OIL & GAS
Overview
The oil and gas industry is renowned to be an indispensable pillar of the global economy, serving as
the world’s chief source of energy. According to the International Energy Agency’s (IEA) report (May
25, 2023), the global fossil fuel industry earned a record-high income of $4 trillion in 2022, which is
expected to cause a considerable boost in fossil fuel investments by 6%, up to $950 billion in 2023.
Such statistics corroborate the reality that the O&G industry is firmly capable of withstanding price
volatility and disruptions in supply. Given the recent geopolitical and economic factors influencing
the market, the industry is bound to face further highs and lows, which poses the question of how
companies will adapt to not just survive, but thrive in the face of uncertainty.
The above graphs showcase that the primary consumers of energy in the form of oil are the large economies of the US, China and India. Notably, India ranks second in the leading consumers of coal in the world, with coal forming the greatest share of primary energy demand (57%), as compared to oil (27%) and gas (6.3%). As for oil supply, India’s Reliance Industries ranks fourth among the leading oil and gas companies worldwide based on market capitalization, after ExxonMobile and Chevron of the US, and Royal Dutch Shell of the UK respectively. However, India does not even feature in the top 15 list of leading oil producers worldwide based on revenue, suggesting that Indian companies are generally unable to compete with the profits earned by the US, China and the UK.
The above graphs showcase that the primary consumers of energy in the form of oil are the large economies of the US, China and India. Notably, India ranks second in the leading consumers of coal in the world, with coal forming the greatest share of primary energy demand (57%), as compared to oil (27%) and gas (6.3%). As for oil supply, India’s Reliance Industries ranks fourth among the leading oil and gas companies worldwide based on market capitalization, after ExxonMobile and Chevron of the US, and Royal Dutch Shell of the UK respectively. However, India does not even feature in the top 15 list of leading oil producers worldwide based on revenue, suggesting that Indian companies are generally unable to compete with the profits earned by the US, China and the UK.
Sanctions on Russian O&G
Russia’s aggressions against its neighbour Ukraine have mobilised spectator nations to step in and
attempt to curb Russian revenues and hinder its war efforts. The Russian economy is extremely
dependent on its energy sector, hence the sanctions imposed on its O&G industry is expected to
deliver a severe impact. With this notion in mind, the EU nations have ended imports of Russian oil
brought in by sea, and co-ordinated a ban on refined oil products. The US and UK have also
implemented bans on Russian crude and refined oil product imports in late 2022. Further, the G7 and
Australia, as members of the Price Cap Coalition agreed that the maximum price per barrel of
Russian-origin crude oil would be restricted at $60. As for Russia’s gas sector, the EU stated that it
would slash gas imports from Russia by two-thirds within a year. The UK, which only imported small
quantities of Russian gas, has now ended this altogether.
The effects of these measures may be quantified with the help of the forthcoming list of leading
global oil suppliers for 2023. In 2022, three Russian companies were among the list of top 15
suppliers; the success of these sanctions would be affirmed by their removal, or lowering in position.
This potential change may empower other companies from countries like Norway or Brazil to climb
the ladder.
MORE OR LESS SOCIAL? – THE ALGORITHM SERVES YOU
Data reveals that as intended, the price of Urals crude oil
originating from Russia has been rapidly dropping
following the imposition of sanctions. However, it is
believed that it is the EU oil embargo impacting the price,
not the price cap. Moscow is losing out on about $175
million per day from fossil fuel exports due to these
sanctions, according to a study by the Centre for Research
on Energy and Clean Air (CREA). However, the price cap
had been specifically designed to diminish Russia’s
revenues, while ensuring that global energy markets
remain stable. It was, therefore, expected to address
inflation and keep energy costs rigid as well. Despite these
efforts, the continually declining prices of Russian oil has
attracted other nations to increase their purchase, through
the loophole of making purchases in their own local
currencies. Most European nations still rely on Russia for
their supply of LNG as well.
- "Russian oil is being traded at around $50 (£40) per barrel. That has been driven by the embargo because Russia now has to try to sell elsewhere." -Ben McWilliams, energy analyst
- "There aren't enough LNG terminals in Europe. This will be a problem for Germany, particularly." -Kate Dourian, energy advisor
The Cheaper, The Better – India's Advantages
Having drastically increased their purchase,
India, China and Turkey currently form the 70%
of all Russian crude flows by sea. As Russia’s oil
is priced much lower than the global benchmark
Brent oil, Russia is now on course to become
India’s largest single supplier, whereas Russia
supplied less than 2% of India’s oil imports at the
start of 2022. India’s actions are in line with its
firm stance that it will purchase oil from the
cheapest source. The continued purchase of
Russian oil will have a favourable impact on the
Union Budget of India, owing to a smaller crude
import bill.
Moreover, the EU’s impositions have
expanded India’s export opportunities,
especially in the private sector; by creating a
demand-supply gap in the market, the
sanctions enable Indian refiners to fill this
gap. As India utilises the discounted Russian
crude oil to produce its petroleum products,
it may be concluded that Russian crude
ultimately reaches European markets through
Indian exports. Hence, Indian companies such
as Reliance Industries may grow
Crude Oil Price Drop
Crude prices have been steadily declining over the last year, and have stayed below $90 for the last six
months. Although crude prices rose slightly in April due to production cuts by the OPEC and its allies
(reduced by 1.16 million bbl/day), they have fallen again in May. Benchmark oil Brent crude, which was
trading at around $85 per barrel a month ago, closed in at $72.61 per barrel on May 4th. Similarly, WTI
prices have fallen from $83.26 per barrel on April 12th to $68.85 on May 3rd. The duration of these
dramatic downward trends is unpredictable; however, if prices continue to drop, oil refiners will be the
first to benefit through lower costs, and these benefits may quickly reach consumers.
WHY THE PRICE DROP?
- The fall in crude prices has been mainly attributed to concerns over the weakening global economy and recession fears, deterring demand for fuels. The US Federal Reserve has played a role hiking interest rates to tame inflation, setting an example for other central banks and consequently dragging down prices. Further, China, the largest consumer of crude oil, has witnessed a slow economic recovery post-COVID, and has not generated the expected high level of demand.
- The oversupply of crude oil along with the lack of demand has also contributed to the price drop; Russia has been pumping more oil into the market despite sanctions and embargoes, by means of cheap exports to India and other nations; according to Reuters, April oil loadings from Russia's western ports recorded their highest since 2019, at over 2.4 million bbl/day. However, the problem of oversupply is anticipated to be resolved soon, as Saudi Arabia and OPEC+ plan to restrict their supply from May till the end of the year.
- The state of US inventories is perhaps the most puzzling element of the downward trajectory. US crude oil inventories fell for the third week in a row in the last week of April, below the five-year average for the first time this year, causing gasoline demand to rise by 992 thousand bbl/day. Normally, inventories and oil prices have a stable inverse relationship, but despite this positive inventory data, crude prices failed to rise. Commodity analysts have noted that these dislocations tend to be temporary and occur at times when prices are moved chiefly by other oil market fundamentals, expectations, broader asset markets and financial flows.
Investor Insights
Between 2020 and 2022, surveys were conducted of 250 institutional investors in the O&G industry
conducted by a leading consulting organisation; the findings reveal that against the backdrop of price
fluctuations in the O&G industry, investors expressed optimism regarding the maintenance of
impressive short-term shareholder returns. As depicted in the below graphs, nearly 70% of
respondents in 2022 expect oil prices to remain above $60 per barrel in 2024, which is significantly
higher than recorded in the 2021 survey, in which the majority of investors projected an oil price
between $40 and $60 per barrel. Moreover, nearly 70% of respondents agree that O&G companies
should actively pursue growth in natural gas, as they believe it will play a crucial role in gradually
decarbonizing the world.
Investors also believe that O&G firms must increase or at least maintain their payouts to investors, through dividends as well as buybacks. Irrespective of the level of oil and gas prices, preserving dividends and growing the top line must remain the focus of Big Oil’s value proposition for shareholders. Majority of investors (about 80%) concur that it was “somewhat” or “extremely important” for O&G companies to maintain or grow their investor payouts.
Investors also believe that O&G firms must increase or at least maintain their payouts to investors, through dividends as well as buybacks. Irrespective of the level of oil and gas prices, preserving dividends and growing the top line must remain the focus of Big Oil’s value proposition for shareholders. Majority of investors (about 80%) concur that it was “somewhat” or “extremely important” for O&G companies to maintain or grow their investor payouts.
CREATING VALUE IN A LOW-CARBON FUTURE
The rising attention given to climate change and environment sustainability has led investors to have
mixed sentiments about the long-term results of their fossil-fuel investments. The below graph
displays that almost two-thirds of the surveyed investors are of the opinion that demand for oil will
peak in 2030, and consequently, 60% feel the pressure to divest their O&G stocks, as they believe that
such stocks will retain much importance in their portfolios in the next decade.
Stemming from the growing pressure, investors are convinced that firms need to take these steps:
Stemming from the growing pressure, investors are convinced that firms need to take these steps:
- Set and meet emissions-reduction targets.
- Invest in clean energy to enhance their long-term value propositions.
- ollaborate beyond the O&G sector to set cross-industry standards regarding emissions targets.
While investors acknowledge that most companies have previously undertaken measures to improve
their green performance, they believe that those measures will not be enough to combat climate
change. Investors want to see firms produce substantial results by creating goals and achieving them.
The Energy Trilemma
The immediate importance of clean energy has never before been emphasised as it is in the present,
with a clean energy revolution sweeping across the world. This has allowed the global renewable
energy sector to steadily expand, and the industry to generate hundreds of billions in economic
activity and rapidly develop in the coming years. The Energy Trilemma relates to finding a balance
between the three pillars – security, affordability, and sustainability – in how we access and use
energy.
Security refers to the ability to access energy in the quantity and at the time that it is needed, that is, ready/uninterrupted availability of energy – in the short term this could refer to an energy system that is able to respond to sudden changes in supply and demand. In the long term, renewable energy sources such as wind, solar and hydropower can improve energy security, as the limited supply of fossil fuels like oil, gas and coal will eventually run out. Affordability refers to the ability to comfortably acquire energy within one’s means – solar and wind power are ranked as the most affordable as compared to fossil fuels, due to efficient energy generation through solar plants and wind turbines. Sustainability focuses on meeting the energy demands of today without negatively impacting future generations – our leading sources of energy, oil and gas, are highly unsustainable as they release mass amounts of greenhouse gases and contribute to the climate crisis. Overall, the energy trilemma suggests that three pillars are fundamentally at odds with one another, and attempts to find a balance between them without entirely sacrificing one to achieve another. The goal of the clean energy revolution would be to slowly phase the existing oil and gas industry out of its present state of production, as the world switches to clean and sustainable sources.
Security refers to the ability to access energy in the quantity and at the time that it is needed, that is, ready/uninterrupted availability of energy – in the short term this could refer to an energy system that is able to respond to sudden changes in supply and demand. In the long term, renewable energy sources such as wind, solar and hydropower can improve energy security, as the limited supply of fossil fuels like oil, gas and coal will eventually run out. Affordability refers to the ability to comfortably acquire energy within one’s means – solar and wind power are ranked as the most affordable as compared to fossil fuels, due to efficient energy generation through solar plants and wind turbines. Sustainability focuses on meeting the energy demands of today without negatively impacting future generations – our leading sources of energy, oil and gas, are highly unsustainable as they release mass amounts of greenhouse gases and contribute to the climate crisis. Overall, the energy trilemma suggests that three pillars are fundamentally at odds with one another, and attempts to find a balance between them without entirely sacrificing one to achieve another. The goal of the clean energy revolution would be to slowly phase the existing oil and gas industry out of its present state of production, as the world switches to clean and sustainable sources.
Efforts In Sustainability
The O&G industry is facing a critical challenge with respect to sustainability; failure to address growing
calls to reduce greenhouse gas emissions could threaten their long-term social acceptability and
profitability. Increasing demands to clarify the implications of energy transitions for their operations
and business models, and to explain the contributions that they can make to reducing greenhouse gas
(GHG) emissions and to achieving the goals of the Paris Agreement are imposed on the industry. A
report put forth by IISD commissioned climate scientists at the University of Manchester prescribes
that O&G production must be phased out by 2034 for rich countries, and by 2050 for the poorest.
However, such suggestions to completely eradicate O&G have fostered scepticism. The core question
to be asked is: should today’s O&G companies be viewed only as part of the climate problem, or could
they also be crucial in solving it?
According to the IEA, the industry faces the strategic issue of balancing short-term returns with its long-term licence to operate. Societies are simultaneously demanding energy services and also reductions in emissions. Companies have been proficient at delivering the fuels that form the bedrock of today’s energy system; whether they can help deliver climate solutions is under study. As the industry landscape is diverse, there is no single strategic response that will make sense for all firms, however, some general steps to be followed can be determined. Listed below are few steps of many:
According to the IEA, the industry faces the strategic issue of balancing short-term returns with its long-term licence to operate. Societies are simultaneously demanding energy services and also reductions in emissions. Companies have been proficient at delivering the fuels that form the bedrock of today’s energy system; whether they can help deliver climate solutions is under study. As the industry landscape is diverse, there is no single strategic response that will make sense for all firms, however, some general steps to be followed can be determined. Listed below are few steps of many:
- There exist ample, cost-effective opportunities to reduce carbon footprints of O&G firms, by minimising flaring of associated gas and venting of carbon dioxide, checking methane emissions, and integrating renewables and low-carbon electricity into upstream and LNG developments. 15% of energy-related global greenhouse gas emissions are derived from the process of getting oil and gas out of the ground and to consumers. Reducing methane leaks to the atmosphere is the most important and costeffective way for the industry to bring down these emissions. The following chart depicts the possible reduction of emissions intensity by 2030 from 2018:
- Investment by O&G companies outside their core business areas has been less than 1% of total capital expenditure. For firms looking to diversify their operations, redeploying capital towards low-carbon businesses leads to attractive investment opportunities in the new energy markets as well as new capabilities within the companies. While some O&G companies have indulged in projects outside fuel supply, such as electricity distribution, a more significant change in capital allocation is required to truly contribute.
- Shifting from “oil and gas” to “energy” allows companies to diversify while managing transition risks. Such a shift would entail the supply of a range of fuels, electricity and other energy sources to consumers. This involves entering sectors, notably electricity, where there is already a large range of specialised actors and where the financial characteristics and scale of most low-carbon investment opportunities are drastically different from traditional oil and gas projects. Electricity offers long-term opportunities for growth and opens the door to broader reductions in company emissions, although investors will carefully watch the industry’s ability to balance diversification with expected returns and dividends.
Shifting from “oil and gas” to “energy” allows companies to diversify while managing
transition risks. Such a shift would entail the supply of a range of fuels, electricity and
other energy sources to consumers. This involves entering sectors, notably electricity,
where there is already a large range of specialised actors and where the financial
characteristics and scale of most low-carbon investment opportunities are drastically
different from traditional oil and gas projects. Electricity offers long-term opportunities
for growth and opens the door to broader reductions in company emissions, although
investors will carefully watch the industry’s ability to balance diversification with
expected returns and dividends.
Challenges & Solutions
While oil and gas remains a lucrative industry, it faces ever-evolving challenges, owing to the changing
landscape of the energy sector and the pressing need to transition to a cleaner, greener state. The
following are some challenges faced by O&G firms and solutions to them:
CHALLENGE
To remain competitive, reducing the costs
of producing raw materials and derivatives
extracted from them to as low as possible is
vital. Cost reduction has to be a crucial
strategy in workflow to achieve the planned
production quantity at lower cost.
SOLUTION
Cost reduction can be accomplished by
various means, such as upgrading
equipment leading to higher revenues,
updating safety systems to prevent
accidents and keep production running,
using the most advanced radar technology
to prevent spills and monitor the process
from extraction to shipping.
CHALLENGE
The economic value of oil resources makes
it a prime target for theft, terrorism, piracy
and sabotage, causing great damage to
companies. Hence, protecting the assets
becomes important.
SOLUTION
This concern can be abated by employing
distinct technologies such as installing
panoramic thermal imaging technology to
ensure security in remote or high risk
locations. Enhanced visibility and early
warnings of potential threats can allow
operators to protect O&G rigs. The use of
automated monitoring, alarms and instant
messages reduces the need for manual
surveillance and the risk of human errors.
CHALLENGE
Companies often search for innovative
solutions to meet their production and
revenue goals. Such innovations are
indispensable in ensuring that the company
is able to retain/grow its market share, that
is, improving overall performance.
SOLUTION
The performance of a company can be
improved by actively implementing an
amalgamation of the above solutions. For
instance, companies may improve their
performance through the modernisation of
their equipment, leading to fewer accidents
and risks, which in turn leads to better data
collection and higher rates of production
CHALLENGE
The O&G industry has faced a talent
shortage due to an ageing workforce and
limited new/young talent entering the
industry, and growing competition for
talent with the technology industry. This
difficulty in getting and retaining talent may
pose significant issues for the future of the
industry.
SOLUTION
The onus is on O&G companies to make
sure they get and retain the necessary
talent by reviewing their recruiting and
retention efforts. They also need to find
ways to upskill or retrain their current
workforce, which is what over 92% of
energy companies plan on doing to address
“climate skills gaps”. Employees with
engineering and PBMS degrees are the
type of skills needed to develop technology
operationalise decarbonisation investments
in the oil and gas industry.
CHALLENGE
In recent years, greater competition from
alternative energy products poses another
threat to the industry, owing to changes in
consumer preferences.
SOLUTION
To remain competitive in the face of
alternative energy industries, O&G
companies must make it an immediate
priority to implement as many sustainability
measures as possible. By doing so, they
may successfully influence consumer
perceptions about the industry and bring in
more continued demand for their products.
