February 2023, Vol. 250, No. 2


Financial Community’s Outlook on Oil and Natural Gas

 If your time to you is worth savin’ 
[Then] you better start swimmin’ 
Or you’ll sink like a stone 
For the times they are a-changin’  

– Bob Dylan, The Times They Are A-Changin’ 

By Richard Nemec, P&GJ Contributing Editor, North America  

(P&GJ) — Hop-scotching around North America in the fall of 2022 turned up varying voices calling for systemic changes in the energy industry that carry impacts from Wall Street to main street, from Canada to Mexico.

 While there is talk of the world’s top banks ploughing billions of dollars into fossil fuels, credible sources also note that oil companies are struggling to secure financing in the midst of climate change as titans like J.P. Morgan and Goldman Sachs come under increasing pressure from investors to prove the sustainability of their investments. The message is clear. As Bob Dylan has articulated, “The Times, They Are A-Changin’.”  

In mid-September at the GPA Midstream Association’s annual convention in San Antonio, Tom Seng, director of the School of Energy, Economics, Policy and Commerce at the University of Tulsa, outlined the “Pros and Cons of Energy Transition,” or the move away from hydrocarbons, saying that it has gone from the backburner to front-and-center in 2022 “with an emphasis on capturing hydrogen, especially from existing sources.” 

The effort to build more hydrogen hubs in North America and Europe is what Seng calls a critical undertaking for 2022. He reminded his audience that a unit of Royal Dutch Shell is building the world’s largest hydrogen electrolyzer at the port of Rotterdam, which at 200 MW is ten times the size of the Dutch company’s plant in China and 20 times that of one in Germany. 

“When the Rotterdam plant comes online in 2025, it will produce 60,000 kilograms of hydrogen daily,” Seng noted.  

Another seasoned voice from the prolific, venerable Permian Basin barks out a more measured observation about a continuing perceived hurdle to long-term project investment coming from a lack of support from Washington, D.C., for the U.S. oil and gas industry.  

Even if there is “expressed support,” said the Permian oilman, it is an inflation-driven rhetorical support for increased production in hopes of lowering costs for refined end-products like gasoline, and not any action (agency-wise or legislatively) in support of long-term growth. 

Meanwhile, at the LDC Gas Forums’ Gulf Coast Energy conference in New Orleans in October, BP plc’s head of gas and power trading in the Americas, Orlando Alvarez, predicted that natural gas and other energy markets are heading further into “unprecedented times” of market volatility and regulatory uncertainty.  

In a keynote address, Alvarez said it is clear energy markets are being impacted from what he labeled as post Covid-19 pandemic constraints and increased geopolitical tensions abroad.  

He said companies are likely to endure even more rapid change in the near-term as the world adapts to the need for new sources of reliable and abundant energy. He doesn’t believe these changes all have to be challenges for the industry. The volatility of the current market is more of an outcome of years of creeping policy and regulatory changes, rather than the cause of evolving dynamics, according to the BP executive.  

Alvarez noted that BP is the leading marketer of natural gas in North America and has been making complementary investments in renewable energy and alternative fuels, and in October the global energy giant purchased a major renewable natural gas (RNG) producer, Archaea, for $4.1 billion in cash and debt.  

While the use of unconventional drilling in U.S. oil and gas basins in the shale revolution strengthened the United States as an energy exporter, Alvarez said, the U.S. energy mix also has been drastically changing. Underscoring the ongoing transition, he points to the accelerated pace of coal generation retirements – more than 70 GW of capacity in eight years, according to BP data.  

Those retirements, along with the addition of more renewable projects to the national grid, are changing the energy landscape as states and utilities focus on environmental, social, and governance (ESG) goals, Alvarez said.  

The credit rating agency Moody’s Investors Service late in 2021 and again in 2022 analyzed the impact of ESG on the risk profiles of oil and gas companies, concluding that it has “moderately negative” overall impact with the greatest pressure coming on oil-only firms. Carbon transition risk is the main negative impact on oil and gas companies, Moody’s reports.  

“Rising global support for less carbon-intensive, cleaner energy will impact the oil and gas industry’s credit quality over time,” according to Moody’s. “Natural capital, water management, and waste and pollution also pose risks for oil and gas companies. While exposure to environmental considerations is highly negative for most companies, a few have only moderately negative exposure reflecting a high natural gas focus, or industry or geographic diversification. 

“The financial community has its own pressures to reduce climate-related exposures,” said Moody’s Senior Credit Director John Thieroff. “While there is a lot of political anti-ESG noise currently in the U.S., we believe that over the longer term that banks and investors will help lead the transition and that capital will flow in the direction of solutions that are aligned with the aims of the Paris Agreement.” 

Another harbinger of the ongoing transition is the emergence of certified natural gas, a low-carbon version, throughout the oil patch these days. Also, at the gas forum in New Orleans, Tulsa-based Williams Companies’ Brian Vogt, director of new energy ventures, suggested that there is a need for oil and gas companies to “build trust” in low-carbon fuels.

Brian Vogt

Vogt expresses concerns because of what he describes as a “lack of transparency and established measures” regarding certified gas. He thinks this has kept investors and international liquefied natural gas (LNG) buyers skeptical as shareholders pressure companies to establish more ESG goals.  

Vogt thinks more data is needed to support claims about the role that U.S. natural gas can play as a key to lower carbon emissions from the energy sector. He is advocating a “consistent scale and language” so customers can better understand why to believe in the value of independently certified gas.  

Deloitte in its 2022 oil and gas industry outlook concluded that the fossil fuel companies will build momentum as they “reinvent themselves,” and they won’t need a continuation of $100-plus oil to do it.  

While historically it has been true that oil companies have demonstrated less capital discipline when the per-barrel price hits triple digits, Deloitte’s survey of more than 500 CEOs and other senior industry officials indicated 76% of the senior oil and gas executives think that prices at $60/bbl or more will “boost or complement” the energy transition in the near-term. 

With European global energy giants leading the way, in 2021 U.S. oil and gas companies, Canadian oil sands operators, and national oil companies joined the push for net-zero operations over the next three decades. Deloitte’s outlook not only said that what it calls “net zero U.S. pioneers and green followers” will strongly fund investments aimed at making “sustainability their core business,” but it thinks higher oil prices can support more riskier technologies. 

“A strong oil price enables investment in riskier and expensive green energy solutions, such as carbon capture, utilization, and storage (CCUS),” according to Deloitte’s report.  

“Given that no single stakeholder can provide the needed investment and absorb all the commercial risks associated with CCUS, all the oil and gas value chain participants – from engineering-procurement-contractors, oilfield service providers, to upstream, midstream, and downstream – become as important as they are involved in more than half of planned CCUS projects.”                                   

As part of the changing financial puzzle, the broadening specter of the energy transition is leaking into mergers and acquisitions (M&A), Deloitte notes in its outlook report. ESG reporting on valuations could be more fully adopted in M&A transactions but reporting standards and guidelines and more clarity about evaluations are needed, according to two-thirds of the executive respondents to Deloitte’s surveyors.  

For example, the Deloitte report notes that advanced digital technologies, such as satellite imaging, blockchain, Internet of Things, and data analytics can be helpful to M&A due-diligence teams, including institutional investors whose support is often critical to M&As being approved.  

Moody’s Thieroff envisions more M&A activity as the energy transition evolves, noting that there are thousands of small producers operating in North America.  

“As we approach and pass the point where demand starts declining, a low-cost structure will be essential for survival,” he said. “That can be achieved a couple of ways – being in basins that have favorable economics and having scale. Ultimately (many years down the road), both will be necessary.” 

“We have seen supermajors backing research projects with satellite operators, potentially as a way to ensure the validity of their emissions reporting,” said the Deloitte report authors. “Similarly, a strong ESG profile can be leveraged to defend against hostile takeover bids from buyers having a weaker ESG profile.” Deloitte analysts see a future in which deal-making in the energy transition could require oil and gas companies to establish what they call “a new equation for valuations” considering both hard assets and ESG profiles. 

Deloitte’s assessment concludes that the oil and gas sector is “rebounding strongly” but realistically there are uncertainties regarding market dynamics in the months and years ahead. The report cites five “signposts” for monitoring future development. Those markers include actions by OPEC, progress in reaching net-zero and ESG goals, and ultimately bridging to a cleaner energy future. 

Stephen Robertson, executive vice president at the Permian Basin Petroleum Association (PBPA), said member companies in the association have not reported much positive news from the financial front this year.

Stephen Robertson

“Pressures regarding return on investment and ESG metrics are still weighing on long-term project investment,” Robertson said. “Sustainability and the pressures of a net-zero carbon future are absolutely present if not constant. The Permian Basin is not exempt from the concerns around sustainability and net-zero carbon. 

“Increasing return-on-investment absolutely continues to be what I hear as the top priority for operational decision making,” he said, emphasizing that the reality is that the Permian Basin is producing more crude oil and natural gas than it ever has, with projections from the U.S. Energy Information Agency (EIA) that mid-year production was around 5.4 MMbpd.  

Robertson notes that in the Permian’s more than a century of commercial production, 2022 was the first time it has produced more than 5 MMbpd. 

“So even without an emphasis on expanding production, the Permian Basin is trying to do its fair share to respond to domestic, if not global, energy demand,” he said. 

“For better or worse, I have not heard of much change in the messaging from financial firms to operators,” Robertson said. “So, maybe business-as-usual, at least as to what we’ve been experiencing in the last few years, might be the best way to describe it.” 

Among the more bullish, the American Gas Association (AGA) and Canadian Gas Association (CGA) jointly commissioned a report that shows strong backing from the financial community for natural gas utilities. The report from the Virginia-based survey firm, Guidehouse Inc., presents background and analysis from qualitative interviews with members of the investment community, seeking to identify any changes in attitudes toward the gas utilities.  

The gas utility-backed study found that investors are confident the utilities have identified their place in the energy transition. With a low-cost energy resource that can’t be easily replaced, the utilities are well positioned for decarbonization and the energy transition, the Guidehouse analysts noted.  

“Investors receive stability and consistency in their portfolios from natural gas utilities,” said Juan Alvarado, AGA director, energy analysis. “Investment in natural gas utilities allows investors to earn a dependable return while managing the risk level of their portfolios, and this study proves it. This report shows that investors positively view utilities that are proactive in addressing decarbonization and also are aware of states where regulatory mechanisms are in place allowing utilities a reasonable opportunity to earn their allowed return.” 

Ditto for CGA’s Paul Cheliak, vice president for strategy and delivery. who notes that gas utilities are advancing several low-emission fuels streams and technologies that position them for long-term success. “We are pleased the study has affirmed that investors remain confident that utilities will play an important part in the North American energy future.” 

A more somber outlook came in late September from Moody’s in a new report on the global energy sector, changing its outlook downward to “stable” from “positive.” Moody’s predicts earnings from energy companies will “ease” through 2023 from recent record levels as the industry “adjusts to a widespread slowdown in demand and rising costs,” according to Moody’s Senior Vice President Elena Nadtotchi, who notes there is restrained investment and rising uncertainty about future supplies.  

With growth in cash flow moderating, oil and gas producers remain “unlikely to accelerate growth in investment,” according to the Moody’s report, which sees continuing pressure to boost returns driven by inflation, and higher capital and regulatory costs.  

A broader context for Moody’s global assessment was offered by credit manager Thieroff, who cautions that Moody’s outlooks are focused on the next 12 to 18 months, so they are very short-term in scope. “[The U.S. economy] is coming off a very strong [post-pandemic] recovery where we had really high growth,” he said.  

“While we still expect the prospects to be good [for energy], the trajectory of growth will level out. Even holding flat, earnings-before-interest-taxes-depreciation-and-amortization [EBITDA] growth is strong, given where we had been in the last few years.” 

Thieroff said that all of the pressure for decarbonization in North America has come from Europe as it has played a leadership role across the Pond through the European Union (EU). He ticks off companies such as BP, Shell, Total Energies, and Equinor, which he thinks have “come under a lot more pressure to accelerate their efforts to decarbonize relative to U.S. major oil and gas companies.”   

As the Moody’s veteran sees it, U.S. capital budgets aren’t shrinking – as they did during the pandemic in response to a steep crash in oil demand – but they’ve rebounded to near pre-pandemic levels. Changes in investment intensity have been a function of investor demands for greater cash returns after a decade-plus of outspending cash flow in pursuit of double-digit growth.

Spending by private E&Ps is growing faster than that of publicly traded producers. In Europe, several of the larger players are beginning to pare back investment (BP, ENI, Total, Equinor) and more aggressively pursuing transitioning to other energy businesses, according to Thieroff. 

“The ability to see out beyond the next three to five years with any degree of certainty has always been a challenge and energy transition makes doing that even more challenging,” Thieroff said. “That said, we expect oil and natural gas demand to keep growing; we don’t expect oil demand to peak until around the end of the decade and natural gas demand will likely keep growing a decade beyond that, if not longer.  

In the near term, tight supply is likely to keep prices above historical averages and these companies will perform well (all bets are off if there is a global recession). Beyond that, those with the most competitive cost structures and/or successful transition strategies will fare much better than those with neither.” 

From the perspective of the past decade before Covid-19 hit, private companies have spent in excess of cash flows, according to Thieroff. Meanwhile publicly held producers have focused on generating free cash flow and paying more dividends and/or doing more stock buy-backs.  

As an example, he cites Irving, TX-based Pioneer Natural Resources Co., which has experienced growth in the double-digits annually and plowed the earnings back into additional growth. In late 2018 and 2019, Pioneer announced a clear shift in strategy, offering bigger dividends, jumping from a few pennies-per-share quarterly to more than $3 annually.  

“They’re paying about $1 billion a quarter, and the amounts of cash returns to investors are massive,” Thieroff said. “That’s what the market wants and what investors want, but there is no appetite for big production growth. These companies are largely just replacing their production and maybe growing in the single digits.” 

Thieroff thinks this is contributing to the growing supply shortage because many of these E&Ps could produce more but aren’t. “Their stocks are getting beat up when they grow beyond cash flow, so they won’t do it,” Thieroff said. “The private companies don’t have the same shareholder pressure, so they are continuing to grow production and reap the benefits in a time of high prices.” 

According to its third-quarter report, Pioneer increased quarterly earnings to $2.4 billion ($9.30/share), as compared to net income of $380 million ($1.54/share) for the same period in 2021.  

For the quarter, the company paid a base dividend of $189 million, or 78 cents/share, and a variable dividend of $1.6 billion, or $6.60/share, as compared to a base dividend of $138 million, or 56 cents/share, and no variable dividend for the same period in 2021.  

During the same period, the company also repurchased 2.1 million shares for $499 million under the company’s stock repurchase program. Pioneer did not repurchase any shares under a stock repurchase program during the three months ended June 30, 2021, and the E&P reported a $2 billion quarterly increase in oil and gas revenues, primarily due to a 69% increase in average realized commodity prices per boe. 

Financial information related to climate change and sustainability is rising in importance on both industry and regulatory radar screens. An example is the U.S. Securities and exchange Commission’s (SEC) proposed new rules addressing “The Enhancement and Standardization of Climate-Related Disclosures for Investors.”  

The proposed financial reporting requirements have drawn strong criticism from the oil and gas sector, led by the voluminous push back from the American Petroleum Institute (API) in an e-mail submittal last June from its CEO Mike Sommers, who stressed that the industry supports timely and accurate reporting of greenhouse gas (GHG) emission, but it cannot support the SEC draft rules as currently written. 

Sommers urged the SEC commissioners to reject changes in existing regulations (S-X and S-K) and instead to consider alternatives “That would better serve investors and would allow the SEC to achieve its stated goal of advancing this rulemaking.” Ultimately, he said, the challenge of both meeting global energy needs and tackling climate change is a “massive, intertwined and fundamental” undertaking. “API is promoting the continued improvement of industry reporting of GHG emissions, and is working to enhance the consistency, comparability, and reliability of the reporting,” Sommers told the SEC. 

API is concerned that the proposed new rules seek to expand the application of “materiality” in requiring new reporting of information when the current standards of material information are sufficient to cover GHG emissions reporting, according to Sommers.  

And if the SEC determines that additional information that is not material needs to be reported, then companies should be allowed to “furnish” that data rather than formally “file” it with the federal agency, he wrote in a 37-page submittal.  

API’s position is that the oil and gas industry and other industries have well-established GHG reporting protocols that are still “evolving and improving,” and they are preferable to the SEC’s proposed “fixed, one-size-fits-all” and less informative disclosure of nonmaterial information. 

Richard Nemec is P&GJ’s Los Angeles-based contributing editor. He can be reached at rnemec@ca.rr.com

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