Oil price deflation and the age of abundance

The low price of oil is creating a ripple effect across a number of industries and market segments. In this brief piece, Strategy& experts examine the impact $50 oil is currently having on spending within the oil and gas products and services space.

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Oil price deflation and the age of abundance
Contacts

Impact of $50 oil on spending on oil and gas products and services
The rapid deflation in the price of crude oil from the 2014 highs of US$100+ to current levels near $50 represents a +50% drop in less than a year. This has had a dramatic impact on the industry’s confidence and its 2015 spend programs. Reductions of 20% to 30% in capital spend are expected across the industry value chain. Though many companies and fields remain profitable at $50 prices, the free cash flow and access to capital the industry enjoyed just eight months ago have dried up. The global oil and gas industry’s spend for 2014 was approximately $1.1 trillion. This included capital and operating spend across the value chain from upstream to downstream. The CAPEX component of the $1.1 trillion was approximately $950 billion. Therefore, a 30% cut in capital budgets would translate into a spend reduction of about $285 billion. This draconian reduction will not be evenly felt across upstream and downstream sectors, but will disproportionately hit upstream exploration (see Exhibit 1, next page). We expect the brunt of the spend decreases to hit the front end of the value chain, where investments take longer to convert to cash, there are fewer existing or stranded investments, and risks are higher (see Exhibit 2, page 3). We also believe that onshore assets (both domestic and international) will be more affected, as they are more variable and can be readily ramped up and down given market conditions. Further, the midstream sector will benefit from serving producing assets, possessing a strong backlog, and having a business model built more on long-term fee-for-service contracts than on commodity spreads or pricing. Finally, though the downstream makes more money from spreads than absolute prices, we expect the margins there to be compressed significantly due to the large-scale price decline (i.e., at $50 oil, you cannot sustain the $18 crack spread you had at $100 oil because it becomes a disproportionately large component of the price relative to the underlying commodity). The implications for equipment manufacturers serving the industry are significant, but vary by the segment served. In addition, manufacturers that also have significant aftermarket services will be less affected, as OPEX and downstream activities are less likely to be reduced. Manufacturers should assess their product and service portfolios with this differentiated impact in mind. Products directed toward onshore exploration will be challenged on margin and volume, whereas products supporting production,

Florham Park Barry Jaruzelski Senior Partner +1-973-410-7624 Barry.Jaruzelski @strategyand.pwc.com Dallas John Corrigan Partner +1-214-746-6558 John.Corrigan @strategyand.pwc.com

midstream, and downstream will be less affected. However, we would expect competition in the midstream and downstream sectors to intensify as companies seek to make up for losses in the upstream sector. This should also be aggressively managed via the manufacturers’ product portfolio strategy.

Exhibit 1 Global oil and gas spend distribution and market risk
Upstream
Location type

Midstream
Gath and processing 3.12% Transmission 0.96% Storage / transport 8.51% Refining / PetChem 0.00%

Downstream

Spend type

Exploration 8.16%

Production 1.06%

LNG 0.00%

Heavy oil 0.00%

Onshore

Capex

Offshore

6.74%

1.06%

0.78%

0.11%

2.13%

0.00%

0.00%

0.00%

Other

19.36%

8.30%

3.90%

1.06%

10.64%

7.45%

1.77%

1.77%

Onshore

1.21%

0.14%

0.50%

0.14%

1.28%

0.00%

0.00%

0.00%

Opex

Offshore

0.99%

0.14%

0.14%

0.00%

0.35%

0.00%

0.00%

0.00%

Other

4.18%

0.00%

0.57%

0.14%

1.63%

1.13%

0.28%

0.28%

Total

40.64%

10.71%

9.01%

2.41%

24.54%

8.58%

2.06%

2.06%

Numbers represent estimated % of total spend Major impact >20% cuts Medium impact 11–20% cuts Minor impact 0–10% cuts

Source: Barclays 2014 O&G Spending Outlook; Rystad Energy, Strategy& analysis

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Exhibit 2 Estimated Annual Reductions — % of spend (Illustrative)

0

Opex

Capex

Downstream
10

Midstream

E&P other

Downstream

Midstream E&P offshore
20

E&P onshore

30

E&P offshore E&P onshore
40

50

Major impact >20% cuts Medium impact 11–20% cuts Minor impact 0–10% cuts

Source: Barclays 2014 O&G Spending Outlook; Rystad Energy, Strategy& analysis

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