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Crude oil last week dived below $40 as the resurgence of Covid-19 cases in Europe prompted new national lockdowns in France and Germany—so far. Yet fears have deepened that more countries could follow. Lockdowns are not good for oil demand. And they are just one aspect of the pandemic that is changing the oil industry landscape.
The United States has not reinstated lockdowns and is quite unlikely to do it. Yet people’s behaviors are changing because of the pandemic, and some of these new behaviors may be here to stay, with their effect on crude oil fundamentals becoming long-term. How will the U.S. oil industry look a year from now?
Fewer and even leaner
The consolidation many expected has finally started, driven in part by the logic-based optimism that prices will have to sooner or later start recovering, and in part by political concerns.
The potential change in administration could result in regulatory and environmental policy changes, too, as well as tax regime changes, says Nicholas Renter, Datasite VP of Sales. The possibility of a tax reform already fueled a surge in M&A deals, Renter noted, and this pace of dealmaking could continue through the end of this year.
The upcoming election is one big source of uncertainty over the immediate future of the oil industry.
“How the future of the oil and gas industry looks a year from now will depend partly on the outcome of the U.S. presidential elections. A Biden win will likely drive a rush for companies to implement decarbonization strategies, spurring investments in green/renewable energy,” said Sarah McLean, partner in Shearman & Sterling’s energy group.
According to David Johnston, partner, US-West Energy Strategy and Transactions Leader, Ernst & Young LLP, the M&A wave we are witnessing took root before the pandemic. Many industry players with strong balance sheets, he told Oilprice, were looking to acquire assets even before the coronavirus emerged.
And now, “With economic activity globally beginning to see a resurgence and continued low commodity prices, it has allowed companies to run through a process and determine if executing a deal now would lead to greater value down the road. This is particularly true in U.S. shale where operators can be a bit more nimble and adjust production to meet demand,” Johnston said.
A year from now, then, there will be a lot fewer players in the U.S. oil field. “A lot” because bankruptcies will likely continue. So far this year, they are fewer than the all-time high of 142 reached in 2016, according to Haynes and Boone data. However, they are still rising and, as Rystad Energy reported earlier this month, the combined debt of U.S. and Canadian companies that have shut shop since the start of the year is at a record high of $89 billion.
The uncertainty about demand created by the coronavirus pandemic has compromised many companies’ ability to raise capital and fund acquisitions. For some, however, this is the time of opportunity, according to Shearman & Sterling’s McLean, as they could ramp up their assets at attractive valuations. These lucky few will dominate the future oil landscape.
Automated world
The oil landscape of 2021 will not only be less crowded, but it will also be more digitalized and automated. The industry was already reaping the benefits of digital tech and automation before the pandemic—motivated to a significant extent by the last crisis when costs again had to be cut deep, and automation helped.
Now, the trend is accelerating because of the pandemic, says E.Y.’s Johnston, and it is accelerating across the oil and gas value chain.
“Increasing automation in field and equipment operations will be key (i.e., pipelines, gas plants, refineries, production wells),” Vicki Knott, chief executive of automation services provider Crux OCM, told Oilprice. “As head count reduces, the only way to maintain profit margins is to increase the level of automation for human workload. I anticipate the landscape to be more heavily focused on leveraging automation as a solution.”
Full automation of some operations is on the horizon as those that survive the downturn seek to make their operations ever more flexible to boost their resilience in the face of price volatility. This will just be one more priority on the agendas of those companies that are today buying smaller rivals because they have the money to do it and because acquisitions could fuel their future growth in a way that organic growth currently cannot achieve.
Peak gasoline demand
The U.S. may have seen peak gasoline demand, says Brian Milne, DTN Energy Editor, Analyst. Shocking as this may sound to those closely following the EIA’s weekly petroleum and fuel inventory update, peak gasoline demand may well be just one more consequence of the pandemic.
“Once the pandemic dissipates as the United States reaches the critical herd immunity stage, upstream and downstream oil companies will need to understand the behavioral changes that have occurred, and in what will continue,” Milne told Oilprice. “Top of mind is the staying power of work-from-home following the pandemic that could have a long term dramatic effect on gasoline demand. Another critical uncertainty is when flying activity returns to its pre-pandemic level.”
There is also a twist: the latest news from medical research on the coronavirus suggests that herd immunity may not be happening. A study from the U.K.’s Imperial College London found the level of antibodies in Covid-19 patients declined over time. This makes secondary infection a clear possibility and flies in the face of hopes for a vaccine with a permanent effect.
This, in turn, means behavioral changes will likely deepen, which will give them longer staying power. And this will inevitably have an effect on oil demand, among other things. In this context, the idea that we are past peak gasoline demand does not look as far-fetched as it may have without it.
Return to normal
Right now, investments in oil are being slashed as companies switch on their survival mode. But these low investments, notes DTN’s Milne, would eventually lead to a tightening of supply, which, in turn, will push prices higher. The industry will likely begin to return to normal. Only it won’t be the old normal.
Digitalization is one facet of the new normal that is already emerging. A potentially significant reduction in the number of industry players is another. A greater focus on alternative energy sources is also likely inevitable as pressure increases from regulators and some legislators and state governors. Lenders and investors are turning their backs on oil because they want something greener to spend their money on. Oil, then, needs to change.
Again, this change was already underway before the pandemic, which only quickened its pace. Refineries were already being converted into biodiesel production facilities before the virus started spreading, DTN’s Milne said. Now they are doing it faster. This means refining capacity—which was in excess before the pandemic—is unlikely to return to pre-pandemic levels. And this suggests production is also not returning to pre-pandemic levels. There may not be a Shale 3.0, at least in terms of production levels.
According to a recent Datasite survey among 150 global dealmakers, the energy industry in the U.S. stands to win if Trump wins a second term. Yet it will be a limited win. The U.S. oil industry is changing, and it was changing even before the pandemic. For all the support a second Trump administration would have for fossil fuels, some state governments are going firmly in a different direction, with their journey fueled by solar and wind power. The oil industry will need to navigate a changing landscape, and as a result, it will change, too, and fast.
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