The devastating effect of the COVID-19 pandemic on global oil and gas exploration and production (E&P) companies is better understood by looking at the industry’s expected total annual revenues for 2020
Rystad Energy’s analysis shows that global E&P revenues are now projected to fall by about US$1 trillion in 2020, down 40 per cent to US$1.47 trillion from US$2.47 trillion last year.
Prior to the COVID-19 pandemic, Rystad Energy expected total E&P revenues to reach US$2.35 trillion in 2020 and US$2.52 trillion in 2021. Now, 2021 revenues are also projected to be lower, at US$1.79 trillion.
The cash flow of companies is also set to sink. For 2020, Rystad estimates that free cash flow for the E&P sector will fall to US$141bn, or one-third of what it was in 2019. This is based on Rystad base-case oil price scenario of US$34 per barrel in 2020 and US$44 per barrel in 2021, so there is a significant downside risk if current low-level prices persist.
“This drop not only undermines the companies’ solidity and reduces money available for investments and dividends, but also significantly cuts government tax revenue. It will be challenging for petro-states such as Russia and many Middle Eastern countries to sustain their budgets,” said Rystad Energy’s upstream analyst Olga Savenkova.
In the short term, national wealth funds might come to the rescue and plug holes in the budgets to avoid sweeping spending cuts, but if the low-price environment persists these countries could come under serious financial stress, added Savenkova.
Initially, Rystad Energy expected upstream spending to fall about 20 per cent this year as a result of the COVID-19 pandemic, which would have reduced investments by US$100bn from the 2019 level. As companies have continued to crimp investments, Rystad now expects upstream spending to fall by 25 per cent instead, from US$530bn in 2019 to US$410bn this year.
US shale remains the largest contributor with reported plans to slash 38 per cent off their previously announced 2020 capital budgets, which implies a cut of nearly 42 per cent compared to 2019 spending. These record numbers are followed by oil sands producers, which have also revised down spending by 42 per cent. Conventional supply segments show cuts in the range of 19 per cent for onshore to 12 per cent for offshore deepwater assets, as these segments are not as flexible when it comes to managing their capital costs.
The capex cuts will have a particularly strong impact on discoveries and companies’ ability to proceed with final investment decisions (FIDs) on new projects. This year might be marked by the lowest project sanctioning activity since the 1950s in terms of total sanctioned investments, dropping to US$110bn, or less than one-quarter of the 2019 level, with most of the projects being deferred.
An operator may need several years to bring a deferred project back on track as more strict economic requirements are applied for a new FID. Facing the threat of prolonged low oil prices, stakeholders are likely to lower projects’ breakeven price requirement, which was already on average below US$35 per barrel even before the crisis. This will send many developments on a long-lasting cost optimisation journey.
But, in contrast to the previous downturn, this time the situation is complicated by the distressed position of many service companies. The oilfield service sector already made substantial improvements in the supply chain with significant cost reductions back in 2015–2016, and operators cannot rely on a repeat performance a second time around.
Operators are now understandably demonstrating extreme caution when it comes to future investment commitments, resulting in a drop in sanctioning as projects are reshaped and paused until oil prices recover. Considering the high maturity of most oil-producing regions, this approach to handle the crisis puts huge volumes of unsanctioned production at risk, potentially undermining medium-term liquids production levels.