To be sure, anyone following developments in the industry on the macro level would be overwhelmed by the almost uniformly negative day-to-day headlines: talk of diminishing Chinese demand, uneven and lackluster US recovery, continued Saudi unwillingness to cut production, and the simple underlying uncertainty about the present investment climate run the gamut of problems facing the industry. And by no means is this list exhaustive.
It would not be unfair to say that the industry is facing difficulties. The real question is how long these difficulties last and what their implications are for the future. To be sure, this situation has its nightmare scenarios, as illustrated by A. Gary Shilling’s article envisioning a $10/bbl to $20/bbl crude price environment. That is a situation few in the industry would want to contend with if they had any say in the matter.
That said, it is easy to forget that the ongoing supply glut is in many ways a symptom of the industry’s strengths. What we have here is a classic example of producers being victims of their own success. Even with significant reduction in capital spending and associated rig cuts, by and large, North American production is forecasted to grow over the next few years. Indeed, Canadian crude production is expected to grow from 3.7 mmbbl/d up to 5.3 million mmbbl/d between 2014 and 2030. Operators in the Eagle Ford are proving just as adept. The consulting group Wood Mackenzie maintained its forecast of 2.0 mmbbl/d average production in 2020, roughly double today’s rate and despite the recent drop in oil prices. Of course, lower commodities prices will have an effect on how fast production grows, but the trends point towards higher growth either way.
The point remains that the industry is not down for the count. Challenges remain, but opportunities abound. The oil & gas industry has a strong track record of adapting to adverse conditions. In the short term, many producers have pursued improving capital efficiencies on the back of lower well service costs, with said costs down anywhere from 10% – 35%. More fundamentally, the industry may have a real opportunity to see a shift in cost structure, assuming the glut is sufficiently prolonged. After all, many would readily admit that above $100/bbl crude prices masked many inefficiencies in the industry and incentivized wasteful operations. With prices in the mid-forties, competition among North American producers for increasingly scarce capital should be fierce. Many producers find themselves with growing debt burdens and some of these also find themselves with declining production. A successful equity issuance or asset sale may be a critical determinant of how well such producers weather this challenging environment. Consequently, the importance of presenting a credible plan backed by operational results cannot be overstated. Producers which previously succeeded in translating their borrowed capital into efficient production and which in turn manage to pull off the twin feat of maintaining balance sheet strength while replacing or even growing production should see their share price remain strong and perform admirably once prices recover.
Prices will recover, perhaps not today nor tomorrow, but eventually and with certainty. Ultimately, this is simply a repeat of the old boom-bust cycle; they do not call it a “cyclical industry” for nothing. As it stands, producers’ incentives are to pursue greater efficiencies and cost reductions without the sacrifice of production growth. The market’s ability to allocate scarce capital to those producers who successfully pursue these incentives should ultimately result in a more efficient and fundamentally sound industry.
– Petur Radevski, J.D., is a business development consultant in the oil & gas industry