As with any market, supply and demand are key to price. Recently, nowhere else has this been seen more acutely than in the oil & gas markets. Headlines at the turn of the year were dominated by the fall in oil prices. Brent crude remains at around US$58 a barrel, down from US$100-120 only last summer. So, four months on from OPEC’s decision (in November 2014) not to cut supply in the face of reducing global demand and increased non-OPEC production, how have companies in the oil sector fared?
Those with deep pockets will obviously fare better than others. Whilst the major oil & gas companies have cut back on exploration, staff and capital expenditure, oil price volatility is not new to them and these companies are generally used to weathering and planning for such storms. Equally, however, oil & gas companies are keen overall not to stop new investment or let skilled staff go. Previous downturns have shown this to be a poor strategy for the medium turn but it needs to be balanced against severe margin squeeze with high-cost production fields (such as US shale oil, Canadian tar sands, the deepwater Gulf, Arctic and UK continental shelf fields).
Those who have felt the ‘pinch’ most over the last few months have been the smaller, independent exploration and production companies (who tend to work in those higher cost fields), and those in the ‘downstream’ oilfield services sector. For those in oilfield services, it could be a supply-chain reset, in a market which had been overheated in recent years by the sustained high price of oil. However, some commentators note that the full impact of capex cuts is probably yet to be felt by this constituency and forecast that the latter part of 2015 will be the main pinch point.
Planning in advance for that eventuality is key, with closer scrutiny of rates and lower activity levels modelled into forecasting. Some distress, in the UK at least, has already been seen in these companies however, with Moore Stephens noting in December 2014 that there had been a trebling in UK Oil & Gas Services insolvencies in 2014. For those companies, pre-planning and early intervention are key, identifying issues and addressing them in advance of significant problems arising including:
- Contractual reviews – which contracts are no longer profitable? How can we (legally) and with least risk renegotiate or terminate these? Care should be taken to ensure there are suitable grounds for termination (if any) as significant damages may ensue if a contract is wrongfully terminated. Can the contracts be modified consensually? Unlikely if this will not benefit the other contracting party;
- Debt restructuring – with largely fixed debt servicing and operating costs, but a fall in revenue, can the terms of debt finance be renegotiated? Early engagement with financers and other investors/stakeholders with a credible restructuring plan will likely increase the chance of a successful outcome;
- Employees – an obvious area when looking at operational efficiencies is a reduction in headcount, but care should be taken when implementing any restructuring and up-front consideration of employee rights in diverse jurisdictions can avoid costly mistakes;
- Contractual protections – do you, as a supplier, have any retention of title or other contractual protection in relation to goods sold, in order to mitigate against the risks of financial distress in the counterparty?; and
- Cross-jurisdictional issues – with diverse contracting relationships across the globe, consideration should be given to which law and which Court will have jurisdiction over any contractual or operational restructuring.
But whilst the low oil prices may mean some losers in the sector, there are also winners. EY has predicted that there will be a strengthening oil and gas mergers & acquisitions market, especially in the later part of 2015, leading to consolidation in the market, removal of underperforming and lower-yield businesses, opportunistic acquisitions of under-valued businesses, and joint ventures to share capital and risk. The recently announced proposed acquisition by Royal Dutch Shell Plc of BG Group Plc may be a sign of things to come in this M&A market. Whilst in North America there has been significant increase in private equity investors coming into the market (in the oil sector increasing by c.33% in 2014), this has not yet translated over to Europe, although it is anticipated that may happen over time with pricing of assets being key.
Further, the International Energy Agency’s Oil Market Report for March notes a slight increase in global demand for oil, leading to a slight upward revision of the 2015 forecast, although global supply also rose, so whether this actually results in a steady rise in prices will only be seen over the coming months.
Given the global nature of the market, and the political factors which also contribute to fluctuations in commodity prices, it has been difficult for commentators to forecast where the oil price may stabilize. Until there is confidence and a consensus on that matter, there will be difficulties for oil & gas companies, their lenders and stakeholders in forecasting what may be coming down the pipeline. Like any business which sees signs of distress, early planning is crucial.