Petroleum Review Editorial November 2008
Crisis over? Everything still changes
World financial markets have recently resembled some terrible cartoon sequence, where every time the hero slips over the cliff he just manages to climb back before once more slithering back to the edge. Switching metaphors (without embarrassment), at the time of writing the economic ‘Fifth Cavalry’ has arrived in the form of massive bank bailouts, funded by the world’s hapless taxpayers. As a result, stock markets have been soaring skywards and the collective sigh of relief can be heard around the world.
Useful analysis, however, depends on a cold-eyed and dispassionate investigation of what is actually going on and an attempt to see how this might affect the energy industries in general – and the oil and gas industry in particular.
For an extended period the world has enjoyed low inflation (Zimbabwe excepted), low interest rates and a relaxed borrowing environment. Governments may hope that easy lending will recommence, but this is unlikely. Banks will be eager, even desperate, to rebuild their balance sheets and regain their freedom from direct government involvement.
Meanwhile, regulators and governments, in the spirit of ‘never again’, will rush to tighten regulation and oversight. The whole episode is likely to produce great debate about the role of government in business in general – and banking in particular – as well as vigorous discussion about the degree to which some of the more critical parts of the economy ‘can be left to the market’.
Banks that face the need to refinance ultimately have three choices. Accept the taxpayers’ money and the restrictions on remuneration and other aspects of business. Or, raise money in the market and pay heavily to the new preference shareholders (Warren Buffet is taking a 10% return on his $5bn support for Goldman Sachs). This option tends to restrict returns to shareholders and reduce the value of shares. The final, equally unpalatable, option is to shrink the bank back within its financial capability and hope to expand again later. For the moment, shell-shocked banks and their shareholders see government bailouts as the best option. However, this may change over time.
The clear result going forward is that lending to companies and individuals will be cautious and carefully (maybe obsessively) monitored. This situation is likely to continue for years rather than months. In addition, heavy borrowing by a company will be seen in a rather more negative light than of late, with consequences in terms of market valuation and vulnerability to takeover. Heavily borrowed companies are likely to try to reduce their vulnerability by aggressively paying down debt.
The clear and obvious winners in this situation are the companies with strong balance sheets and low debt. The traditional oil majors and megamajors predominantly fall into this category. As a group they will be able to use their strong balance sheets to take over weaker or more leveraged companies. For the largest oil companies, which have been having such difficulty maintaining their production flows; it will be a unique opportunity to acquire reserve-rich rivals relatively cheaply.
Similarly, many companies in the alternative energies space have fairly weak balance sheets and limited cash raising abilities – despite having recently had quite aggressive share valuations. Again, the strong balance sheets of the majors and megamajors will allow them to acquire alternative energy companies. The very real danger is that the oil companies would use such acquisitions to slow the pace of change to alternative energies. If, however, they had the courage to follow the GE example of developing new businesses to destroy existing businesses it could actually speed the move to alternative energies as their stronger balance sheets would allow them to invest more in alternative energies and do it faster.
Already there is some rather naive commentary suggesting that slowing oil demand will postpone the peaking of oil supplies and give the world more time to adapt. However, the maths is simple, straightforward and brutal. Global depletion, as the International Energy Agency (IEA) showed in this year’s Medium Term Oil Report, is currently running at between 3.5mn and 3.7mn b/d per year. What this means is that to postpone peak oil by one year, demand must be cut by between 3.5mn and 3.7mn b/d for a year. This would be a cutback that would involve a significant recession broadly equivalent to what happened after 1974. In other words, only semi-permanent recession will significantly postpone the peaking of oil supplies. [For more information on this topic, the EI’s annual depletion conference is to be held on 24 November – see p39.]
The other ‘clear and present danger’ is that companies will worry more about cost overruns than project delays in future projects. While this is a logical outcome of present pressures, if project delays increase oil supplies will peak earlier. Similarly, for the highest cost projects – incremental Canadian tar sands supplies, which now need oil prices of over $100/b, and complex deepwater fields that require over $80/b for sanction, look very vulnerable to delay, postponement and cancellation. The impact of this will be to increase OPEC’s share of global production going forward, with all that this implies.
This leaves us with a rather bitter paradox. The aftermath of the current financial crisis will undoubtedly slow economic activity and increase unemployment. However, any economic alleviation caused by lower oil prices will, quite quickly, increase OPEC’s leverage and hasten the peaking of global oil supplies.
Chris Skrebowski
The opinions expressed here are entirely those of the Editor and do not necessarily reflect the view of the EI.
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