidley Austin
Mayor sees plenty of potential for an increase in M&A.
“I have a lot of clients that are sitting on a lot of cash, and they are actively looking for opportunities,” she said. “They are hoping that the price environment shifts downward a little bit more to close the bid/ask price gap which makes the multiples not tenable. So, in this current price environment, even though there’s cash available and consolidation probably would be a good thing, I’m not bullish that we’ll see a lot of M&A in the near term.”
Growth: It was the age of wisdom…
There’s no lack of public pressure, including pressure from the White House, for the industry to quickly ramp up production. It’s not going to happen, though, not like it has in the past.
“I don’t think you’re going to see many people pursuing a strategy of going out there and finding prospects, drilling them up and trying to flip them,” Vrielink said. “I think that strategy is just not the main strategy anymore. There was a time period when that was what people really did. It really was all about growth.”
In recent years, though, it’s all been about capital discipline and about returning cash to investors, he said. Not that many aren’t tempted, given the persistently lofty levels of oil prices.
“I think you will continue to see people ease away from that some,” he said. “And some people will be more aggressive than others. But the pendulum swings and I think it will return more to the middle than it has.”
The transition from a negative price for a barrel of oil to a news event when the price slips below $100/bbl has put executives in a tricky situation, Mayor said. How long will these high prices last? And how long will inflation remain high? And what is the best way to add production in this regulatory environment?
“With that inflationary pressure that’s right in their face, they also—because they have a natural pessimism about what’s going to happen to the economy in the future—they’re not that bullish about unleashing a lot of capital spend, too,” she said. “It’s really a lose-lose mindset that they’re grappling with and struggling with.”
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