Oil and Gas: Working the New Normal in the Time of a Pandemic

Monday,January 11, 2021 /05:45 PM / By Proshare Research/ Header ImageCredit: EcoGraphics

Executive Summary -O&G: Managing a Transition Mindset

Always expectthe unexpected. The oil and gas industry is terrible at predicting anything.Always have a back-up plan. -David Dixon

TheO&G business is in a period of transition as executives of variouscompanies in the sector begin to reimagine, rethink, and strategize theirmodels. Sustainability will no longer be just about wellheads and sales volumesbut about technology adoption, cost minimization, and adaption to new marketexpectations (see illustration 1 below).

Illustration 1 O&G: A Time of Change and Challenge

In2020, the oil market became frenetic as forward prices crashed to negativevalues as storage capacity disappeared and oil sellers had to pay buyers forpicking up excess quantities of fuel in the absence of storage capacity. Theanomaly corrected itself, but not before Saudi Arabia, a leading member of theorganisation of petroleum exporting countries (OPEC), entered into price andproduction cut agreements with close competitor Russia, the leader of theso-called OPEC-Plus bloc of countries. The agreement worked as it slowly moppedup excess crude supplies, reversed previous deep discounts, and restoredstability to the international price discovery process as American shaleproducers saw their rig-head counts eviscerated by tumbling prices.

Oilanalysts' expectations for crude prices in 2021 fall between a floor of US$48per barrel and a ceiling of US$51 per barrel (even though in the first week ofthe year Brent crude oil breached the ceiling by reaching US$54.3 per barrel).The average price of crude in 2021, according to analysts' opinions sampled,would settle at US$49 per barrel. For oil-dependent countries like Nigeria, theeconomic prospects are mixed as a rise in the price of crude oil would bolsterfiscal revenues, but it would also increase the domestic retail pump price ofpetrol, leaving the country squeezed between improved fiscal revenue andincreased domestic cost of transportation which would feed into higher domesticfood and other retail prices.

Nigeria'sinflation rate is already a cause for worry for many analysts as the headlineinflation rate has sprinted ahead from 12.13% in January 2020 to 14.89% inNovember. Food inflation rose from 14.67% in January 2020 to 18.3% in November.The enthusiastic rise in the county's average price level indicates that everyhundred naira in the pocket of the average Nigerian would be worthapproximately fifty naira in a matter of just five years.

Arise in the retail pump price of petrol and a jump in the cost of domesticelectricity would pummel both individual and corporate citizens in 2021,leaving households worse off than they have ever been. The international oilmarket in 2021 will not only shape the direction of the Nigerian economy, butit would also determine the life and livelihoods of its citizens (see Table 1 below).

Table 1 Nigerian Households, Riding a Carousel

However,beyond oil, households, and the economy, the industry itself is at the cusp ofbeing reimagined. The change in international macroeconomic perspectives with agreater emphasis on environment, society, and corporate governance (ESG), meansbusinesses must rework their earlier operational modes of existence and set newtargets for pursuing emerging paths and engaging in fresh activities.

Riding the TechnologyTsunami

Aglobal shock wave related to both the COVID-19 pandemic and disruptions tomarket demand and supply were only the first in a series of expecteddisruptions in the O&G industry. Other dislocations that could emergeinclude, a shift in technology deployment and the move towards unlearning oldways, learning new ways, and relearning what was forgotten in the fog ofprevious corporate execution. The technology-supported corporate governanceframework of the industry would also be expected to change as governanceexpectations tighten.

Oiland Gas experts concede that going forward, the required skills expected ofworkers would be dictated by a different approach to meeting fluid consumerexpectations and preferred user-experiences (seetable below). The alternative energy market that emerges may quietlybut surely displace the demand for high carbon-emission sources of power. Thenew low-carbon energy alternatives would lean heavily on international oilprices and unhinge the collaborative price mechanism created by the OPEC andOPEC-Plus partnership. With wellheads gradually closing and oil rigs nodding toa stop, the new kings of power will be the old or new corporations that take aten-year view of continued oil production and a declaration of purpose towardscleaner energy activities such as Solar, Battery, Hydro, and Windfarmtechnology.

Table 2: The New Job Imperativesfor O&G Companies

Researchand Development (R&D) must become an integral part of the corporation'sreason for being, as O&G companies find new ways of providing economicallycompetitive sources of energy. Some developments that are likely to occur in2021 and 2022 are the collapse or mergers of a few O&G companies and areclassification of the business purpose of others (merger activities in theO&G industry have declined steadily across Africa between 2015 and 2019) (see chart 1 below). Companies that are unable tokeep up with emerging technology and the requirements of adaptive service orproduct delivery pipelines may disappear.

Chart 1: Gazing at African O&G Mergers

Breaking Down Numbers and Dredging up Opportunities

Thereport takes a helicopter view of the state of the O&G sector globally andin Nigeria and explains the powerful trends that will bring about change in thesector from 2021. Section 1 of the report new corporate visioning,governance standards, and profit margins based on existing realities andprospects.

Section2 of the report looks at the link between the financialservice sector and the O&G sector and points out the significance of thesector to the quality of bank's statement of financial position and the size oftheir bottom lines. It draws attention to the anomalous state where banksthrive as O&G companies' pine. If O&G companies represent a significantproportion of bank books, then their fortunes and misfortunes should reflect inbank profitability contrary to recently published deposit money bank (DMB)results up to 9 months 2020.

Togain a deeper understanding of how O&G firms have performed in recent timesunder a variety of situations between 2015 and 2020, section 3 of thereport deconstructs the revenues and profit of companies in the O&G sectorlisted on the Nigerian Stock Exchange (NSE). The results show a mixed bag ofoutcomes, upstream companies seem to have been under severe strains in the lasttwo years. A company like SEPLAT Plc has seen revenues dipped from N228.39bn in2018 to N214.16bn in 2019. However, it must be noted that SPELAT Plc's revenuerose from N138.28bn in 2017 to N228.39bn in 2018, representing a growth of +65.16%. NDEP, listed on the over the counter(OTC) NASD Exchange has also seen its turnover rise steadily despite adisruptive global oil market in the last 36months.

NDEPsaw revenue rise from N33.78bn in 2017 to N39.05bn in 2018 and 45.96bn in 2019.NDEP's stable revenue growth has been notable when considered against afrenzied global oil market that was unforgiving in dragging O&G companyrevenues down. Another O&G company, 11Plc equally saw revenues riseconsistently between 2017 and 2019 but its 2020 number could prove to be trickyas the 9month 2020 revenues of the downstream corporation fell by -18.91% from N141.51bn in 9months 2019 to N114.75bn in9months 2020.

In2020 the performance of the NSE O&G Industry Index trended upwards in asimilar manner as the NSE All Shares Index (ASI). However, the Oil and Gassector Index movement appears to have been sharper than the ASI. While the ASIsaw mild bearishness in the early half of the year the O&G Index showed amore severe orientation up until July 2020. However, both indices showedsimilar bullishness between August and October with the ASI shooting ahead ofthe O&G sector between November and December 2020 (see chart 2 below).

Chart 2: O&G Industry Index VsNSE ASI

Proshare Nigeria Pvt. Ltd.

Source: NSE, Proshare Research

Section4 of the report picked up a telescope and took a longgaze into what could be considered the O&G industry's future and concludedthat the best gambit for firms in the sector was to shift their concentrationfrom crude oil to gas. According to the report, "As white oil products seedemand fall and prices drop, O&G companies will increasingly see a rise indemand for gas, hence shifting the dynamics of their businesses. Industryconnectivity will be more gas-facing than oil-facing and the industry valuechain will pivot away from oil as new gas-related technical skills become morein demand and logistic channels alter to accommodate the new requirements ofdistribution and delivery".

Inthis light, section 5 of the report concludes by giving insights intothe emerging gas market and how O&G companies will have to wash out thegrime of the past from their eyes and vision a new global gas reality. Theauthors of the report point out that "The new business mindset would need toaddress the cost efficiencies that would make cleaner manufacturing and powergeneration practical and affordable. Therefore, O&G firms will have todrive operational models that cut costs, reduce time to market, and integratehorizontal and vertical value chains to deliver goods in a cheaper, cleaner,and safer manner. This is not impossible, but it is a massive request toask from companies that are not familiar with such levels of technologicalinnovativeness, operational efficiency, and cost-effectiveness".

Thesection also provides readers with all relevant references to issues raised inthe report and helps users of the report with comprehensive backgroundinformation and related articles that enhance the information experience of thereader. It also provides readers with advice on how the report can be used andrepresents the report's appendices with provides the reader with a list of thecharts, tables, and illustrations that were used during the analysis. The lastsection of the report also gives acknowledgment to those that participated inputting the report together and informs readers on how to contact Proshare orits analysts.