Professional services organisation, PricewaterhouseCoopers (PwC), published their latest report, 'A Sea Change - The future of the North Sea Oil & Gas', which seeks to define the state of the North Sea Oil and Gas industry and, through the contribution of some 30+ anonymous 'senior industry stakeholders', give some guidance on how the industry could change to secure a turnaround in fortunes within a 24-month window of opportunity. Whilst full of positive sentiment, I can't help but worry that fundamentally, the North Sea Oil and Gas industry is averse to change.
The strongest element of the report is the urgent need for disruptive thinking within an industry that has always cyclically repeated the past and now, in a lower for longer environment, expects and needs different results. It shouldn't take Einstein to see the insanity of that as a strategy.
In theory, three of the most innovative or potentially most impactful ideas mooted are: consortium funding; nationalisation of the supply infrastructure; and standardisation of technologies. However, in heeding lessons from other large scale industries that have been forced into significant change, these are sometimes not without their problems when it comes to practical implementation.
The exit of many forms or scale of traditional funding from the industry has crippled exploration and development activities. Consortium funding, where those Operators (or Service companies) with deeper pockets club together to finance projects of mutual benefit could well go some way to replacing some of the more risk-averse sources that have withdrawn their support in recent times, scared off by unworkable reserves or performance covenant based lending. The worry is that whilst this may reduce the capital injection required, lenders will still take funding decisions or guarantees based on the weakest link in any partnership. Recovering after the 2008 financial crash, lending institutions of all sizes, despite having billions made available to inject back into the market, were more interested in rebuilding their own balance sheets before providing much-needed market stimulation. Perhaps, in the North Sea, those with the deepest pockets could provide more assurity than others, but then with shareholder pressure, Operators and Service companies may take the same approach in addressing their own needs first.
One of the biggest threats to the sustainability of supply in the North Sea is the integrity and long-term viability of the supply structure. Much of the efficiency savings achieved in the last decades that have driven the North Sea production cost to be amongst the most competitive in the world stem from collaborative use of the offshore pipeline and tie-back infrastructure. As fields face decommissioning or reduced investment in integrity, this advantage may literally erode. So, the industry suggests passing the maintenance of the infrastructure onto the Government. However, as an option, this has a familiar ring.
The nationalised National Rail inherited a poorly maintained infrastructure from the private Rail Track group of companies. Several catastrophic failures, mismanagement and massive losses led to this re-nationalisation where the bulk of the ongoing cost for the upkeep falls to the tax payer. A similar deal with the UK people, who perhaps would not hold the same fondness for bailing out the oil and gas industry, may struggle to find far-reaching support.
A key collaborative initiative that will only work if there is true commitment to co-operate from both Operators and Suppliers is standardisation. Macondo and other milestones have necessarily driven the performance standards demanded of oilfield equipment and operations higher and higher. However, raising the bar to a level where all equipment must meet the same stringent specifications whatever the working conditions is an expensive gold-plated option that led to spiralling industry costs in recent times. Likewise, the pursuit of competitive advantage by technology developers has baked in over-complexity and a lack of interoperability that similarly impacts on costs. Lessons can be learned from the automotive industry that introduced cross-manufacturer standardisation and many other technology and supply chain collaborations that greatly contributed to reduced manufacturing costs.
An industry averse to change
Change management experts identify several common traits in individuals and organisational cultures that lead to the lack of success or failure of change programmes. I believe that industries as a whole, including the Oil and Gas industry, can also be affected by these same factors leading to less than practical success when compared to the vision or goals such as this one.
Fear of the unknown
The precipitous decline of the oil price came as a surprise to most. However, like a blind-sided boxer left reeling from a stunning left hook, the industry has taken too long to gather its wits and come back fighting.
As an industry, Oil and Gas displays an astonishing lack of flexibility in its interpretation of and reaction to the information it has to hand. Just like the proverbial oil tanker, even with all the signs of oversupply, spiralling costs and reduced global demand, the industry failed to read the signs and change direction. And now, almost two years later, we are still lamenting how the industry should change rather than celebrating how it has changed.
Greater emphasis needs to be placed on reading the signs of the cycle and not adding too much complexity on what is still essentially a supply and demand driven market.
Much hope is placed on the UK Government's fiscal mechanisms to create a more favourable market environment. Whilst the PwC report cites praise for some of the changes that have been made, they make little difference currently in a market without revenue. UK Energy Secretary, Amber Rudd, on a trip to open the new Total Shetland gas plant, made no apologies for her lack of a visit to Aberdeen fully a year after taking up the appointment that oversees the UK's energy policies - including North Sea Oil and Gas. That is clearly not something that inspires trust within the industry that the Westminster government has a clear plan. One could argue that they do not even have a vested interest in the industry with the tax take moving into negative figures for the first time in 2015-16, falling from over £2 billion the previous year and down from £10 billion contribution just five years ago.
Loss of control
The perception that change will take away control has a crippling effect. The often quoted story of the howling dog not moving from the nail it is sitting on because the pain is not yet bad enough, exemplifies how the fear of what is on the other side of change outweighs the imperative for action. But surely, the industry has endured a deep enough pain that even the most thick-skinned or stubborn cannot ignore.
The longer the industry waits to make significant changes the less chance they will be made. As the oil price appears to stabilise around $50, the industry is already showing signs of drawing its breath in preparation to releasing a collective sigh of relief. However, $50 as the new bottom is tenuous and there is still a long way to go before significant spending returns. There will be many more companies and individuals who do not retain their positions to see the benefits of a market recovery.
PwC's report suggests a 24-month window of opportunity. I would ask why more was not done a year ago when the window was open even wider.
Predisposition toward change
Finally, a person's attitude to change plays a large part in how actively they engage with it. We all know and understand that the Oil and Gas industry operates on a cycle of boom and bust. If so, then as an industry why change at all? Let's just wait for the next upcycle to swing by.
Even if there is sufficient oil under the North Sea for another 20+ years, there is the clear and present danger that without decisive change, the UK's ability to extract it profitably will be severely damaged. Lack of investment in exploration and production, the supply infrastructure or retaining the skilled workforce within the North Sea basin will all impact negatively and, again, drive costs up and competitiveness down.
It is likely that seeking salvation from outside the industry at a Government level will not bear much fruit. Instead, change should be led from the inside out. Our industry leaders, therefore, bring the greatest chance of change within the Oil and Gas industry.
Organisations that want to have a long-term future in the North Sea, need to embed change within their organisations from the top down. Executive teams need to consider change at the forefront of their strategy and decision making, ensuring that it is a core competency of management and a key skill throughout the organisation.
Through championing change, great leaders create an environment that nurtures the most innovative and creative thinking from their people. Openness, transparency and availability of information for improved decision-making build the integrity and trust needed to drive difficult changes throughout the workforce and the whole industry. Developing a wider sense of trust will also bring greater collaboration between industry players.
By David Wilson from Refining Business
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Recent headlines on the oil industry have focused squarely on the upstream side: the amount of crude oil that is being produced and the resulting effect on oil prices, against a backdrop of the Covid-19 pandemic. But that is just one part of the supply chain. To be sold as final products, crude oil needs to be refined into its constituent fuels, each of which is facing its own crisis because of the overall demand destruction caused by the virus. And once the dust settles, the global refining industry will look very different.
Because even before the pandemic broke out, there was a surplus of refining capacity worldwide. According to the BP Statistical Review of World Energy 2019, global oil demand was some 99.85 mmb/d. However, this consumption figure includes substitute fuels – ethanol blended into US gasoline and biodiesel in Europe and parts of Asia – as well as chemical additives added on to fuels. While by no means an exact science, extrapolating oil demand to exclude this results in a global oil demand figure of some 95.44 mmb/d. In comparison, global refining capacity was just over 100 mmb/d. This overcapacity is intentional; since most refineries do not run at 100% utilisation all the time and many will shut down for scheduled maintenance periodically, global refining utilisation rates stand at about 85%.
Based on this, even accounting for differences in definitions and calculations, global oil demand and global oil refining supply is relatively evenly matched. However, demand is a fluid beast, while refineries are static. With the Covid-19 pandemic entering into its sixth month, the impact on fuels demand has been dramatic. Estimates suggest that global oil demand fell by as much as 20 mmb/d at its peak. In the early days of the crisis, refiners responded by slashing the production of jet fuel towards gasoline and diesel, as international air travel was one of the first victims of the virus. As national and sub-national lockdowns were introduced, demand destruction extended to transport fuels (gasoline, diesel, fuel oil), petrochemicals (naphtha, LPG) and power generation (gasoil, fuel oil). Just as shutting down an oil rig can take weeks to complete, shutting down an entire oil refinery can take a similar timeframe – while still producing fuels that there is no demand for.
Refineries responded by slashing utilisation rates, and prioritising certain fuel types. In China, state oil refiners moved from running their sites at 90% to 40-50% at the peak of the Chinese outbreak; similar moves were made by key refiners in South Korea and Japan. With the lockdowns easing across most of Asia, refining runs have now increased, stimulating demand for crude oil. In Europe, where the virus hit hard and fast, refinery utilisation rates dropped as low as 10% in some cases, with some countries (Portugal, Italy) halting refining activities altogether. In the USA, now the hardest-hit country in the world, several refineries have been shuttered, with no timeline on if and when production will resume. But with lockdowns easing, and the summer driving season up ahead, refinery production is gradually increasing.
But even if the end of the Covid-19 crisis is near, it still doesn’t change the fundamental issue facing the refining industry – there is still too much capacity. The supply/demand balance shows that most regions are quite even in terms of consumption and refining capacity, with the exception of overcapacity in Europe and the former Soviet Union bloc. The regional balances do hide some interesting stories; Chinese refining capacity exceeds its consumption by over 2 mmb/d, and with the addition of 3 new mega-refineries in 2019, that gap increases even further. The only reason why the balance in Asia looks relatively even is because of oil demand ‘sinks’ such as Indonesia, Vietnam and Pakistan. Even in the US, the wealth of refining capacity on the Gulf Coast makes smaller refineries on the East and West coasts increasingly redundant.
Given this, the aftermath of the Covid-19 crisis will be the inevitable hastening of the current trend in the refining industry, the closure of small, simpler refineries in favour of large, complex and more modern refineries. On the chopping block will be many of the sub-50 kb/d refineries in Europe; because why run a loss-making refinery when the product can be imported for cheaper, even accounting for shipping costs from the Middle East or Asia? Smaller US refineries are at risk as well, along with legacy sites in the Middle East and Russia. Based on current trends, Europe alone could lose some 2 mmb/d of refining capacity by 2025. Rising oil prices and improvements in refining margins could ensure the continued survival of some vulnerable refineries, but that will only be a temporary measure. The trend is clear; out with the small, in with the big. Covid-19 will only amplify that. It may be a painful process, but in the grand scheme of things, it is also a necessary one.
Infographic: Global oil consumption and refining capacity (BP Statistical Review of World Energy 2019)
|Region||Consumption (mmb/d)*||Refining Capacity (mmb/d)|
*Extrapolated to exclude additives and substitute fuels (ethanol, biodiesel)
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Source: U.S. Energy Information Administration, based on Bloomberg L.P. data
Note: All prices except West Texas Intermediate (Cushing) are spot prices.
The New York Mercantile Exchange (NYMEX) front-month futures contract for West Texas Intermediate (WTI), the most heavily used crude oil price benchmark in North America, saw its largest and swiftest decline ever on April 20, 2020, dropping as low as -$40.32 per barrel (b) during intraday trading before closing at -$37.63/b. Prices have since recovered, and even though the market event proved short-lived, the incident is useful for highlighting the interconnectedness of the wider North American crude oil market.
Changes in the NYMEX WTI price can affect other price markers across North America because of physical market linkages such as pipelines—as with the WTI Midland price—or because a specific price is based on a formula—as with the Maya crude oil price. This interconnectedness led other North American crude oil spot price markers to also fall below zero on April 20, including WTI Midland, Mars, West Texas Sour (WTS), and Bakken Clearbrook. However, the usefulness of the NYMEX WTI to crude oil market participants as a reference price is limited by several factors.
Source: U.S. Energy Information Administration
First, NYMEX WTI is geographically specific because it is physically redeemed (or settled) at storage facilities located in Cushing, Oklahoma, and so it is influenced by events that may not reflect the wider market. The April 20 WTI price decline was driven in part by a local deficit of uncommitted crude oil storage capacity in Cushing. Similarly, while the price of the Bakken Guernsey marker declined to -$38.63/b, the price of Louisiana Light Sweet—a chemically comparable crude oil—decreased to $13.37/b.
Second, NYMEX WTI is chemically specific, meaning to be graded as WTI by NYMEX, a crude oil must fall within the acceptable ranges of 12 different physical characteristics such as density, sulfur content, acidity, and purity. NYMEX WTI can therefore be unsuitable as a price for crude oils with characteristics outside these specific ranges.
Finally, NYMEX WTI is time specific. As a futures contract, the price of a NYMEX WTI contract is the price to deliver 1,000 barrels of crude oil within a specific month in the future (typically at least 10 days). The last day of trading for the May 2020 contract, for instance, was April 21, with physical delivery occurring between May 1 and May 31. Some market participants, however, may prefer more immediate delivery than a NYMEX WTI futures contract provides. Consequently, these market participants will instead turn to shorter-term spot price alternatives.
Taken together, these attributes help to explain the variety of prices used in the North American crude oil market. These markers price most of the crude oils commonly used by U.S. buyers and cover a wide geographic area.
Principal contributor: Jesse Barnett