If the oil and gas sector is to meet the growing demand for oil and gas, significant investment will be required over the next five to 10 years. Although most of the oil majors have liquidity within their portfolios to fund projects, much of the burden of growth will fall at the feet of independents and for these, it is a different story.
Philip Lambert of Lambert Energy Advisory set out the challenges that industry faces. Chief among these is a U.S. foreign policy that is trying to starve large sections of the oil and gas industry of capital provision, Iran being the most obvious followed by Russia, he said.
Another issue he highlighted was the capital bottleneck from oil and gas investors.
“The people who provide the lifeblood for the industry want the money back quicker in the form of dividends and money buyback,” he said. “Are they there for the long-term industry that we have been used to?”
The final piece of the puzzle is sustainability. Investors are prompting companies to invest more in low carbon segments of the industry. “As you invest more money in low carbon areas is there less money available for oil?” Lambert asked. “We have just emerged from a vicious three-year bear market, and the scar tissue from that bear market still exists, and that will constrain capital.”
Large Capital Requirement
The energy industry spends about US$648 billion (£500 billion) a year in capex. Whatever future path the industry takes, trillions of dollars will be required to meet the world’s energy needs.
Ben Monaghan, partner at PJT Partners, pointed out that there were four significant numbers to consider:
- $5 trillion, the total assets held by funds that have committed over the coming years to disinvest from hydrocarbons;
- 60, the number of major institutional investors who wrote an open letter calling for all oil companies to be more transparent on how the risks of climate change will impact on their valuation;
- $22 billion, the negative free cash flow from shale in 2014 and
- 300, the number of upstream bankruptcies so far this cycle involving $150 billion of investors' debt.
With all these figures and negative headlines, it is all too easy to lose perspective, and ask will the industry make itself un-investable? However, there is an even more significant number that puts everything in perspective. Consultancy group Bain estimates that the total capital available for investment across all industry by 2020 is £900 trillion, all of which is looking for good, risk-adjusted investment.
“Despite all the long-term headwinds there shouldn’t be any lack of capital for this industry,” Monaghan said. “But there is an intensifying capital challenge. What it means is that companies need to sharpen their investment message.
“They are going to need to use M&A tactically, and they need to expect and accept that the cost of capital will rise,” Monaghan continued. “For now, the industry is in excellent shape. But as investors look out into the medium term, they know that valuations are supported by growing dividends, and these are only delivered by investment.”
At the core of that is smart capital allocation, which has always been a core competence of the industry. “I think that is going to become the defining competence moving forward,” Monaghan added. “Not just how they do it but how companies articulate their capital allocation. Of course, renewables are part of that allocation process, but I think it is fair to say that now most oil companies are struggling to allocate the capital that they have set for renewables given the pressure from upstream.”
Catering to Independents
Jeremy Low, head of energy EMEA for BMO Capital Markets, agreed that oil and gas majors are large, cash-generating companies that pay significant dividends and at the current oil price they should be well funded for most of the programs they want to undertake. Generally, larger companies are expected to be able to capture, through their free cash flow generation, the capex and the dividend funds they need.
“There are challenges there, and all those oil companies are under pressure from shareholders,” Low said. “They need to increase dividends, provide better returns on capital that historically across the industry have not been very good and growth; how cautious should they be in the current market with the reduced oil price.”
However, the question remains how the independents and oilfield service companies can secure the funding they need. Corporations at this level are smaller, sometimes new, and they do not have cash flow. So sourcing their capital is very challenging. A further challenge comes when looking over recent history and seeing that the equity investors and banks that supply capital to those small corporations have ended up losing money.
“We remain very positive about the availability of capital. Where we remain concerned, and this is both regarding equity and debt, is that the market remains very much focused on the very lower risk aspect of the industry,” Low said. “What you will see is a real differentiation between funding for producing assets in Norway and the U.K. against exploration and production in emerging markets such as Africa and Asia. Certainly, the cost and sometimes the availability of capital for those projects is a genuine challenge.”
Daniel Rice, former CEO of Rice Energy who now sits on the EQT board, addressed the elephant in the room earlier this month at Hart Energy’s Energy Capital Conference.
Denbury Resources and Penn Virginia mutually agreed to terminate their merger after the $1.7 billion cash-and-stock transaction faced difficult market conditions and shareholder opposition.
Apache recently agreed to sell its Midcontinent positions in the Western Anadarko Basin and Scoop/Stack in separate transactions with two private-equity backed E&Ps.