Persistently low crude oil prices have hampered upstream and midstream activity. This has been worsened by the increasing emphasis on sustainability and decarbonisation. Will the oil industry remain in the doldrums?

SINGAPORE (Dec 2): Saudi Aramco, the national oil corporation (NOC) of Saudi Arabia and the world’s biggest oil producer, finally launched its IPO on Nov 3 . Unfortunately for Aramco, the US$2 trillion ($2.73 trillion) valuation target set by Crown Prince Mohammed bin Salman was seen to be too lofty by the company’s IPO arrangers. As a result, Aramco is selling three billion shares, or a 1.5% stake, at an indicative price range of SAR30 to SAR32 each, potentially raising up to US$25.6 billion. This values the company at between US$1.6 trillion and US$1.7 trillion.

The reduction in valuation is perhaps a reflection of the slow recovery in the oil industry. While activity within the upstream and midstream segments of the oil value chain has increased, it is still below the levels seen before the mid-2014 crash in crude oil prices. And this is compounded by the increasing trend towards sustainability, in particular, efforts to decarbonise, which are prompting banks and investors to shun oil companies.

Oil companies are thinking about how to reduce their carbon footprint. Angus Rodger, research director at Wood Mackenzie, says a recent visit by his colleagues to industry players and clients in Texas underscores how sustainability has become the leading topic of discussion.

“It was not fracking, gas-to-oil ratios, cube developments, prices [or] mergers and acquisitions. But what came up in every single meeting was how to [integrate] the environmental, social and governance principles into the oil industry,” he says at a Nov 12 briefing. “Twelve months ago, this would not have turned up at any meeting.”

Meanwhile, global growth is expected to decline as the US progresses further into the economic cycle, heightened by its unresolved trade war with China. This is compounded by the geopolitical tensions arising from Brexit in the UK and the political turmoil in Hong Kong, which could continue to roil financial markets. Its effects may indirectly impact the oil industry.

“I’m sure all those factors are baked in. Nobody is going to part with [their money for the Aramco IPO at such a lofty valuation],” Andrew Duncan, principal adviser at oil and gas (O&G) consultancy Gaffney, Cline & Associates (GCA), tells The Edge Singapore in a recent interview.

Yet, there are signs elsewhere that could indicate that the recovery in the oil industry may be picking up pace. For instance, Quetzal Capital on Nov 4 announced a voluntary conditional cash offer for all of the issued and outstanding ordinary shares of PACC Offshore Services Holdings (POSH). Quetzal Capital has offered to pay 21.5 cents a share, representing a premium of 97.2% over POSH’s Oct 30 closing price of 11 cents. The offer price also represents a premium of 109.8%, 96.2%, 69.6% and 35.3% over the one-, three-, six- and 12-month volume-weighted average prices respectively. On the other hand, this is a huge discount to POSH’s IPO price of $1.15 in April 2014. Since then, the offshore and marine (O&M) industry has experienced a sea change, with charter rates for offshore support vessels (OSVs) at a fraction of 2014 rates, owing to a persistent oversupply.

Quetzal Capital is the bid vehicle formed by certain members of the Kuok group of companies. They comprise Kuok (Singapore), Trendfield and Merry Voyage, a wholly-owned subsidiary of Kerry Holdings. POSH is one of the largest Asia-based international operators of OSVs that provides services to the O&G industry.

Given the generous offer made by Quetzal Capital, could the move to fully acquire POSH be seen as an anticipation of a quicker pace of recovery in the oil industry? After all, the Kuok group of companies are known for their shrewd management and business acumen.

Stable crude oil prices for now

Crude oil prices are a major factor for consideration in the O&G value chain. The higher the prices of black gold, the more oil producers are incentivised to explore, drill and produce oil. Crude oil prices, in turn, are influenced by the market forces of demand and supply.

The mid-2014 crash in crude oil prices was caused by a few factors: The US and Canada became important producers of shale oil as fracking technology improved, bringing down the cost of production; slowing demand from China and India exacerbated the resulting oversupply; and the Organization of the Petroleum Exporting Countries did not help. Saudi Arabia preferred to let oil prices fall rather than cede market share by cutting production. In addition, speculators played a role in driving prices up, and their rush to the exit made the decline worse.

As crude oil prices continued to remain low, exploration and production projects were slashed. As a result of the prolonged downturn, many companies across the value chain suffered cash flow problems and went bust. Companies that suffered included the OSV providers, and capital goods providers such as rig and ship builders, as charter rates fell and rig day rates collapsed.

Today, crude oil prices are trading far above the five-year low of US$20 to US$30 a barrel in early 2016. But they are trading nowhere near their heady days of above US$100 a barrel. On Nov 27, the West Texas Intermediate and Brent crudes traded at US$58.11 and US$64.06 per barrel respectively. Could crude oil prices trade above US$100 per barrel and usher in a recovery in the oil industry?

GCA’s Duncan says crude oil prices are unlikely to return to that level. But the silver lining is that companies operating in the oil industry have adapted to the low crude oil price environment. These companies have restructured to survive and are showing “signs of life”, he notes.

More importantly, crude oil prices have so far seen little volatility. Duncan says this sense of stability is allowing oil majors to plan their capital expenditure (capex) ahead. “A period of US$60 to US$80 a barrel may not sound like stability, but it is as stable as you are going to get. That is what we are going to see in most people’s planning horizon,” he says.

Growing demand for energy could continue to support crude oil prices. According to a report by McKinsey & Co, global energy demand is forecast to grow — albeit at a slower pace — at 0.8% a year until 2030. By then, global energy demand would have peaked, thanks to energy-efficient measures. But as oil is still an important energy source, the consultancy expects oil demand to peak at 108 million barrels per day (bpd), compared with about 100 million bpd currently.

Giovanni Bruni, associate partner at McKinsey & Co and the lead for McKinsey Energy Insights in Asia, tells The Edge Singapore: “To meet this demand, the world will still need an additional 45 million to 50 million bpd of new liquids production by 2035 — with North American shale and offshore resources competing (in terms of project economics and risk profile) to provide over half of that supply.”

According to a Deloitte report, the US and Brazil are delivering growth in supply barrels from onshore shale plays and deepwater plays respectively. Together, they added 1.4 million bpd of liquids supply (including crude oil, condensates and natural gas liquids) in the first nine months of 2019. The Canadian oil sands can also deliver more barrels from current projects if required by the market, the report says.

GCA’s Duncan reckons shale oil producers, which have always been a “North American story”, will continue to act as a “moderating influence”. But he warns that other shale oil formations, such as Vaca Muerta in Argentina, are starting to gain momentum. These shale producers have improved their cost structures and increased production. “What’s interesting is that there are [other] shale basins that could come into meaningful production,” he says.

Virendra Chauhan, senior analyst at Energy Aspects, agrees. He notes that the International Energy Agency (IEA) recently raised its forecast for shale production “quite materially”. In particular, three million bpd could be added to the market by the 2030s to 2040s. Hence, he reckons that a “slowdown” in the pace of shale oil production is required to keep crude oil prices firm.


That aside, the transition to the so-called cleaner sources of fuel is also complicating matters. In particular, the Paris Agreement is putting oil companies in the crosshairs as it aims to keep global temperature rise this century to “well below” 2oC above pre-industrial levels. The agreement also aims to pursue “efforts” to limit the temperature increase even further to 1.5oC. In addition, the agreement aims to strengthen the ability of countries to deal with the impacts of climate change.

As a result, financial resources are pouring into renewable energy. According to Wood Mackenzie, the decarbonisation bill in Asia-Pacific could hit US$3.5 trillion by 2040. This includes investments in solar, wind, hydrogen, nuclear and hydro power. The majority of the region’s decarbonisation bill will come from the power and transport sectors, as both accounted for over half of the region’s carbon emissions last year, Wood Mackenzie says. This significant shift requires investment and support from all stakeholders, especially China and India, it adds.

In contrast, the sources of financing for oil companies have been hard hit. The carbon footprint of assets in the portfolio is now a “key concern” for public-listed players and directly affecting capital allocation decisions, says Wood Mackenzie.

Chauhan of Energy Aspects says large fund management firms are “well aware” of the attractive cash flow potential that can be generated by upstream oil companies. “But at the same time, they don’t want to be seen on the front page of [newspapers for investing] in an oil sands company that emits X thousand tonnes of carbon emissions every year,” he tells The Edge Singapore in a recent interview.

Fortunately, the investment void is beginning to be filled by pension funds and private-equity firms, says GCA’s Duncan. These group of investors are keen to invest in oil infrastructure, as these assets offer long-term, large investments that have attractive returns. They include pipelines, liquefied natural gas (LNG) liquefaction plants and floating production, storage and offloading (FPSO) units. Duncan notes that upstream oil companies are willing to divest these infrastructure because it allows them to free up capital. “[Although the pension funds and PE firms] are typically quite conservative, we are starting to see a lot of interest,” he says.

Many oil companies are trying to rebrand themselves as energy or power companies. For instance, Statoil, the NOC of Norway, had last year renamed itself as Equinor to support its strategy and development as a broad energy company. “The whole energy space is in a transition at the moment,” Chauhan says.

The big question, then, is whether renewable energy will completely replace conventional fossil fuel energy, which would spell the end of the oil and related industries. After all, advancements in battery technology have improved storage capacity to address intermittency concerns — though there is still a long way to go. Moreover, the economics of power storage is becoming more feasible. Hydrogen fuel is also starting to emerge as a reliable source of energy, complementing solar, wind and hydropower energy sources.

Still, the weak political will is proving to be a significant challenge. Gavin Thompson, Asia-Pacific vice-chair of Wood Mackenzie, believes the world is not doing enough. “In our base-case view, we think we are heading towards a three-degree global warming world. So, [this is] significantly below the Paris accord’s two degrees by 2100,” he says at the same Nov 12 briefing.

At the policy level, Thompson says there is currently no global agreement on carbon price and taxation. Without that in place, companies would not move fast enough in transition to renewable energy, he warns. In particular, companies involved in sectors such as shipping, aviation, agriculture, steel and cement are “almost untouched”, he adds. Furthermore, companies are not spending enough to shift to renewable energy, especially the large oil companies, he noted.

Keisuke Sadamori, director of the energy markets and security directorate at IEA, reckons the renewable energy market will continue to grow. But it will not be able to fully meet the growing energy demands in Asia. As such, fossil fuel sources will still be depended upon in the meantime. So, when will renewable energy replace conventional energy? Sadamori says it “depends”. “As the population grows, energy demand will grow too. So, it is more difficult to reduce emissions,” he says at an Oct 30 briefing during the Singapore International Energy Week (SIEW) 2019.

Francesco La Camera, director general of the International Renewable Energy Agency, is more optimistic. He believes renewable energy sources will completely replace conventional energy by the second half of this century. For now, like Sadamori, he thinks conventional energy will still be required, but with a declining share. He spoke at a separate briefing during SIEW 2019.

‘Partial’ recovery

So, what does all this mean for companies operating in the oil industry? Singapore’s capital goods providers Keppel Corp and Sembcorp Marine have deftly shifted to the LNG space. LNG is a transition fuel that produces less carbon emission than oil. Rodger of Wood Mackenzie says more than half of all volumes discovered over the last decade was gas and it is “steadily” increasing.

Bruni of McKinsey & Co agrees. “We have already seen a number of project FIDs [final investment decisions] taking place this year. We will continue to see this increasing, driven by the expected continued growth in LNG demand... However, market volatility will always be a factor,” he says.

Investment in oil projects will still continue. But there is a catch. Chauhan of Energy Aspects says much of the capex poured into these projects is allocated to existing oil assets. For instance, drilling and extraction infrastructure is built to connect a “pocket of oil” to the main oil asset. In contrast, little investment has been made to scour for new potential oil assets. “Essentially, the focus has gone from developing large-scale green oil projects to [how to extract more and more from] what we have in place,” he says.

In the midstream segment, Bruni expects the O&M shipbuilding sector to experience a “partial” and “delayed” recovery to pre-2014 levels. He notes that the cumulative new orders are estimated to range from US$100 billion to US$120 billion, from 2019 to 2024. These are expected to grow to about US$180 billion from 2025 to 2030, driven by the requirement for new offshore resources to come online to replace depletion, he says.

Bruni points out that new orders will be driven primarily by production platforms/ FPSOs and gas solutions, including LNG carriers. Drilling rig orders, however, will remain muted, owing to oversupply, he says. Offshore wind power will become increasingly “material” and account for about 5% of the market, he adds.

GCA’s Duncan thinks Singapore O&M companies have the advantage to overcome these challenges, as they are perceived as “reliable” and “quality” offshore service providers. For instance, he notes that Keppel Corp is undertaking the conversion of an LNG carrier into a floating LNG vessel for Gimi MS Corp, a subsidiary of Golar LNG. “That’s probably a scope of work that very few yards in the world [can do],” he says.

Even if Singapore O&M companies are not able to deliver the full scope of the job, they are “flexible” in teaming up with a foreign partner, he says. It helps that the city state is in a good position geographically to collaborate with players from China and South Korea, he adds. “Singapore companies are good at joint ventures,” he says.

Whether or not the recovery in the O&G industry will pick up pace remains to be seen. The conundrums faced by the industry are complex and multi-faceted. But for now, all eyes will be on the upcoming listing of Aramco. As at Nov 26, its IPO subscription had reached SAR27.04 billion ($9.85 billion), according to lead manager Samba Capital. Perhaps Aramco’s debut performance could be a clearer indication of the state of the O&G industry.