Oil and gas companies are presenting dual credentials – avid cost-cutters with newly stabilised finances. Strategies are being adapted to the reality that lower prices will persist for some time.
The focus is on cost efficiency, cash flow metrics and tight capital discipline. Dividends are sacrosanct, for the Majors at least; investment almost secondary in terms of capital allocation. Capital expenditure is targeted at low-risk opportunities, and IRR is usurping NPV as the benchmark for new projects.
Growth for growth's sake is off the agenda.The implications are that production profiles may decline and companies may get smaller – but returns should improve.
It’s an ultra-conservative approach that has yet to hit home with sceptical investors. The shares of the Majors have underperformed the wider global stock market by 22% in 2017. The industry outside the US L48 is still struggling to attract capital.
What do oil and gas companies need to do to attract capital back into the sector?
Besides the oil price, there are big challenges looming over the sector such as peak oil demand and the energy transition. But these will play out only in the longer term, and in the meantime there is much that can be done to bolster confidence in the sector. Talking with providers of capital in Aberdeen, here is a list of to-dos.
1. Deliver on target and do so consistently
Cash flow neutral in 2017 doesn’t mean the job is done. Maintain tight discipline on capital and grow cash flow. Free cash flow growth in a flat price environment into 2018 and 2019 will send a strong message to providers of capital.
2. Strengthen the resilience of the portfolio
Drive down costs – the low-cost producers will be king, and make money in any price environment. High grade the portfolio by selling non-core, high cost assets. Seize opportunities in the current soft M&A market that can strengthen core, advantaged positions.
3. Understand growth isn’t the be all and end all – far from it
Better a declining production profile with improved returns on capital and increased certainty of dividend sustainability than investing for growth and the risk – or probability – of diluted returns.
4. Don’t drop the ball if the oil price jumps
Stick with the conservative approach. Bury the recidivist tendency to fall back into the bad old ways.
Will it be different this time? It has to be different because the challenges of oversupply and potential disruption are new. The encouraging sign is that change is underway. The industry just needs to make it structural rather than cyclical.