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'Brutal' Cost Cuts May be Ahead for Oil Industry

March 10, 2020

Illustration by Funtap - AdobeStock
Illustration by Funtap - AdobeStock

Oil and gas companies might be heading for another round of 'brutal' cost cuts in the wake of the oil price crash caused by coronavirus outbreak and Saudi-Russia stand-off on output cuts.

Wood Mackenzie’s Tom Ellacott said: “The price collapse could be the trigger for a new phase of deep industry restructuring - one that rivals the changes seen in the late-1990s."

Ellacott, senior vice president, corporate upstream at the energy intelligence company said: “Indebted Lower 48 producers could be forced to act sooner rather than later.

“This is not the first time we’ve seen a price war – the last was as recently as 2015/16. But this time, oil demand is also weak as the coronavirus outbreak depresses global economic growth. The macro-economic backdrop is completely uncharted waters for oil and gas companies.”

However, Wood Mackenzie has stressed the oil and gas industry’s financials are in much better shape, thanks to the actions taken following the last price collapse.

“At current activity levels, we estimate that many companies need an average Brent price of US$53/bbl to break even in 2020, including dividends at expected current levels and announced buybacks,” Ellacott said.

But gearing levels remain high for many players, limiting their ability to absorb any sustained oil price weakness through the balance sheet.

$380 billion of cash flow might vanish

Fraser McKay, head of upstream analysis, used Wood Mackenzie’s Lens platform to calculate that up to US$380 billion of cash flow would vanish from forecasts if Brent prices average US$35/bbl for the remainder of the year. This represents an 80% drop relative to a continuation of the US$60/bbl it has averaged year-to-date.

McKay said: “Sustained prices below US$40/bbl would trigger a new wave of brutal cost-cutting. Discretionary spend would be slashed, including buybacks and exploration. But given the lack of excess in the system, the cuts to development activity will be necessarily fast and brutal. US tight oil development activity, though not as flexible as many believe, will react immediately.

“Unsanctioned conventional projects will also be delayed, and in-fill, maintenance and other spend categories scaled-back.”

Ellacott said: “More highly leveraged players will be forced to make the deepest cuts to stave off bankruptcy. Aggregate cash burn from the companies we cover in our Corporate Benchmarking Tool amounts to US$130 billion in 2020 in the US$35/bbl Brent scenario.

“There is much less obvious excess spend to cut this time around after five years of disciplined investment and austerity. Raising capital is also much harder now, especially for US Independents, and upstream M&A market activity is at record lows. In addition, many companies have already made the most of the obvious asset sales.”



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