By William “Bill” Maloney, Energy Advisory Board, University of Houston
There are many aspects of what we are experiencing today in energy markets that can lead you to believe we are simply in another commodity cycle. In years past we have seen the low-cost producers maintain production to capture market share. We have also seen production cuts aimed at balancing supply and demand. Today we are approaching a delicate supply-and-demand balance. We see oil prices firming as a result.
However, I do not believe this is the entire story. My view is that there are four factors impacting the energy business that will lead to long-term structural change. They are:
- Changing of the guard: We are witnessing a change in the type of individual running some of the largest energy companies. ExxonMobil, Chevron, Shell, Total and Statoil are all currently or about to be run by people who have significant downstream experience. Why is that important? The downstream sector of the energy business (refining, chemicals and marketing) has had to live with thin margins forever. So the focus on cost cutting and a relentless drive for improvement has always been part of downstream’s DNA. Now the same drive to control costs and improve profitability will be happening across all sectors within these companies – upstream, downstream and new energy.
- Costs: We have experienced a large reduction in the cost of doing business especially in the upstream sector. Service companies are hurting and struggle to make a profit at current commodity prices. As supply and demand comes into balance and prices firm we will likely see some increase in costs. However, an argument can also be made that a significant percentage, perhaps up to 50% of the cost reductions we have witnessed are both structural and sustainable. Many publicly traded companies are disclosing how they are now profitable at $50 a barrel. They have made changes to their businesses in the form of greater efficiency, fewer staff and the application of technology. In my view, there is no going back. Having worked hard to make these changes, companies are not likely to abandon all the good work they have done.
- Climate: Many oil and gas companies are working toward producing cleaner and greener energy. Many states in the U.S. and countries outside the U.S. are demanding a stoppage or significant reduction to flaring. Companies are spending more money on various forms of clean and renewable energy. Looking toward the future we can already see that power generation, heating in buildings and passenger cars are all changing and will result in less carbon usage in decades to come. We are clearly on a long journey, which will result in the world changing to a lower carbon society.
- Financial markets: We have just finished third quarter earnings reporting. The financial markets are pushing companies for even more capital discipline and even further improvements on returns. Some companies are almost bragging about their ability to lower costs and be robust at current commodity prices. Right now only the best projects, especially offshore oil and gas, are being funded. Non-core or non-competitive assets in company portfolios are being sold to others that can see better profitability. No longer are the headlines being about growth in reserves. Rather the conversation is all about the growth in profits.
These four factors will have a large impact on the energy business going forward and will lead to some structural change. Recently I was talking about this on a radio program and the interviewer asked, “What about the state run companies? Will they be doing what you describe as well?” My answer was first, we are all aware that Saudi Aramco is getting ready for an initial public offering (IPO). When that happens, Saudi Aramco will be subject to the same pressure from financial markets that I have mentioned. In addition to that, if any company, be they public, private or state run, can increase profitability, bring down costs and produce cleaner energy, it is a win for all concerned. So my view is that state controlled companies have as much to gain as public companies in running their businesses as efficiently as possible.
I would like to mention one more thing. The structural changes outlined above will not circumvent commodity cycles. Companies have adjusted to a low price environment by cutting costs, lowering capital expenditures, deferring projects, layoffs and some have even cut their dividend. There will come a time where this underinvestment will manifest in a supply shortage. As a world, we use over 30 billion barrels of oil a year. We are currently not replacing the reserves we produce by a wide margin. Additionally, oil fields naturally decline at 5% each year, although I continue to marvel at how advances in technology enable the industry to slow that decline.
In any case, at some point in the next decade we could very well see a supply shortage due to the massive underinvestment we are witnessing at the moment. Related to this, some believe that shale in the U.S. can come to the rescue. I would not count on that. Today the onshore U.S. produces approximately 8% of total world oil production. It is hard to visualize a world where shale can take the place of a large portion of today’s conventional oil production.
In closing, many people ask me what the future will look like, especially for jobs in the energy industry. Bringing reliable energy to the world’s population will always be a priority for any energy company. The fundamentals of science and engineering will never go away. They are the foundation of the energy business.
Technology will improve and as it does, it will only enhance our ability to safely and efficiently bring energy to the world. So my view is that while today things may look tough for employment in energy, the future is bright. The world needs energy and it needs smart dedicated men and women to deliver that energy.
William “Bill” Maloney has been a member of the University of Houston’s Energy Advisory Board since 2014. He is currently on the Board of Directors of Trident Energy and serves as an energy advisor to Warburg Pincus. Bill retired from Statoil in 2015, where he was Executive Vice President, leading the business area Development and Production North America. Bill attended Syracuse University where he received an MS in geology.