“It was the best of times, it was the worst of times…” Just as in Charles Dickens’ classic “A Tale of Two Cities” describing life in Paris and London during the French Revolution, the statement also reflects perspectives of the U.S. oil and gas industry over the past ten years depending upon one’s vantage point.
As we leave the 2010s in the rearview mirror and accelerate into the 2020s, the past decade will be forever known as the decade of the “shale boom.” Origins of the boom started in 2005 when natural gas was first developed from the Barnett Shale and grew rapidly to shale plays around the country, where crude oil and natural gas production skyrocketed. The abundant gas supply reversed the industry’s focus from an LNG importing model to an LNG exporting model. Booming crude oil production, primarily from the Permian Basin, Eagle Ford, DJ Basin and Bakken inspired Congress and the Obama administration to reverse a decades-old policy by lifting the ban on crude oil exports.
Fast forward to Sept. 2019, when the U.S. officially became a net exporter of crude oil and refined products on a monthly basis for the first time since monthly records started in 1973, according to the U.S. Energy Information Administration (EIA). What seemed impossible a decade ago is now real, and with huge benefits for the U.S. economy, balance of trade and geopolitical position, with even more potential milestones ahead. For example, EIA last year predicted that the U.S. would become a net energy exporter in 2020, with natural gas and natural gas liquids added to the calculation. This is a feat that hasn’t been accomplished since 1953.
Yet, while the shale boom has created the “best of times” for the nation, the economy and consumers, the same cannot be said for the industry itself. The 2010s have been dubbed the “lost decade” for oil and gas companies who have suffered from volatile (mostly low) commodity prices, high supply, low margins, poor financial performance and a growing lack of favor from the investment community.
As we move into the 2020s, the outlook for oil and gas is, at best, mixed. Virtually all exploration budgets will be down in 2020, while most producers expect production to stay flat or even increase. This presents a dilemma for oil and gas producers in the U.S., who need less supply on the market to bring prices up. Something will have to give.
A round of mergers and acquisitions in the U.S. upstream and midstream sectors is highly anticipated and, to some degree, has commenced. Many operators have been producing for months without a real profit — a trend that cannot last forever. Thus, larger and more profitable producers are expected to start acquiring smaller, less-profitable ones. This should provide some relief on the supply side. The same is expected for the oil services sector.
Eroding Investor Confidence
Investors have increasingly lost their appetite for oil and gas, especially the shale plays, as debt-driven growth has fallen out of favor. Returns for the sector have been less than stellar. According to Reuters, the S&P 500 Energy Sector Index gained only six percent for the decade, while the broader S&P stock index rose 180%. Total earnings for the sector during the 2010s fell by 14.8%, compared to growth of at least 28% in all other major sectors. The energy sector’s relevance to the entire stock market has declined as well.
Investment capital flight from the oil and gas industry is occurring for other reasons as well, with institutional funds increasingly reducing their fossil energy investments as certain investors react to the climate change-led divestiture movement and sour to the sector. This attitude has also begun to bleed into the broader investor community, with some private equity funds now eliminating or reducing fossil energy investments. Investors also increasingly view oil and gas as having a finite future, with peak demand imminent in upcoming decades. There is also concern over a shrinking availability of talent.
Investors, especially private equity investors, are demanding that the oil and gas sector focus on performance and are seeking returns over growth. Against that backdrop, the industry is expected to increase efficiencies, generate more free cash flow, strengthen the balance sheet, monetize inventory and improve environmental, social, governance (ESG) factors.
Global supply and demand present significant challenges to the oil and gas industry as we move into 2020. Simply put, oil and gas production is outpacing global demand. While recessionary threats have subsided in the United States, economic growth has slowed in Asia, where the energy industry is depending on future demand growth.
At the same time, OPEC’s December announcement to cut another half million bpd through March has slowed a slide in commodity prices. Saudi Arabia has borne the brunt of the cuts. In addition to its portion of the production cuts announced in December, the Saudis have agreed to keep in place the 400,000 bpd voluntary cuts it has been maintaining. In addition, nations with political instability such as Venezuela have kept their production curbed as well. Amid all these developments, OPEC has revised downward its global demand estimates, stating that it is expecting its output to decline by about seven percent over the next four years, falling to an average of 32.7 million bpd in 2023.
Meanwhile, U.S. production is expected to increase as a share of global production, overtaking OPEC production by 2024. While one might think that this would make the United States the new swing producer, the nature of the private market does not enable the country to rapidly adjust production up and down the way the Saudis are capable of doing. To further illustrate, Saudi Arabia’s production was at an eight-year low when its largest crude processing plant was attacked in September. Within one month, its production increased by 1.1 million bpd, preventing an anticipated global price spike.
Public Policy Factors
While the U.S. industry faces its share of challenges in terms of commodity prices, performance and access to investment capital, it also faces a host of global and domestic public policy challenges.
The policy implications of climate change are a dominating factor. Globally, nations are being judged by their adherence to the Paris Agreement goals. Few countries are meeting their goals. Even in Europe, where public support for taking action to address climate change goals is highest, efforts to actually implement policies such as hikes in fuel taxes have led to public unrest.
While the U.S. began the process of withdrawing from the Paris Agreement in November, it has proven to be one of the few nations globally that has actually been lowering greenhouse gas (GHG) emissions, largely due to the successful displacement of coal-fired power plants with power plants fueled by natural gas and renewable energy.
Despite the environmental benefits of natural gas, natural gas faces growing challenges by activists and public utility commissions (PUCs). In general, activists and NGOs are vilifying natural gas, labeling it as a climate change contributor on a similar level as coal. That activism is increasingly thwarting energy projects such as pipelines, power plants and transmission lines. Activists are reacting to specific projects while also becoming more involved in formal processes like FERC approvals and PUC hearings. Utilizing knowledge and tactics that are proving to be more effective, sophisticated and coordinated, they are making their voices heard in the boardroom through shareholder proxies, in the investment community, in statehouses and at regulatory agencies.
In reality, natural gas is increasingly needed globally, including in places like Europe and Asia in order to achieve climate change goals, displace retiring nuclear facilities, meet energy supply and growth needs and reduce air pollution. Reflecting that reality, the United States, Russia, the Middle East and Australia are competing globally to supply gas markets around the world. Russia, which is embarking on the Nordstream II gas pipeline to Germany, is now claiming that its gas is cleaner than what it deems “dirty, fracked U.S. gas,” thus setting a stage for labelling their gas as “greener.”
At the same time, the U.S. gas industry finds itself disadvantaged from a public perception perspective, as the spotlight is cast on the flaring occurring in the Permian Basin, Eagle Ford and Bakken shale. The Environmental Defense Fund’s recent announcement that it began using advanced emissions monitoring in the Permian to map methane emissions and will use satellite data to identify and report flaring will only further highlight the fact that flaring and venting of natural gas in the Permian Basin reached a new all-time high in the third quarter of 2019, averaging more than 750 million cubic feet per day (MMcfd). While a lack of pipeline takeaway capacity has been a significant reason behind the flaring situation, new capacity should help the industry make important progress toward reducing emissions.
Meanwhile, the 2020 U.S. Presidential Campaign is well underway, with a slew of Democratic candidates vying for their party’s nomination. Through the early stages of the campaign, Democratic candidates have been more than forthcoming in their opposition to fossil energy. Their proposals include a ban on hydraulic fracturing, federal oil and gas leasing and fossil fuel exports, 100% carbon neutrality by 2030, 100% renewables by 2035 and various carbon pricing and taxing scenarios. The discourse has been largely dismissive of any benefits derived from the shale boom, and candidates acknowledged the resulting job losses from these policy proposals as necessary “sacrifice.”
Legislatively, Congress has and will continue to weigh in strongly on energy and climate policy. Under Democratic control, the House of Representatives has focused its attention on climate change and public policies to address it. The House established the Select Committee on the Climate Crisis to highlight the impacts of climate change, review policies to address climate change and support the Green New Deal (GND), a proposed package of legislative initiatives that aim to address climate change and economic inequality. Elements of the GND include a plan for 100% renewable energy by 2030, a carbon tax, major changes to the transportation system and eliminating GHGs from agriculture.
The Republican-controlled Senate took an early vote on a GND resolution that unanimously rejected it, with most Democrats voting “present.” While little action is expected in the Senate on major energy policy, a change in the makeup of the Senate and a Democratic victory in the presidential elections would likely result in a paradigm shift in U.S. energy policy, from one that embraces fossil energy production and export to one that does not. Under the current makeup, one area of potential progress on Capitol Hill is the reauthorization of pipeline safety legislation.
Much of the recent energy policy developments in the United States have involved administrative actions to support President Trump’s goal of “energy dominance.” To that end, the Trump administration has:
· Opened up more Bureau of Land Management acreage and proposed opening up more offshore oil and gas acreage to oil and gas leasing;
· Lifted federal lands moratoria;
· Withdrawn the Obama administration methane rule;
· Signed orders to make it more difficult to thwart pipeline construction under the Clean Water Act;
· Pushed for expedited permitting for offshore seismic studies;
· Moved to open the Arctic National Wildlife Refuge to oil and gas development; and
· Expedited permitting for LNG exports.
Although Trump’s trade negotiations with China have caused uncertainty for the oil and gas industry and especially for U.S. LNG projects, progress in December on a Phase One trade deal with China and agreement on the U.S.-Mexico-Canada trade deal are positive signs on the trade front going into the new decade.
ESG and Sustainability
Notwithstanding all the headwinds, there are ways that the oil and gas industry can effectively fight back. First, it can act collectively to identify vulnerabilities and address them. These include flaring, water management and GHG emissions. While several organizations and working groups have been established to address these issues, the industry needs to go further and establish goals and metrics for itself and demonstrate progress on these issues. In addition, individual companies need to pursue ambitious ESG programs and goals to create value and reduce risk. This will improve individual companies’ attractiveness to investors and reduce their vulnerability to NGO attacks and the vulnerability of the industry as a whole. Finally, the industry needs to lead by telling its own story that highlights its contributions to society. In the U.S., natural gas is reducing GHG emissions and helping to lift millions of people out of energy poverty. It can do the same for the world, as evidenced by how U.S. natural gas exports to developing nations like China and India are improving their air quality and reducing pollution-linked mortality.
As we begin the 2020s, there are positive developments that the oil and gas industry should embrace. Oil prices ended 2019 roughly 30% higher than they started the year. Producers continue to increase efficiencies and lower costs. Mergers and acquisitions on the horizon will create more efficiency and more opportunities for improved margins. To build on this positive momentum, it is important for the industry to identify and adhere to industry standards and best practices for sustainable shale development, improve ESG performance amongst companies individually and industry collectively and tell its positive story to important stakeholders around the world.
By taking these proactive measures, the industry can help ensure that at the end of 2029, it exits the current decade on a higher note than it did the last one.
Brent Greenfield serves as Vice President and Counsel at Cornerstone Energy Solutions. He provides clients with strategic policy and management guidance, research, analysis and communications support across the upstream, midstream, and downstream segments of the energy industry.
In addition, Brent serves as executive director of the National Ocean Policy Coalition, an organization comprised of members representing sectors including energy, fishing, waterborne transportation, construction, agriculture, and critical infrastructure.
Jack Belcher joins Cornerstone in 2019 with over 25 years of experience in energy and energy policy. As senior vice president of Cornerstone Energy Solutions, he provides strategic and tactical advice to energy and transportation companies and financial institutions, focusing on government relations, regulatory affairs, public policy, strategical communications, situational risk management, and Environmental, Social, and Governance (ESG) performance. Jack also serves as managing director of the National Ocean Policy Coalition.