Drilling down - the factors driving
change in oil and gas
There are several factors driving seismic change in the oil and gas sector...
1. Changing global enery consumption
Global consumption of hydrocarbons is projected to increase. This is despite the cost of renewable energy becoming competitive with coal, oil and natural gas within the next decade. McKinsey reports that new-build solar or wind capacity will become cost-competitive with existing fossil fuel plants before 2025 in India and China. Gas continues to grow until 2035 when it plateaus and then declines. Meanwhile, oil and coal demand growth is expected to slow, with oil peaking in the early 2030s.
Global consumption patterns are affected by:
Demand from growing economics
Global Energy demand grew by 2.9% last year. This growth was largely driven by China, US and India, which when combined accounted for around two-thirds of the growth. Meanwhile, Africa is emerging as a major force in global oil and gas markets. Oil demand is projected to grow by 3.1 million barrels per day between now and 2040, higher than the projected growth in China and second only to that of India.
Ambar Gupta, Head of Risk, Gulf Petrochem Group, notes, “There are still plenty of parts in the world that are undeveloped. Until such time we reach parity, the demand for fossil fuels is not going anywhere.”
He adds, “It is very easy for big cities and big developed countries to switch to electric, but they account for a very small part of the entire world. First and foremost, people need to have access to 24 hours of electricity to be able to switch to electric cars. I do not think we are anywhere near seeing the end of gasoline and diesel as auto fuels.
“Second, aviation is going to play a major part in bringing the world closer together. Africa, India, South America, these are countries which are still not serviced, as well as, Europe or the US is in terms of air travel. We are nowhere near the kind of road connectivity which we see in the Western world, so we will need bitumen as well. There is just enough use for fossil fuels as we move along to not warrant any worry in terms of the demand. It might flatline but it will definitely not decrease.”
We’ve expanded more across East Africa reaching up to Kenya, Uganda and South Sudan. We have also expanded our downstream footprints in Zambia and Tanzania.
Temitope Olagbami, Head of Corporate Finance, Sahara Group
Shale oil
The shale oil industry is having a major impact on global oil supply trends.
Harry Tchilinguirian, Head of Commodity Research, BNP Paribas, believes the US shale oil industry will continue to be an important part of non-OPEC supply growth for at least another five to six years. He says, “The sector is evolving as we have witnessed US oil majors divest from Canadian oil sands for example and redirect resources towards shale. There are various reasons behind this move, but shale oil certainly adds flexibility to a company’s portfolio of producing assets given that is it a short-cycle form of supply – development time to the first barrel is a matter of months compared to years in conventional oil production. By extension, the return on capital in shale is de facto faster.”
In turn, the changing global marketplace driven by the US and Canada’s ability to supply their own energy will drive growth in developing economies.
As the US and Canada produce larger amounts of fuel and have less dependence on imports, that makes the market tighter for everyone else. Now that there is more fuel available for developing countries, they are much more able to negotiate. And they are able to grow faster than when they are competing with the US and other developed countries. So, what we are going to find is that a lot of this is going to shift towards developing countries, India, China, Nigeria.
Frank Ihekwoaba, Chief Financial Officer, Eroton Exploration & Production Company
Climate change
According to BP’s 2019 Statistical Review of World Energy, energy consumption increased in 2018 by 1.5%, while global energy demand and carbon emissions from energy use grew at their fastest rate since 2010/11.
The report states: “BP’s economics team estimate that much of the rise in energy growth last year can be traced back to weather-related effects, as families and businesses increased their demand for cooling and heating in response to an unusually large number of hot and cold days. The acceleration in carbon emissions was the direct result of this increased energy consumption. “
2. The impact of renewables
Renewable technologies are getting cheaper and more efficient. In January 2020, McKinsey reported that the cost of solar energy, both photovoltaics (PV) and utility-scale, has fallen more than 70% in the US since 2011, and the cost of wind by almost two-thirds. It states: “By 2025, they could be competitive with natural gas-based power generation in many more regions”. In 2018, 80% of India’s total energy lending went to renewables.
Right now, though, there is a clear blue sky between the promise of renewable tech and the reality. Frank Ihekwoaba, Eroton, says: “The alternatives are not coming in as quickly as we would like. There is a difference between what you desire to see, in terms of having much cleaner and more efficient fuel options, and what technology is able to achieve. People and organisations have to continue to find opportunities within that gap.”
The renewables market is hard to forecast and previous predictions have been a long way wide of the mark. There is increasing awareness of the environmental impact of renewables, such as mining for lithium for electric vehicle batteries ro decommissioning wind turbines.
“What I have seen in the last few years is that almost every forecast has been far from accurate,” says Pedro Nobre, Senior Crude Oil Trader, Galp Energia. “Nobody would have said a few years ago that China, for example, would be one of the biggest countries in the world investing in electric vehicles and renewable power plant units. On the other hand, I also think that the majors are changing their mindsets. An oil and gas company is not only an oil and gas company anymore. It is more than that. It is an energy provider, customer-tailored, meeting their needs with an extensive portfolio of energy solutions, from the full spectrum of energy sources and prices.”
The big trading firms are taking more non-traditional funding roles in the light of dwindling international financing by European banks. There’s a lot of risk but a structure where commercial arrangements are interwoven makes interests align.
Temitope Olagbami, Head of Corporate Finance, Sahara Group
3. Oil player diversification
Oil and gas companies are diversifying and developing new business models to future-proof revenues and secure reliable relationships within the value chain. Despite the perception that emerging economies drive demand for hydrocarbons, the reality is more nuanced and oil and gas businesses need to be agile to respond to changes in the market.
Analyst McKinsey argues that growing GDP and energy demand do not necessarily go hand in hand. It points to factors that ‘help unhitch the rate at which the economy and energy demand grow’.These might include lower energy intensity resulting from the shift from industrial to service economies in fast-growing countries such as India and China.
McKinsey predicts that novel business models are likely to appear – such as a retailer becoming an energy producer by installing solar panels on store roofs. An OEM might become a service provider, as transport-as-a-service eclipses car ownership. Or producers of fossil fuels might move into new energy types or invest in storage solutions.
Gulf Petrochem Group is responding to the changing landscape. Ambar Gupta, Gulf Petrochem Group says, “We used to be a predominantly oil player up until 2017, but in the past two years we have diversified into other products. We are starting a biofuels test next year as well, again keeping in mind the changing trends. We are slowly moving out of and shutting down our fuel oil business because the world is moving to lower sulphur.
“Biofuels will be playing an important role as we go forward. People need to eat that is why we started the grains desk.”
Others are reviewing their position in the value/supply chain. Frank Ihekwoaba, Eroton, notes, “We are making great investments in the area of gas. Not just as a part of drilling new gas wells, but as we increase production over the next 10 years, we are likely going to be forced to step down in the value chain from where we are now, to more of maybe the refining stage in the midstream.”
While alternative forms of energy will continue to develop and electric vehicle penetration in the car fleet will rise, oil still has a future grounded in GDP and population growth, notably in the emerging markets. At the same time, with GDP growth and ensuing growth in the consumption of manufactured goods, greater demands will be placed on the petrochemical sector for plastics and packaging among other products.
Harry Tchilinguirian, Head of Commodity Research, BNP Paribas
4. Technology innovation
Oil companies are investing in technology as a way to protect their revenues. Commodity trading, transaction and risk management solutions that handle oil and gas transactions are becoming more sophisticated, incorporating technologies ranging from intelligent data analytics to blockchain, to secure the transaction and manage risk.
Sahara Group is seeing the benefit of big data. Temitope Olagbami, Sahara Group, says: “Technology comes into play making processes more efficient. Big data is very important, especially in the oil distribution and marketing business. This helps us to understand our customers better and how we can more efficiently distribute our product. For example, in marketing and distribution there is really no product differentiation. What sets you apart is the value-add and big data provides that platform for valuable insights into how you can optimise your distribution channels to add more value to customers.”
Reuters reports that trading houses are now investing in artificial intelligence and other technology to process growing volumes of data: “Vitol, the world’s biggest oil trader, lifted traded volumes by a third in the last five years but added just 15% more staff. However, IT staff numbers rose by 60%.”
Many oil players are still evaluating the cost-benefit equation of investment in technology. Some prefer to continue to diversify their product set to future-proof themselves.
A growing number of businesses use a technology platform to track vessel or transport routing in real-time, for example. But adoption is not widespread and many oil players consider these solutions fall short of what is needed.
Savvas Manousos, Global Head of Trading, Maersk, explains, “You can buy an app for a couple of dollars on your iPhone and find where any ship is in the world, where it has been, in what direction it’s now heading and at what speed it is going. What isn’t widely known is the ultimate destination of the vessel. There will be a number of discharge locations available to it and the user of the ship won’t declare that until quite late. Quite often because they haven’t sold the cargo yet.“
“So that last bit of who’s chartered the ship, what cargo is it carrying, where is it going and who has bought it is the piece of the jigsaw that is not in the public domain. Some of the majors have spent an awful lot of time on this, with mixed data quality and results, to be honest. Learning and data mining is maybe where the next breakthrough comes from.”
Our current focus is still on the core business of refining. As far as refining is concerned, we are not moving away from the core business, but this is the Pakistani scenario that I’m talking about.
Imran Ahmad Mirza, Chief Financial Officer, Pakistan Refinery Limited
What we’re doing right now is mostly diversification focusing on different types of products from lubing grease, to different types of solvents, waxes, petroleum wax and synthetic waxes. All of them are in the petroleum product spectrum. The focus for us right now is to be diversified in this type of segment using our existing capabilities because we are not big enough to invest in revolutionary technology. We’re mostly focusing on incremental growth as a follower, not a leader.
Mehrdad Vajedi, Director, Permian Energy
5. Evolution of trade finance
Trade finance is key to continued revenues in the hydrocarbons sector. Yet the finance landscape is complex and changeable. As the energy sector becomes more integrated with the financial markets, factors ranging from currency shifts to news stories impacting financial sector sentiment such as threats of war and pandemic affect the supply of energy finance.
In June 2019, Reuters reported that profit squeezes and probes into trading activities were negatively impacting oil trade finance. Finance houses and fund managers were increasingly using (EnviroSocial and Governance) ESG ratings that did not favour investment in hydrocarbon businesses.
BP, Shell, and Total, three of the biggest oil companies listed in Europe, were all rebranding as ‘energy companies’ as big banks did not want to be seen as major investors in oil and gas. As traditional trade finance suppliers back off, often under pressure from environmental activist shareholders, new business models are emerging.
Some big houses like Trafigura have been using their own cash account to supply trade finance to customers or suppliers who would not normally be extended traditional trade finance. In the Middle East, big oil trading houses are coming to the fore. For example, an Abu Dhabi bank backed by the oil state is allowing Emirates companies to extend finance to Sudan, and even Somalia. We are seeing Arab Gulf Banks step into spaces where European and US banks used to be dominant.
By January 2020, Bloomberg was reporting that 2019 had been one of the all-time best years for energy trading. At Davos, Bank of America, CEO, Brian Moynihan argued that restricting trade finance would be counter-productive to the Green agenda. He is reported as saying that oil and gas companies need funding so they can be part of the solution to climate change: “We should lend to those companies to help them make progress faster, rather than divest from them, which won’t help them at all.”
Savvas Manousos, Maersk, notes, “Trade finance has gone through a number of cycles. When interest rates were higher, it tended to be more the banks that occupied that space and you had people like BNP and SocGen as primary providers. I think as interest rates came down that gave space to the majors and oil traders to step in.”
The role of big oil or big trading houses in providing trade finance continues to evolve. Temitope Olagbami, Sahara Group says: “The big trading firms are taking more non-traditional funding roles in the light of dwindling international financing by European banks. Traditional funding sources are not sustainable in the long-term and costs are prohibitive. There’s a lot of risk in funding oil and gas projects but a structure where commercial and funding arrangements are interwoven makes interests align and you could also share the risk.”
Technology’s role in energy supply and trading cannot be overstated. All the components to finance, track, plan and deliver parcels are already available. It is the coordination of these moving parts which remains a challenge.
Chris Mudry, CEO, Amphora
Stiffening regulations and banks’ CSR policies, have meant banks began to withdraw capital from some certain areas of the commodity sector, such as withdrawal of capital to Canadian oil sands. And that’s where companies who have sufficient cash flow may be tempted to use it to get involved where banks are no longer or less involved.
Harry Tchilinguirian, Head of Commodity Research, BNP Paribas
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