Reinventing the oil and gas industry: compounded disruption

The global oil and gas industry has faced difficult times before, but the situation it faces in 2020 is unprecedented. It exists today within a context of compound disruption – a first blow from worldwide oversupply, then a second blow from the destruction of demand caused by the COVID-19 pandemic together with pressures to improve its response to climate change, may herald a call for deep transformation.

Even before these events, the industry faced growing challenges. Despite prices averaging $77 per barrel over the past 10 years, free cashflow from core operations has been insufficient to maintain shareholder returns as in the past. Industry returns are below the cost of capital, and – according to proprietary analysis by Accenture – capital expenditures have declined by 30% in response to COVID-19. The leverage ratio of total debt to total liquidity has almost doubled since the depths of the 2008 financial crisis, and the industry’s share of the S&P 500 has been cut by half over the past decade. In addition to these elements, consumers and investors have sought out alternative energy sources in response to climate change, affecting the supply of and demand for fossil fuels.

When the industry encountered difficulties in the past, it was able to cut costs, defer investments and wait for an upturn in oil prices. Many believe this time things are different, as some major shifts are attributable to fundamental transformations in arenas such as economics and society.

Transportation – a major demand sector for the oil and gas industry – provides an example. Vehicles using internal combustion engines (ICEs) still enjoy an economic advantage, along with greater convenience and flexibility, over alternative light-duty transportation in most geographies. In the US, for example, the total cost of ownership (TCO) for electric vehicles (EVs) is significantly higher than it is for ICEs. Fuel prices for ICE light vehicles could be over $4 per gallon (reflecting $120/barrel oil) and ICEs would still be competitive based on today’s TCO.

By 2030, however, some projections suggest that EVs could have the upper hand, particularly if the cost of carbon emissions is factored into the equation. Due to major improvements to the cost and efficiency of batteries, the TCO for EVs would drop sharply, putting pressure on the cost of fuel for ICEs. According to analysis by Accenture, it is estimated that the maximum gasoline price for ICEs to remain competitive will be about $1.50 per barrel, indicating a crude price of $10 to $20 per barrel in 2030 in the absence of any carbon tax or fuel tax parity. Every $1,000 of EV purchase price subsidy reduces the maximum oil price by another $11 per barrel. If these subsidies are eliminated and there is parity in fuel taxes and externalities, crude would be competitive at a maximum price of $40 per barrel.

Power generation is another major demand sector affected by competition from alternative energy sources. Penetration of increasingly low-cost renewable power sources is constraining the growth in gas demand. The demand for alternative and increasingly low-cost renewable power sources to replace coal and gas is increasing rapidly. The industry had been looking to liquid natural gas (LNG) to serve as a transition fuel in key markets such as China and India, but this role is predicated on gas displacing coal. In developing countries, the limited domestic infrastructure and cost of importing natural gas as LNG can favour coal, particularly when coal is sourced domestically (in China and India, for example), although in some settings air quality and emission concerns militate in favour of gas-fired power over coal-fired power.

Other factors challenging the industry include:

1. Increasing pressures to improve environmental performance. Analysis by Accenture suggests that carbon taxes could increase oil prices by $3 to $8 per barrel of oil equivalent (BOE), changing the cost curve and reshaping oil company portfolios. There are significant variations from region to region and from asset class to asset class due to differences in energy and carbon intensity. For example, North American shale flaring assets are likely to incur approximately $5 billion in additional carbon taxes over non-flaring assets. Latin American assets, characterized by sour crudes requiring high energy intensity, will also incur higher carbon taxes.

2. Increasing competition for capital. Years of lower returns, climate-change driven divestments and the growth of alternative energy investments are decreasing oil and gas companies’ access to capital. At today’s level of invested capital, margins must equal $8/BOE under a $40/barrel scenario (compared to current margins of about $11/BOE under a $60/barrel scenario) to deliver a return on invested capital (ROIC) of 12% and create value. Continuing returns below the cost of capital will further challenge the industry’s ability to attract capital.

3. Increasing scarcity of talent. The industry is struggling to recruit and retain the next generation of workers and to attain a gender-balanced work force. The industry’s recent cycles and its long-term outlook are deterrents to recruitment. It is estimated that more than 1 million jobs will be lost in 2020 in oilfield services alone due to the pandemic, representing a large loss in talent and human capital.

This Agenda article is part of a series exploring the future of the oil and gas industry as a result of the compounded disruption it faces in the current context. Jointly developed by Accenture and the World Economic Forum, it will tackle the need to redefine fundamentals and identify opportunities for concrete collaboration across different players in the petroleum ecosystem.