Opinion

The oil industry needs to get used to dwindling demand

Posted by Scott Johnson

27-Aug-2020


Earlier this year, crude oil consumption fell by as much as a third as a result of the coronavirus crisis. But falling demand has been a worry since long before this year. While many in the industry may stick their head in the sand or plug their ears, they need to realise that demand may never fully recover.

The pandemic is not the only culprit of this shock. There are numerous other factors that have led up to this, which will force oil firms to adapt if they want to survive. In what will become a ‘new normal' for oil companies, several factors are at play. If firms ignore the warning signs and continue with their current models, they may not see out this decade.

ESG and other trends

Any oil company that isn't clued in on environmental, social or governance factors is already well behind the times. The world is increasingly scrutinising oil and gas companies through this lens. Many countries and investors alike are looking to promote a transition to more sustainable methods of energy production.

In March 2019, Norway's Government Pension Fund Global announced that it would sell off around £5.7 billion worth of stocks held in oil & gas exploration, as well as production companies who had failed to invest in renewable energy. Countries and private investors fear both the returns they make, as well as the damage these investments pose to their reputation. A study by Transmission Private found that the public were more likely to think highly of a well-known individual if they didn't invest in industries like oil, tobacco or arms. The same principal applies to both individual investors and countries.

Elsewhere in Europe, banks are turning their backs on the financing of raw materials like oil. BNP Paribas, previously one of the biggest names in the commodities trade, announced earlier this month that it would pull out from funding this area of the market. Dutch bank ABN Amro similarly announced its exit from commodity trade financing shortly after.

The increasing electrification of the planet is also another factor that will throttle the demand for oil & gas. Many investors are seeing better returns with so-called ethical funds, especially this year, while facing comparatively little risk to their reputations.

Increased supply and dwindling demand because of the pandemic have caused prices to plummet. However, OPEC expects this to recover after 2021, as touted by its July report. They expect demand to bounce back by a record amount, spiking by roughly 25%.

The way forward

While the industry may not be facing imminent extinction as some sources suggest, oil & gas firms do need to prepare for a world with significantly lower demand. Some firms, such as Royal Dutch Shell, are racing to invest in clean energy.

Bloomberg reported that since 2010, major European firms have closed 7 times as many deals with renewable-electricity and storage companies as their counterparts in the US. There is clearly a larger appetite among oil firms on this side of the Atlantic. Likewise, there has petrochemicals may prove to be a key option in the portfolios of many players. As demand for oil wanes, many major players see diversification as their ticket to survival.

However, jumping ship to renewable energy isn't the only option. If firms have the right strategy, there are certainly wins still to be made. When faced with a difficult situation, sometimes the only option is to innovate. If you harness and optimise your technology, you may find a more efficient way to still operate in the industry in comparison to your competitors.

In a report by McKinsey & Co, it was highlighted that oil companies with scale, strong balance sheets, best-in-class integrated portfolios, advantaged assets, and superior operational abilities should create value even in a challenged future. They also highlight basin leadership as a source of value creation in the industry.

Smaller firms need to take this opportunity to specialise, as many won't have the luxury of a large, diverse portfolio that majors have. Some examples of this are the likes of independent US companies active in shale and enhanced oil recovery segments, as well as Canadian firms specialising in tar sands.

The waning public perception of oil & gas, as well as the rise of cheaper, renewable alternatives have caused a shift in the industry, which the coronavirus crisis has exacerbated. Firms need to adapt if they want to survive beyond the next decade, either through diversifying their portfolios, smart strategizing, or investing capital into specialization.



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