The Future of Oil & Gas: A

2020 Market Report

Produced in conjunction with Reuters Events: Future of Oil & Gas 2020
 Upstream Oil & Gas: State of Market during Covid-19

When a global pandemic and oil pricing war collide

Even before COVID-19 was declared a global pandemic by the World Health Organization (WHO) on 11 March,
the origins of the virus in China, the world’s largest importer of oil and natural gas, was disseminating global
demand.

Since 2013, China’s oil production had declined by almost 15% at the time that its oil requirements had risen
by 30% to reach 10.12 million barrels per day (bpd) by close-2019, according to Reuters’ calculations based
on data from the General Administration of Customs.

In 2019, China relied on imports for 75% of its oil usage, with crude imports in September 2019 up 11% on
2018 levels. In addition, stockpiling oil to strengthen energy security during pricing dips, has spurred imports
(Forbes, China Is the World’s Largest Oil & Gas Importer, October 2019).

China accounted for more than 80 percent of global oil demand in 2019 (Energy Voice, Will Covid-19 Kill the
Oil Industry, April 2019).

A similar story has unfolded with natural gas imports. Although domestic production has doubled over the
past decade, import reliance sits at around 45% (Forbes, October 2019). In December 2019, natural gas
imports, including fuel supplied as liquefied natural gas (LNG) and via pipeline, were 9.45 million tonnes
(Reuters).

By February, reduced industrial output and electricity demand resulted in coal consumption at power plants
down by 36% and domestic oil refining capacity reduced by 34% (Energy Voice, April 2019).

Produced in conjunction with Reuters Events: Future of Oil & Gas 2020 2
 Beyond China, as the pandemic forces the stalling of large construction projects, depresses electricity loads,
and supresses the infrastructure investments which have typically driven oil and gas orders, total demand is
down.

In the US, data from the Energy Information Administration (EIA) shows that consumption of petroleum prod-
ucts up to April 2020, are the lowest in decades. The fallout from limited travel and economic slowdown in-
curred by lockdown measures has translated into total petroleum demand averaging 14.1 million barrels per
day (b/d) in the week ending April 17, up slightly from 13.8 million b/d in the previous week—the lowest level
in EIA’s weekly data series, which dates back to the early 1990s.

That accounts for a 31% decline on the average consumption levels in January through mid-March, in the
period prior to US restrictions.

Goldman Sachs estimated that as of close-March, global oil demand had fallen by 25%., with the Interna-
tional Energy Agency (IEA) reporting that oil demand is likely to decrease by 29 million barrels per day (bpd)
in April 2020, and by 23.1 million bpd in Q2.

But demand is not the sole issue at play.

Here Reuters Events leverages its viewpoint from across oil and gas verticals alongside insight garnered from
ongoing conversations with stakeholders as they respond to the pandemic, to mull over some of the key ques-
tions and considerations H1 2020 has thrown up, for oil and gas.

OPEC+ and the Russia-Saudi Arabia price war

In response to early demand dips, and the anticipated continued glut as the pandemic engulfed the globe, in
early-March, the Organization of the Petroleum Exporting Countries (OPEC) alongside ten additional oil pro-
ducing nations (OPEC+) set about carving out bilateral capping arrangements to stabilize production levels.

Produced in conjunction with Reuters Events: Future of Oil & Gas 2020 3
 At the summit, OPEC+ proposed to cut global production over Q2 by more than 1.5 million bpd, with the view
to review again in early June. Russia was reportedly unwilling to accept OPEC members’ requests to assume
0.5 million bpd of cuts, triggering oil prices to fall immediately by 10%.

A couple of days later, Saudi Arabia, who had assumed the majority of OPEC’s capping measures since the
entity was set up to manage production levels in late-2016, introduced price discounts of between $6-8 per
barrel to import customers across Europe, Asia and the US.

As a result, the West Texas Intermediate (WTI) fell by 20%. 

Pledges to increase production volumes from both nations followed, culminating on 20 April in the WTI fall-
ing into negative territory for the first time in history.

Inability to stall productions entirely in response to plummeting prices - resulting in insufficient storage ca-
pacity – converged with the global decline in demand to reach a level of -$37/bbl.

On April 12, a new OPEC+ deal was cut, in which members agreed to the following terms:

• Adjust downwards their overall crude oil production by 9.7 mb/d, starting on 1 May 2020, for an initial
period of two months that concludes on 30 June 2020.

• For the subsequent period of 6 months, from 1 July 2020 to 31 December 2020, the total adjustment
agreed will be 7.7 mb/d.

• It will be followed by a 5.8 mb/d adjustment for a period of 16 months, from 1 January 2021 to 30 April
2022.

• The baseline for the calculation of the adjustments is the oil production of October 2018, except for the
Kingdom of Saudi Arabia and The Russian Federation, both with the same baseline level of 11.0 mb/d.

• The agreement will be valid until 30 April 2022, however, the extension of this agreement will be re-
viewed during December 2021.

The OPEC+ curtailments, combined with a US campaign to reduce throughput by 4 million bpd, and the
Saudi government pledging to absorb an extra 1 million bpd, has seen prices level out at around 80% higher
in mid-May than that of mid-April.

Murmurs are now circulating that a potential deficit could be on the cards, with further suggestions that pro-
ducers might decide to increase production levels to capitalize on a potential deficit whilst prices are rising.

Indeed, there are reports that this is already happening.

According to oilprice.com, an oil pipeline major commented that some shale producers were ready to start
ramping up production again once WTI stabilized around the high-$20s or low-$30s. Another source said
that a quarter of shut-in wells in the Permian had already restarted as of May 10. 

Too much, too soon, would cap recovery.

Produced in conjunction with Reuters Events: Future of Oil & Gas 2020 4
 In early-May, Reuters’ John Kemp commented on this. “With future prices back over $30 per barrel, if they
rise much more, some drilling will start to become economic again, perhaps limiting further upside potential
for prices.”

How long and how far producers can financially hold their nerve will be important to track over the coming
weeks.

Catching a breath: What can be applied from the 2010s pricing crash?
The oil and gas industry was just about dusting itself off from half a decade of depreciated pricing caused by
an over-supply of commodity in the US, when COVID-19 took grip.

A series of production-driven optimizations, onboarding of technological innovations, and corporate restruc-

turings in the US market coupled with strategic curtailment measures from OPEC, worked to eventually sta-
bilize the industry.

The concern here is that demand decline from China, and the rippled effect across O&G importing nations, is
much more difficult to control and rebalance from within the industry.

During the 2015 oil price crash there was a c.40% drop in investment. Yet, production still increased because
the industry managed to make efficiencies. This time, there are limited efficiencies to be cut, with much of the
fat having recently already been trimmed, so to speak.

That means the 2020 crash will hit the upstream industry harder when CAPEX investment drops. Majors have
already announced cuts in budgets somewhere around the 20% level, exceeding $80 billion across the sector
by mid-April. Importantly these cuts are undergoing continuous revisions, with operators expected to make
deeper cuts throughout the year.

Saudi Aramco have announced a CAPEX reduction from a planned $35-40 billion to $35-30 billion. Many
companies are also focusing on freeing up cash flow and increasing liquidity access. Technip FMC and Petro-
fac have freed up $7.7bn and $1.1bn in liquidity access respectively for 2020.

For producers, the easiest way to cut budgets is to not start projects, delaying that spend into the future. For
sanctioned projects, companies will be looking at contracts and assess what can be cancelled. With contracts
typically running lower costs of exiting, it will be projects under development that will be hit. For insight proj-
ects and oil producing assets, anything that is discretionary will likely be cut.

At start of 2020 Wood Mackenzie identified a healthy number of projects pre-FID that were expected to move
forward. Since the crash, a review of that pipeline shows that only 10-15 projects are likely to move forward
this year.

The majority of pre-FID projects can afford to run at $40-50 per barrel, which was fine under earlier pricing
levels. Only the most robust and strategic core projects will be able to proceed in a $30 per barrel climate.
The projects that do go ahead will be reliant upon operating companies finances rather than the feasibility of
the project on a cost per barrel assessment.

Produced in conjunction with Reuters Events: Future of Oil & Gas 2020 5
 Consolidation: The de facto response?
Consolidation has historically been the de facto response to oil and gas pricing slumps.

But unlike the last pricing crash which opened up vast opportunities for new entrants and carved out in-roads
for a new class of tech driven operators, the coronavirus pandemic has meant the broader investment and
business world is experiencing parallel operational challenges, therefore limiting the investor pool.

Intra-industry opportunities will be up for grabs for the largest and most financially robust of companies.
Mergers, acquisitions and restructurings are likely to occur in both the production and service sectors.

Consolidation will be a necessary solution, but it will be imperative that innovations spearheaded by some of
the industry’s smaller, yet most agile and resourceful entities are not lost as companies scoop up their com-
petitors.

That said, continued innovative manoeuvres from these nimble players, could see them out survive their larg-
er peers. A system could emerge whereby we have large at-scale and small, niche companies, with not much
happening in the middle tier.

McKinsey analysis has contemplated a more novel consolidation mechanism.

“Broad-based consolidation could be led by “basin masters” to drive down unit costs by exploiting synergies.
In the shale patch alone, we estimate that economies of skill and scale, coupled with new ways of working,
could further reduce costs by up to $10/bbl., lowering shale’s breakeven point and improving supply resil-
ience” (McKinsey & Company, Oil and gas after COVID-19: The day of reckoning or a new age of opportunity?,
May 15, 2020).

Over on the supply and service side, McKinsey argue that this crisis calls forth the kind of tough restructuring
and business reconfiguration, technological innovation and customer partnership optimizations that never
came to fruition from the 2014 crash. As such, “much of the oil and gas supply industry was in a dire position
coming into the crisis; significant over-capacity had emerged, and profitability collapsed after 2014,” (McK-
insey, May 2020).

Produced in conjunction with Reuters Events: Future of Oil & Gas 2020 6
 Maintaining operations against squeezed profitability and falling demand
Whilst oil and gas activities have been sanctioned by global governments to continue operations throughout
lockdowns as part of essential activities, the shake-up in global demand is having a very immediate impact
upon productions.

Data from the US EIA indicates that active oil rig volumes have historically followed changes in oil prices with
a lag time of about four months in the US.

The latest declines in rig count following the recent oil price decrease is proving to be much more rapid, with
the spot price of West Texas Intermediate at $46.78 per barrel (b) at the start of March, and ending the month
at $20.51/b, with most of the decrease occurred in the first half of the month (EIA, May 2020).

That represents a monthly (if not fortnightly) decline of 56%. It is hardly surprising that US active rig counts
are at the lowest point since EIA records begun in 1988.

Producers were operating the fewest oil and natural gas drilling rigs on record in the United States at 339 on
May 12, the lowest level in the Baker Hughes Company’s rig count data series that dates back to 1987. The
number of active rigs began sharply decreasing in mid-March as crude oil prices fell: rigs have fallen by 56%
(433 rigs) since March 17. Most of the decrease was in oil-focused geologic plays, but natural gas-focused
plays also saw significant decreases.

The U.S.’ move to curtail 4 million bpd was a pure economics driven campaign by producers, who outside of
the OPEC+ curtailment sharing deal, were responding to simple supply and demand dynamics, profitability
squeezes and ongoing storage scarcity.

The U.S. shale patch has announced more than 1.5 million bpd in cuts for Q2, lifting the oil prices and market
sentiment over the past two weeks. Resilience to the pricing and demand slumps of 2020 and beyond - EIA
forecast a 0.8 million bpd decline in U.S. crude oil production in 2021, which would be the largest annual
decline in U.S. crude oil production on record - will vary markedly.

Produced in conjunction with Reuters Events: Future of Oil & Gas 2020 7
 In the US, basin location will be the may determinant in how companies fare. Companies residing in the high-
er cost basins, where it’s more expensive to produce oil will be most greatly impacted.

Companies that already have ongoing production, that have steady cash flow, for the longer term, are in
better shape. For example, shale production comes on very strong, and production drops very quickly. Com-
panies focusing on shale must continue to invest, otherwise their production runs out. The short cycle nature
of investments in the US lower 48 will see the region experience most immediate and dramatic losses. By
comparison, the EIA forecasts GOM production to remain relatively flat, averaging 1.9 million bpd in 2020
and 2021, nearly unchanged from its 2019 average. In addition, EIA expects no cancellation in announced
GOM projects for 2020 and 2021.

The storage factor

If the current oil price persists, 2020 free cash flow may be even more challenged than in 2015 and 2016.
Global E&P investments are expected to fall by 8% in a $40/barrel scenario, a situation which would also
plunge North American Shale investments down 25%.

Sanctioning activity would also fall considerably. Onshore sanctioning could drop from $88 billion to $43
billion in a $40 per barrel world and $30 billion in a $30/barrel environment.

The actual impact on oil prices will be determined by global storage capacity, as the recent flood of oil from
Saudi Arabia will be multiplied by the onslaught of demand destruction.

Implied stock builds could amount to as much as 1 billion barrels by the summer, exceeding the remaining
capacity for crude and products in the entire supply chain. As such, production must halt when oil prices fall
below a field’s marginal cost of production, which ranges from $10 to $25/barrel for fields globally.

Produced in conjunction with Reuters Events: Future of Oil & Gas 2020 8
 Reverberations across the supply-chain
Oilfield service companies are likely to be the most affected in the near-term because they of course, service
the industry and send teams out into the fields and send teams out internationally. A lot of their services are
going to be cut as part of CAPEX leaning, whilst being quarantined in different jurisdictions affects their abil-
ity to physically get out and serve those clients.

From the producer’s perspective, this is also an issue because if your service provider can’t get out there and
service your wells, can’t provide maintenance you have to think about alternatives otherwise production stops.

The million-dollar question is, are there efficiency gains to be made within the current supply chain? The ser-
vice sector is in a worse position heading into this downturn than last time – the majority are already operating
with stretched balance sheets and are struggling to gain pricing power due to overcapacity in a lot of areas.

Efficiency-gains wise, there are few bright spots of cost inflation – there is downward on service companies’
balance sheets and moving forward some companies will be executing contracts at a loss, keeping staff and
machinery occupied in the hope of a recovery. There will also likely be capacity coming out of service sector
where companies go bust.

2021: A delayed cashflow crisis or a global demand spike?

Most companies are not well hedged into 2021 to safeguard revenues. There are 2 million barrels a day
hedged for 2020, whilst only 200,000 barrels are hedged for 2021. If low prices persist, 2021 could be the
hardest hit year of the crisis.

But 2021 will also likely see a resurgence in global oil demand as the pandemic is controlled, or economies
adapt much more effectively to operating near capacity under restrictions. China and India’s rebounds will be
critical to an upswing in global oil demand. Moreover, as markets seek to claw back lost time and mobilize
mega infrastructure projects, for example, as a mechanism to kickstart economies, we could see oil demand
spike above 2019 levels.

Concluding thoughts
Artificial and confined pressures such as those concerning the Saudi Arabia - Russia pricing struggle are
arguably easier to square-off than the spiralling, embedded fallout caused by a global pandemic; now there’s
some perspective!

Coronavirus has destroyed the demand for fuel, while the oil price war between Russia and Saudi Arabia un-
dermined global markets. The resulting turmoil is raising significant legal issues for the energy industry, from
slacking demands and quarantines, to revenue hits and volatile markets.

If the health pandemic spurs large-scale investment in renewable energy deployment as many sources are
postulating, the horizon of oil and gases pending expiration could be brought forward. The convergence of
these pressures presents oil and gas sectors with its most challenging outlook to-date.

But if harnessed shrewdly. the epidemic will give producers and oilfield supply chain participants pause for
thought. Post-epidemic data analysis will inform future hedging, procurement and risk mitigation strategies.
Globalised supply networks could be augmented with a resurgence in local manufacturing. But to offset the
increased cost, investment in technology-led regionalization would need to accelerate.

Produced in conjunction with Reuters Events: Future of Oil & Gas 2020 9
 References:
Forbes, China Is the World’s Largest Oil & Gas Importer, October 2019

China General Administration of Customs

US Energy Information Administration

International Energy Agency

OPEC

McKinsey & Company, Oil and gas after COVID-19: The day of reckoning or a new age of opportunity?, May
15, 2020

Reuters, COLUMN-Oil futures point to long and deep recession, April 2020

Energy Voice, Will Covid-19 Kill the Oil Industry, April 2019

Wood Mackenzie GEM Q1, 2020

Rystad Energy UCube March 2020

Produced in conjunction with Reuters Events: Future of Oil & Gas 2020 10