Big Money Still Loves Oil & Gas
The entire oil and gas industry and its investors are seriously reassessing the value of their beloved fossil fuels in the context of a major energy transition. But don’t be fooled: The returns of oil and gas projects are still highly competitive and plenty of capital is still flowing.
While the energy transition and the low-carbon energy themes will only become more prominent in the coming years, oil and gas returns will continue to be competitive with the returns on investments in green energy, analysts say.
Transitions, after all, are never as simple as crossing a border from one country into another. There’s a massive swathe of no-man’s land here that will continue to be populated by all forms of energy.
Still, oil and gas companies now know with certainty that they must start to align their capital allocation strategies with the growing investor pressure to show willingness and commitment to curb emissions and help save the planet.
Energy Transition Starts To Shape Capital Flows and M&A Deals
Oil and gas firms continue to raise a lot of capital and strike mega merger deals, but the low-carbon and net zero themes have started to shape the nature of deals and capital-allocation strategies, EY said in its Global oil and gas transactions review 2019 this month.
According to EY, both the values of mergers and acquisitions (M&As) and capital-raising were robust in the sector last year.
Oil and gas firms raised US$617.4 billion in capital in 2019, up by 7 percent on the year, with loans and bonds accounting for 92 percent of capital raised. The total value of capital raised was the highest in five years, but the number of fundraisings was down for yet another year, reflecting challenging conditions for some segments in the industry, notably financial stress among U.S. exploration and production companies and among oilfield services, EY said in its review.
In M&A, the value of upstream deals rose by 17.6 percent to US$160.5 billion, thanks to Occidental’s acquisition of Anadarko. Excluding this deal, total global deal value dropped by 24.2 percent. In exploration and production, the U.S. continued to lead the way for M&A deals for a fifth consecutive year, representing 60 percent of the world’s total upstream deal value, EY’s review found.
Yet, growing concerns about long-term oil demand and heightened focus on the environmental, social and governance (ESG) credentials of companies depressed equity and asset valuations, with U.S. exploration and production firms seeing an annual drop of more than 25 percent in equity valuations.
These lower valuations, however, provided opportunities to more robust and resilient companies to scoop up assets at attractive prices, EY said. In short, global capital raising and M&As in the oil and gas industry didn’t see any seismic shift in 2019, when ESG became the focus of everyone’s attention—from investors to portfolio managers to the oil and gas companies themselves. But this increased concern about the industry’s “social license to operate” begins to shift strategies in the sector.
“The oil and gas deal environment continues to reflect uncertainty, as the industry redefines its role and the value of its assets in the face of the growing transition to low-carbon and no-carbon energy. Despite this upheaval, we see an environment in which asset attrition outruns whatever reductions there might be in demand. This means the industry will need to attract capital and offer returns that support continued investment,” said Andy Brogan, EY Global Oil & Gas Leader.
“2019 brought a greater focus on environmental, social, governance and energy transition considerations and these will continue to be key themes for how capital is deployed in 2020,” Brogan noted.
Can the Oil & Gas Industry Be Part of the Solution?
As the calls for low-carbon energy from the investment community are getting louder, industry analysts are asking—are oil and gas companies only part of the problem? Can they be part of the solution?
According to the International Energy Agency (IEA), they could be part of the solution – the deep pockets and expertise in project management of the majors could help alternative energy solutions such as offshore wind to further trim costs and become an energy source with competitive returns on investment. The international oil majors could also help hydrogen, biofuels, and carbon capture, utilization and storage (CCUS) technologies to reach maturity.
“Despite growing consensus on the need for urgent and bold steps to mitigate climate change, new technologies are not mature or scalable enough to immediately displace the oil and gas volumes that are consumed today,” EY said in its review.
The new technologies can be used then by smaller energy companies and alternative energy providers to boost the share of low-carbon or zero-carbon energy.
“Smaller companies will be rapid adaptors of emerging technology, but they need for it to be commercially developed so it can be economically implemented,” David Johnston, oil and gas transactions partner with Ernst & Young, told Mella McEwen, Oil Editor for the Midland Reporter-Telegram, in an interview.
The oil and gas industry has the chance to help the more expensive emerging green technologies to scale up to commercial development, the IEA said in its The Oil and Gas Industry in Energy Transitions report last month.
Oil firms currently invest a small amount of their capital expenditures in green energy, compared to their core business, but they could become part of the solution if they take the necessary steps to address climate concerns, the agency notes.
Faced with the need to balance short-term high returns from oil and gas projects with the long-term ‘social license to operate’, the oil and gas industry continues to raise capital and engage in M&As, but it has started to account for the energy transition in capital investments. If oil and gas companies are to prosper in the long term, they must respond to the society and investors demanding climate action.