Vol 12 (2015) - Issue 4

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Impact of Declining Oil Prices

Issues impacting the market from on-going oil price volatility
The global energy industry has been dominated recently by the sudden and dramatic decline in crude oil prices. After remaining consistently above USD 100 per barrel for several years, the Brent crude oil price started tumbling in June 2014 to slip below USD 50 only six months later, before bouncing back to now hover around the USD 60 mark. The lower oil price and recent volatility has industry-wide implications for everyone from exploration and production (E&P) companies and financial institutions, to renewable energy players, traders and governments.
Perhaps the clearest trend making headlines is the significant cost reductions announced by a large number of E&P companies – from major International Oil Companies (IOCs) and National Oil Companies (NOCs), to junior and mid-cap independents – to be effected over the next few years through cutting exploration activity and overheads, and postponing developments. Capital preservation is a key focus, as is protecting the dividend payout for IOCs.
Those E&P companies feeling the most stress are likely to be those who became highly leveraged before the fall in oil prices, and who are now faced with substantial cuts to revenues and a reduced borrowing base, while exposed to developments or minimum work obligations that they have already committed to. Major projects that advanced and were financed based on oil price expectations of USD 100 or more, might cease to be economically feasible if this new oil price environment continues.
A related trend of contract renegotiation is unfolding. Some oil companies are seeking to renegotiate existing services contracts in an effort to reduce their capital and operating costs, both to offset drops in revenue and in an effort to make new developments financially feasible. With services companies facing a lower book of business, it’s a tricky balance between maintaining customer relationships, keeping busy, and protecting revenues.
Oil companies, contractors, suppliers, and related infrastructure may also find themselves exposed to counterparties entering bankruptcy or other formal insolvency processes, and should actively take steps to protect their interests.
The considerable fall in revenues has also contributed to substantial cuts in market capitalisation which in turn creates new challenges when looking to secure financing. It’s not the best time to be tapping capital markets for equity fund raising, while the falling oil price significantly reduces borrowing power under reserve-based facilities. Alternative sources of finance are being explored.
This all creates opportunities for energy companies with strong balance sheets, private equity, and other non-sector capital sources to invest in quality businesses, equipment, and personnel, and to increase market share and generate cost optimisation benefits. Transactions have started, but we expect activity to surge in the second half of 2015.
Beyond oil-related transactional, contractual, and financial impacts, broader energy industry implications are being felt. The global liquefied natural gas (LNG) market, which has faced a 35 percent decline in LNG prices since June 2014; the future of U.S. shale production and development of the European shale market; the ability of governments reliant on petro-dollars to balance budgets; as well as ramifications for renewable energy policy and projects, are all caught in the squeeze of lower crude oil prices.

Traditional liquidity sources are limited – other sources of liquidity must be pursued
The impact of lower oil prices on revenue was easy to predict; but it seems harder to anticipate exactly what the lower prices may mean for transactions in the oil and gas sector. What does seem clear is that many oil and gas production companies will be working hard to find the liquidity needed to maintain key operations which will then enable them to capitalise on higher prices if and when they do materialise. That will require executives vigorously to explore all of the various opportunities available to them, which is likely to spur increases in the number and diversity of transactions executed by production companies.