Why consolidation will be key for oil companies

With the coronavirus pandemic big oil companies may have no choice but to look at synergies in order to survive

TAFT, CA - JULY 22:  Oil rigs just south of town extract crude for Chevron at sunrise on July 22, 2008 in Taft, California. Hemmed in by the richest oil fields in California, the oil town of 6,700 with a stagnant economy and little room to expand has hatched an ambitious plan to annex vast expanses of land reaching eastward to Interstate 5, 18 miles away, and taking over various poor unincorporated communities to triple its population to around 20,000. With the price as light sweet crude at record high prices, Chevron and other companies are scrambling to drill new wells and reopen old wells once considered unprofitable. The renewed profits for oil men of Kern County, where more than 75 percent of all the oil produced in California flows, do not directly translate increased revenue for Taft. The Taft town council wants to cash in on the new oil boom with increased tax revenues from a NASCAR track and future developments near the freeway.  In an earlier oil boom era, Taft was the site of the 1910 Lakeside Gusher, the biggest oil gusher ever seen in the US, which sent 100,000 barrels a day into a lake of crude.  (Photo by David McNew/Getty Images)
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Oil companies are survivors: Shell, BP and ExxonMobil each date back more than a century. After surviving wars, pandemics, depressions, gluts and nationalisations, they had begun to grapple with a new existential challenge: how to transform themselves in the era of climate change. Now the coronavirus crisis threatens to derail the big oil companies’ emerging plans.

During 2019, the industry conversation on climate change changed utterly. Oil companies had been relying on improved energy efficiency and a gradual conversion into big gas players, relying on the fuel’s lower carbon footprint. Suddenly this was not enough, as shareholders, policymakers and activists challenged them on their long-term sustainability.

With the 2015 Paris Agreement implying a rapid decrease to near-zero global greenhouse gas emissions by 2050, they had to explain how continuing sales of oil and gas could be compatible with that. Between December and January, BP, Repsol, Equinor, Eni and Shell set plans to have net zero or near-zero emissions by mid-century.

There is still no clear path for how to achieve this. Using carbon capture and storage to mop emissions, and moving more into petrochemicals, is part of the plan. Converting gas to the clean fuel hydrogen could be part. Then there is the repurposing of skills: Equinor’s talent in offshore oil platforms translates to floating wind power; Shell’s and Total’s retail networks to selling electricity and battery storage.

The main American companies are a sharp contrast. Under little domestic political pressure for now, they have maintained their view that oil and gas demand will keep growing for decades. They invested heavily in shale: ExxonMobil paid $41 billion (Dh150bn) for unconventional gas player XTO in 2010, then $6.6bn for the Bass family’s Texan fields in 2017. Chevron, which had inherited a large land-holding in the key Permian basin of west Texas and New Mexico, said it would more than double its output there by 2023, to 900 000 barrels per day, almost as much as Oman’s national production.

Smaller US companies sold off foreign assets to become “pure-play” shale drillers. Occidental, almost the only American company with a vision on becoming climate-compatible, paid $38bn for rival Anadarko in 2019, outbidding Chevron, and quickly moved to offload its African assets.

But shale costs are high, and wells decline rapidly. Investors were already growing tired of a lack of financial returns.

Now coronavirus faces oil companies with the worst oversupply in history. Traders Vitol and Trafigura believe oil demand could be down 10 million barrels per day, out of 100m bpd total pre-crisis.

At the same time, after the collapse of the Opec+ pact, its former adherents are collectively boosting output by between 3m to 5m bpd. Global storage will soon be full, which will mean the world's higher-cost producers will have to stop production entirely. It could take years to work off the surplus.

For now, the American and UK industries are looking for short-term financial help: purchases for the US’s strategic petroleum reserve, perhaps relief on royalty payments, an easing of already not very onerous US regulation. In an almost unprecedented move, a commissioner of the Texas Railroad Commission, the state’s petroleum regulatory body, floated the idea of co-operating with Russia and Saudi Arabia on production cuts.

Chevron and ExxonMobil are better-placed than their pure shale rivals: they at least have moderate debt and ongoing cashflow from previous investments in areas such as Kazakhstan and the Middle East. Occidental has strong Middle East assets too, but the debt it took on to buy Anadarko has placed it in jeopardy: its market capitalisation has crashed to only $9bn. Shale pioneers such as Chesapeake and Ultra are staring at bankruptcy.

Consolidation is inevitable, in the style of welding together two car wrecks to make a half-viable vehicle. Very cheaply, a supermajor could build a business to rule all shale – but it would be a huge gamble.

Shell has raised its dividend every year since the Second World War. With the collapse in share prices, implied dividend yields have reached extraordinary levels: 10 per cent for ExxonMobil, 12.4 per cent for BP, 14 per cent for Shell. But how long can such payouts be sustained if oil prices drop below $20 per barrel?

The European companies had been planning a steady transformation into new energy champions, selling off mature North Sea fields and purchasing smaller businesses in batteries, wind and solar to a gain a foothold in new energy. At some point, one or more might have made a bold move to buy a big independent power company, or to spin-off their low-carbon investments.

Now that looks in doubt; bare survival is the name of the game. Electricity consumption in the heavily-affected countries, such as Italy, has already dived. Government plans for economic recovery post crisis are likely to follow a “Green New Deal” pattern, not favouring oil companies.

Instead, as they did when oil dipped to $10 per barrel in the late 1990s, the big oil companies may find safety in numbers, merging to keep scale and cut costs. Eni, Total and Equinor are probably politically untouchable, and a transatlantic tie-up looks ideologically unlikely, leaving only Shell-BP or acquisition or mergers of smaller companies such as Repsol, OMV or Wintershall. Or instead of cannibalism within a shrinking pond, will lean post-crisis years be the time for a bolder deal, a joint venture with a big green energy venture, a leading commodity trader, or even a national oil company?

Robin  Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis