Asia upstream’s strategic challenges
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Visiting Asia this month was an opportunity to gauge how oil and gas companies there are faring. We’ve been impressed by how the Majors are emerging stronger from the downturn, using industry upheaval to their advantage. They have run the gamut of business development – judicious divestment, organic investment, targeted acquisitions, exploration success and accessing discovered resource opportunities (DROs).
It’s a breathless list that puts the peer group in a better place than before the downturn. The Majors can look forward to more prolonged production growth from 2017 than we forecast in 2014. Most are financially in better shape too, having adjusted cash flow breakevens down below US$50/bbl.
Have Asian companies been able to perform the same trick? Financially most are in just as good shape as the Majors. But that’s where the comparison ends.
Asian companies have been on the back foot during the downturn, business development largely on hold. Intense scrutiny around corporate governance and the merit of acquisitions made early this decade have been constraining factors for some. Others, like INPEX, have been tied down in capital intensive investment.
Even so, there have been successes. CNOOC Ltd shared in Guyana’s giant oil discoveries (ExxonMobil operator), beefed up its position in Uganda, and won high-potential deepwater acreage in Mexico and Brazil. CNPC and INPEX both took stakes in the ADCO contract extension (Abu Dhabi), the latter also participating in ACG (Azerbaijan); CNPC signed Iran's first IPC for the South Pars 11 domestic gas project (Total operator). PETRONAS, after cancelling its high-cost Canadian LNG project, is selling down Malaysian LNG and has secured new exploration acreage in Mexico.
But the relative inactivity is plain to see in M&A.
Chinese NOCs, Japanese E&Ps and PETRONAS have spent less than US$1bn in total on acquisitions since 2014, whereas the Majors have invested US$110bn (including Shell/BG). Yet upstream business development needs to be a constant discipline as reserves deplete and companies strive to maximise value in the long run. The hiatus leaves upstream portfolios badly in need of attention.
The Chinese NOCs all face declining production into the mid-2020s. All rely heavily on mature, conventional portfolios and face a drop in combined domestic production from 5.6 million boed to 4.0 million boed by 2025.
There are limits to how much EOR and exploration might mitigate decline in a US$50-60/bbl world.
There’s been varying success in generating growth from overseas acquisitions, with CNOOC Ltd most successful on our forecasts. CNPC and Sinopec need to take action to sustain production levels overseas in the early 2020s and avoid compounding domestic decline.
The challenges for PETRONAS and Japanese E&Ps differ, but there is a common thread – concentration of value, lack of diversification, and limited growth. All E&Ps need a ‘hopper’ for future investment optionality; but material pre-sanction development opportunities are missing from many Asian companies’ portfolios.
So what should Asian companies do to build a self-sustaining, balanced and diversified upstream portfolio?
First, business development needs to be strategic – it’s a long game.
M&A is one route, but there are others with varying times to payback, and a range of risks and returns. Big IOCs will use a mix of M&A, DROs and exploration as they build for the future – Asian companies need to do the same. Specifically, most are light on international exploration exposure and should follow the Majors’ lead in reloading acreage at low cost.
Second, deepen and broaden core skills.
Most NOCs are defined by their domestic DNA. A decades-long history as an expert in one resource theme limits capabilities and appetite for risk elsewhere. Deepwater, LNG and unconventional oil and gas are a big part of upstream’s future opportunity set and Asian companies need to acquire the relevant skills. CNOOC Ltd has shown with Nexen that M&A can provide a way in; so too can partnering. We don’t think Asian companies use their network of JV partnerships to the maximum to build exposure to new themes.
Third, don’t hang around too long, the opportunity won’t last forever.
Asian companies are caught in the headlights of oil price uncertainty. The Majors in contrast are prepared to act on uncertainty, and have shown how a portfolio can be revitalised in a relatively short period. There are still opportunities out there; Asian companies need to seize the moment.