[NGW Magazine] Agonising reappraisals for the IOCs

This article is featured in NGW Magazine Volume 2, Issue 15

Eni’s creation of an advisory board in late July typifies the concerns facing the international oil company (IOC) today: its members bring their expertise to tackle the three big worries that the IOCs have.

First is geopolitics – in one sense, nothing new; but raising the question, why now? – second is climate change and the Paris Agreement; and the third is mergers & acquisitions in a low-cost environment that must become lower-cost.

Other decisions over the last few weeks have propelled IOCs further towards a fundamental rethink of their own purpose, and their medium- to long-term future in a world that is moving inexorably away from oil in particular. Generally seen as useful commodities where transport, power generation, heat and manufacturing are concerned, oil and gas now come with heavy baggage, their former apparent scarcity now seen as an embarrassment of riches as production costs tumble and new energies come to the fore, while carbon capture and storage is yet to become mainstream.

This unpredictability has proved too much for some companies to manage: French Engie and UK Centrica are joining E.ON and other utilities, spinning off their upstream businesses – with neat symmetry, the former boss of Centrica Sam Laidlaw is in the frame to buy a controlling stake in the upstream business of Engie, leaving both companies free to focus on the increasingly disruptive consumer.

Indeed the IOCs are being very gradually forced out of some sectors, by a combination of societal pressure and the technological changes that pressure can induce. Even private transport could be carbon neutral in entire nations by 2040 if the UK and French plans materialise; or much sooner, if the rate of change continues to accelerate.

The miserly average 9% increase in the Brent crude price in the second quarter this year relative to 2016 has refuted the optimism of 2015: it is indeed to be lower for longer, and "Fit for $40" is the new mantra. The industry was quick to respond: producers have focused on lower-cost production, cutting capital expenditure and tendering more aggressively for contractor services, a sector that has also seen consolidation.  

There has also been a move, conversely, to stimulate demand: development of ever more modest LNG transportation facilities for marine or road transport will provide producers with another outlet for their gas, adding value in the form of zero sulphur and particulate emissions, although this is to be mainly at the expense of oil. Less efficient, reciprocating gas-fired generators are also being built, as they are able to respond more quickly than combined-cycle gas turbines to sudden changes in output from renewable generation.

This month, another Canadian LNG project, long suspected of being out of the money. has finally admitted to hitting the buffers while international oil companies are courting the world’s largest LNG supplier, Qatar, for a slice of the expanded pie. Iranian gas too is back on the agenda. So all things being equal, this means, as Shell has said, some fundamental rejigging of the IOCs’ own corporate priorities: there will have to be some tearful farewells for projects that were intended to develop less advantageously priced or located reserves but which for now make no sense. East Africa and the eastern Mediterranean no longer seem so compelling, but drilling is starting off Cyprus so that cannot be written off yet.

So the continuing low price of Brent crude – still south of $50/barrel despite Opec’s plans – promises not to drive competition upstream but to limit it, to the lowest-cost producers of oil and gas.

Politics too can play a part in limiting demand for oil and gas. The US, discovering that it has plenty of both, is seeking to promote sales of its own and to inflict pain on Russia. This will be yet another turn-off for the European consumer, especially if the US gas comes with strings attached. Welcomed in Poland and Lithuania, the anti-Russia rhetoric does not go down so well in the European Commission and Germany, a long-term buyer of Russian gas.

The sanctions also come in spite the failure of the first set, the fruit of close US and European Union collaboration in 2014, to halt Russian-backed troops in Ukraine. This latest set is misjudged if it punishes EU companies for allegations of Russian meddling in US elections while the Minsk accords – the preferred European Union approach – go ignored. 

Generally this is not good news for gas demand, even before considering what response Vladimir Putin might choose to make. Politicising gas places it under the control of governments rather than of markets, which is why the distinction between Gazprom and the Kremlin is often blurred. It explains why multi-billion dollar projects – Vladivostok LNG, South Stream and so on – vanish and reappear, creating massive uncertainty for investors.

On the other hand, the 2014 sanctions have forced Russian industry to develop its own world-class technology. For example, Novatek says it will be Russian machinery that liquefies its gas for its second Arctic export project, if it takes a positive investment decision later this year. The weak ruble has also allowed Gazprom to keep its domestic expenses low, as it is paid in euros.

NGW

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