The past two years have been nothing short of extraordinary. The oil & gas industry experienced a significant disruption in energy trade between Europe and Russia. A shortage of agricultural products for renewable fuels impacted the transition to green energy options. And supply challenges for low-carbon technologies curtailed energy transition initiatives (source). Yet the global upstream industry generated its highest-ever free cash flows of close to $1.5 trillion (source). Certainly, a case of divergent conditions! Where is the future of the Oil & Gas industry heading?
The first thing to consider is the record profits that were achieved in 2022 by the Oil & Gas industry. After a prior year of extreme contractions and supply chain issues, oil companies are flush with cash now. So, the question becomes where to best spend this windfall.
This is not an easy question. Despite there being multiple initiatives to invest in, significant obstacles exist. Several economic, geopolitical, trade, policy, and financial factors have curtailed investment. Risk is everywhere.
Deloitte recently published an industry forecast for 2023. The authors highlighted three critical industry obstacles now creating an “Energy Trilemma” that has delayed forward progress:
- Energy Transition – The move to low-carbon energy is being slowed with still evolving technologies and demand, hard-to-abate sectors, nascent infrastructure, and low investor returns.
- Energy Diversification – Concentrated demand, production, supply, or trade of energy resources, and limited energy choices for consumers are stifling the industry’s ability to diversify fast enough.
- Energy Security – Underinvestment has occurred in the industry despite strong and resilient demand, primarily due to low oil prices, investor pressures, and regulatory uncertainty.
Where to Invest Record Profits?
Future investment will occur where the industry perceives is the least risk and resistance. Once risks are better understood, resistance will decline to help to unlock future industry initiatives and capital investment.
Today, industry resistance is being generated by VUCA. Uncertainty in policies, pricing variability, new technology complexity, and geo-political ambiguity is contributing to elevated industry risk. See further insights here, Striking the Balance – How and Where Will Oil Producers Deploy their Cash? Yet despite headwinds, industry optimism is strong. The results of a Deloitte-led 2023 outlook survey revealed that 93% of respondents remain positive to cautiously positive about the industry in the coming year. Record balance sheets are likely influencing this optimism!
One area where big oil companies have been allocating free cash flow is by strengthening the balance sheet – a strategy shared by 40% of the industry. Some plan to increase this payout in the future as a way to avoid taking bigger risks when facing the current VUCA environment. Other capital expenditures are likely to be impacted by region and organizational funding structures. Sustainability and net-neutral carbon initiatives are much stronger in Europe. Expect greater investment allocation for these organizations. Companies funded largely by the public markets will be more impacted by higher interest rates and investor expectations. This will lead to lower levels of exploration or new technology investments.
U.S.-based oil majors are driving U.S. shale production programs. Expect these investments to continue in 2023 by continuing to build and leverage an integrated infrastructure. These organizations will be well suited to expand this investment into new technology programs. These investments can increase automation and efficiency to remain profitable during this period. These companies are also starting to ramp up investment in low-carbon businesses, especially carbon capture and storage, renewable fuels, and hydrogen (source).
New Policies to Accelerate Industry Transformation
Several factors have contributed to an elevated awareness and need for climate change. This awareness is driving new initiatives that will impact the future of the Oil & Gas industry, among other energy companies. Clean energy investment by O&G companies has risen by an average of 12% each year since 2020 (source) and is expected to account for an estimated 5% of total O&G capital expenditures in 2022, up from less than 2% in 2020 (source).
Several policies and legislation have been passed by the United States, Europe, and other countries that are paving the way forward for even greater investment in these programs. In just the United States, over $450 billion has been allocated towards clean energy and related investments (source & source). These policies will help create a greater focus on investing in new cleaner energy options, however, customer demand must also increase to justify the greater investment. Two factors will be critical to make this happen. The first is that consumers must demonstrate a higher demand for low-carbon, clean energies. The second is that more scalable and economical low-carbon use cases must be identified, tested, and put into place.
Here is where the continued need for investing in new technologies comes into play. The future of the Oil & Gas industry will in large part be determined by how much emphasis is placed on streamlining all operations and increasing automation. The shift to new clean energies will take substantial investment before operations can scale, new industry knowledge and expertise are gained, and consumers change energy habits. Close monitoring of these key industry variables will provide the best visibility into future industry direction – and therefore provide the best guidance for industry performance.