Stephen Rogers and Ondrej Sanislo explain why low oil prices may drive pervasive structural changes in upstream oil and gas

Many of the highest-cost and technically most complex oil and gas development projects, including remote and deep-water fields, are still deferred or cancelled as their economic outlook remains poor. This presents international oil companies (IOCs, or the ‘majors’) with an increasing reserves-replacement challenge that the largest national oil companies (NOCs) do not face, or at least not in the same way.

Developing scenarios for IOC development As a consequence of these challenges, traditional IOCs’ future access to economically viable resources is becoming increasingly difficult, especially in this relatively low-oil-price environment and uncertain market. This presents IOCs with a growing strategic dilemma. The first step in analysing possible ways forward is to examine the key drivers of change in the sector, considering both their likelihood and impact, and then to develop coherent combinations of these changes that can be developed into scenarios.

  • Carbon constraint (likely/high impact): SS Current pressures for limits on carbon emissions are likely to become more severe.
  • Opening of closed resource areas (uncertain/moderate impact): The reform and opening up of E&P provinces that are currently closed to IOCs, particularly those involving less-developed NOCs, could generate very attractive prospects for IOCs.
  • Supply security of major producers (likely/high impact): Changes to either the political or security environment that impacts a major oil or gas producer may have a critical impact on supply levels and pricing in the global market.
  • Advances in fracking technology (certain/high impact): The increasingly low-cost gas volumes that result will continue to displace gas from conventional projects elsewhere in the world and set a cap to gas prices. Several IOCs may, as a result, continue to establish significant positions in this unconventional sector.
  • Pace of demand recovery (uncertain/high impact): Given current production overcapacity in both oil and gas, and significant current levels of oil overstocking, it may be several years before demand growth leads to rebalancing of supply and demand.
  • Investment-capital spend rate (uncertain/moderate impact): The uncertain timing of future tightening of supply and demand is significantly governed not only by the rate of natural production decline in existing fields, but also by the depth and duration of the current slow-down in investment in new-production capacity.

Scenarios for IOC development
By combining potential outcomes from the above drivers to form discrete and internally consistent scenarios for the sector’s development, we form a series of alternative future visions for the environments in which IOCs may come to live. These outcomes also describe the strategic responses that the IOCs may have to make.

Scenario 1 – ‘Carbon controlled’
This is a world in which effective policies to reduce worldwide carbon emissions are effectively enforced. There is continued rapid growth in renewable energy sources, driven by technology breakthroughs and progressive policy pressures. In the longer term there will be continued and even greater growth in renewable energy production, together with slow expansion of nuclear capacity. Progressive transport electrification and a shifting of gas-fired power from base load towards mid-merit and peak will lead to erosion of demand for both gas and liquids, and particularly for oil. This reduced oil and gas demand growth will suppress prices and eliminate high-cost supply sources.

The early increase in demand for gas, as coal is displaced over the next 10–15 years, will strengthen gas prices sufficiently to stimulate major new gas projects. These will mostly be pursued by IOCs worldwide, together with expanded unconventional gas capacity in the US. This will be stimulated by continued fracking technology improvement, with the resulting associated gas liquids further dampening any oil-price rise.

As a consequence, it will be common for IOCs to shift towards being more strongly gas-dominated as the availability of project finance becomes more difficult for major new developments.

Scenario 2 – ‘Open house; return to easy oil’
The adoption of fossil-fuel constraints is relatively slow, though the gradual changes that are made will dampen coal demand in particular. Partly as a result, oil-demand growth is restored by continued Asian economic strength, and met by reinstated additional supply from markets such as Iran, Iraq, Libya and Mexico. These markets may have not only undergone political, and in some cases security, settlement, but will start to undergo major capacity overhaul.

In most of these cases the local NOCs will still lack the strengths and capabilities to perform this capacity overhaul themselves. The unlocking of the currently untapped, lowcost potential in these areas can therefore only be carried out by active engagement of IOCs and service companies. There will thus be significant growth in the opportunities open to these companies.

Scenario 3 – ‘Return to mega-projects’
Slow oil and gas demand growth will prompt gradual strengthening of oil and gas prices over the next five to ten years, at least partly due to continuing security challenges or political instability in certain areas and continued closure of IOCs in many NOC provinces.

However, the next few years of low prices will result in a cash-flow crisis and low earnings, which will drive an extended and pervasive wave of M&A consolidation involving most IOCs, both majors and large independents (such as the recently mooted Anadarko/Apache tie-up and the Shell/BG merger). Mergers or fire-sales involving debtridden smaller independents are also very likely. As a result of these aggregations, the fewer remaining much-larger entities will be better able to take advantage of the slow oilprice recovery.

Conclusions
These outlines should provide a selection of alternative visions of the future, against which companies might stresstest their own portfolios to identify the most viable and profitable strategies for long-term growth. The best approach would be to develop strategies that are resilient under most plausible scenarios and can be relatively easily adapted depending on which direction the energy world takes.

Arthur D. Little
Stephen Rogers is a Partner and Ondrej Sanislo,is a Consultant at Arthur D. Little. Arthur D. Little has been at the forefront of innovation since 1886. It is a thought leader in linking strategy, innovation and transformation in technology-intensive and converging industries. Its consultants have strong practical industry experience combined with excellent knowledge of key trends and dynamics. Arthur D. Little is present in the most important business centres around the world.

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