Following the

capital trail in
oil and gas
Navigating the new environment
A report by the Deloitte Center for Energy Solutions
 Following the capital trail in oil and gas

About the authors

John England
John England is the vice chairman and US Oil & Gas leader for Deloitte LLP. In this role, England
steers Deloitte’s overall delivery of a broad range of professional services, from technology
integration and operational consulting to human capital offerings and tax services, as well as
financial advisory offerings and attest services. England is a frequent speaker on energy industry
issues and trends as well as on all aspects of energy trading and risk management. England serves
on the National Petroleum Council, the Business Department Advisory Board of Stephen F. Austin
University, the board of directors for the Southeast Texas chapter of the Alzheimer’s Association,
and the advisory board of the University of Oklahoma—Price College of Business Energy Institute.

Gregory Bean
Gregory Bean is an Oil & Gas director in Deloitte’s strategy practice based in Houston. He has
served many international oil companies, independents, and national oil company clients. He has
over 30 years of oil and gas management consulting and industry experience and has led many
projects, including major corporate, business unit, and capital investment strategy assignments and
organization-restructuring efforts.

Anshu Mittal
Anshu Mittal is an Oil & Gas research manager in Deloitte’s Market Insights team. Mittal has
close to 12 years of experience in financial analysis and strategic research across all oil and gas
subsectors—upstream, midstream, oilfield services, and downstream. Before joining Deloitte in
2005, Mittal worked with Credit Rating Information Services of India Limited, a subsidiary of
Standard & Poor’s, as a lead industry researcher in petrochemicals and petroleum sectors. His
recent Deloitte publications are US shale: A game of choices and The rise of the midstream: Shale
reinvigorates midstream growth.

Deloitte’s* Oil & Gas industry practice helps companies address complex challenges and
capture growth and performance improvement opportunities through our consulting, risk, tax,
and financial advisory services. Our Capital Efficiency practice helps organizations map their
investment profile, establish effective capital budgeting and project prioritization processes,
and implement effective capital management governance structures. Deloitte’s Capital Projects
Services group helps clients improve capital projects across all phases of the project life cycle,
from strategy and planning through construction and execution, with advisory services on
project optimization, management, and governance. Reach out to any of the contacts listed in
this article for more information.

* As used above, “Deloitte” means Deloitte & Touche LLP, Deloitte Tax LLP, Deloitte Consulting LLP, and Deloitte Financial Advisory Services LLP.
 Navigating the new environment

Contents

Executive summary | 2

The recent past: Record capital growth | 3

The situation today: A period of capital disturbance | 5

Finding a new balance | 7

A new path forward | 16

Appendix: Methodology | 17

Endnotes | 18

1
Following the capital trail in oil and gas

Executive summary

A FTER driving a period of record capital

inflows and spending, growing sup-
plies from shale have led to a new investment
• Deploying capital in assets and markets
that offer greater portfolio and operational
flexibility, allowing for changes in projects’
environment for crude oil and natural gas capital intensity or the company’s service
(O&G) companies—one that is low-priced for orientation and providing an opportunity
exploration and production (E&P) companies to implement reforms
across the globe, and short-cycled for E&P
companies focused on shale. Taken together, • Optimizing cost structures by adopting
these two factors mean a new environment of leaner and modular designs, increas-
increased uncertainty and variability for E&P ing project repeatability, automating and
companies, with a ripple effect across the O&G integrating processes, reviewing alternate
value chain. designs and development options, and
Apart from balancing cash flows, this new enhancing commercial agility in supply
environment will likely require new capital chain and contracts
strategies and greater dynamism in the capital
decision-making cycle of an O&G company. This report provides insights into these
Traditional modes of sourcing, deploying, and possible strategies for company groups across
optimizing capital have to give way to new the value chain: from independents, integrated,
forms of: and national oil companies (resource-rich and
resource-poor) focused on E&P, to oilfield
• Raising capital and unlocking value service providers and drillers, liquids and natu-
through new low-cost investment mediums, ral gas transporters (midstream), and refiners
repurposing noncore assets to improve cap- and marketers.
ital utility, and rightsizing capital structure
in the light of the changing capital markets
and industry environment

2
 Navigating the new environment

The recent past:

Record capital growth

W ORLDWIDE growth in energy demand

and the emergence of new supplies have
led to record inflows of capital into the energy
Figure 1. Net new capital raised by industry (excluding the
financial industry*)

3,500
and resources (E&R) industry since 2008. A
global study of 39,273 publicly listed compa- P&U
(20%)
nies in nonfinancial industries found that E&R 3,000
1,510
has surpassed manufacturing to become the P&U
(47%)
(13%)
biggest issuer of net new capital, defined as 741
(26%)
the sum of net equity and net debt issued. (For 2,500 O&G O&G
(13%) (27%)
more details on the study, refer to the meth-
odology discussion in the appendix.) The E&R
2,000
industry raised more than $1.5 trillion during
the past five reported fiscal years—almost 50
$ billion

percent of the total net new capital raised by all 1,500

1,563
(56%)
nonfinancial industries. In the five-year period 1,310
before that, it accounted for just 26 percent (40%)
(figure 1). 1,000
Much of the increase came from the
booming O&G sector. In fact, the O&G sector
became a magnet for new capital: It raised 500 429
(15%) 449
about $850 billion from 2009 through 2013, 70 (2.5%) (14%)

accounting for 27 percent of all new capi- 160 (5.7%) 25 (0.8%) 120 (3.7%)
0 -167
tal raised during this period. Cash flowing -166 (-5.9%) (-5.2%)
-167 (-5.2%)
out of other industries, such as the technol- Fiscal years Fiscal years
-500
ogy, media, and telecommunications (TMT) 2004–08 2009–13
industry, reduced the competition for capital
and encouraged the migration of capital into Energy & resources Manufacturing Real estate

the O&G sector. The O&G sector benefited Life sciences and Consumer business Technology, media,
health care and communications
from this momentum, issuing more equity and providers
reducing stock buybacks while taking advan-
*The analysis excludes the banking, financial services, and insurance
tage of low interest rates to issue debt. sectors, as their business is the sourcing and lending of money.
This massive influx of capital, supported by
Notes:
high oil prices, transformed the O&G sector at Net new capital raised = net equity issuance (equity issued - buybacks) +
its core, making it one of the fastest-growing net debt issuance (total debt issued - total debt retired). The data consist of
39,273 publicly listed companies worldwide, including those acquired from
sectors across all industries. Its revenue grew 2004 to 2013.
by 60 percent over the past five years, reaching
Source: FactSet and Deloitte analysis.
$6.6 trillion in fiscal year 2013–14. In com-
Graphic: Deloitte University Press | DUPress.com
parison, manufacturing revenues grew by 32
percent, life sciences and health care (LSHC)

3
Following the capital trail in oil and gas

revenues grew by 27 percent, and TMT rev- during 2004–2008), the O&G sector increased
enues grew by 21 percent. its capital spending significantly. Spending
The O&G sector has not only distinguished for the sector rose by 50 percent over the past
itself in raising capital but also in how it has five years, to $890 billion in the last fiscal year.
deployed the money raised. While other This compares with a 40 percent rise in the
industries earmarked much of their capital real estate industry, 36 percent in consumer
outflows for distributions (share buybacks business, 29 percent in LSHC, and 27 percent
and dividends) and refinancing (conversion in TMT.
of liabilities and retirement of debt added

4
 Navigating the new environment

The situation today: A period

of capital disturbance

T HE growth in spending in the O&G sector

boosted oil and gas supplies considerably.
Supplies of crude oil increased by 5.5 million
degree of loss varied. US O&G companies,
which were the principal issuers and spend-
ers of capital, lost more than $550 billion in
barrels a day (MMbbl/d) during the past five market capitalization (figure 2).
years, despite 2.7 MMbbl/d of production
going offline in the Middle East and Africa due Figure 2. Market capitalization of O&G segments (before
and after oil price decline)
to political unrest.1 Such an increase in supply
has not occurred since the late 1990s, when $6T
6,000
Iraq and Venezuela increased their production 448
significantly. Of the 5.5 MMbbl/d, about 50
percent came from the United States alone due 762
5,000
to the shale (tight oil and gas) boom. In 2014,
US tight oil supply increased by more than $4.4T
682
1 MMbbl/d, the highest growth recorded in 390
any year.2 4,000
485
This rapid growth in supply (particularly
from shale), along with weaker-than-expected
$ billion

1,514
618
growth in demand from Asia as well as the 3,000
Organization of the Petroleum Exporting
Countries (OPEC) declining to cut output to 984
regulate the market, was the perfect recipe for
2,000
a collapse in crude oil prices.3 In fact, oil prices
fell from $110 per barrel in June 2014 to $55
per barrel by the end of 2014. This crash, and 2,636

the market pessimism that remains ominously 1,000 1,959

in place as 2015 progresses, has degraded the
value of the capital flows of the recent past and
threatens the profitability and, in some cases, 0
Market capitalization Market capitalization
even the survival of O&G companies. ($110/bbl, Jun. 30, 2014) ($55/bbl, Dec. 31, 2014)
The signs of degradation are starkly evi-
Refiners & Oilfield service Crude oil and natural
dent, with the market shaving $1.6 trillion
marketers (R&M) providers & drillers gas transportation
from the sector’s market capitalization in the (OFS) and storage providers
last six months of 2014. With about $1 trillion (midstream)
Exploration and International oil
in future oil projects at risk, the market had production (E&P) companies (IOCs)
to react severely.4 The loss was spread across
all O&G segments and regions, although the Source: FactSet and Deloitte analysis.
Graphic: Deloitte University Press | DUPress.com

5
Following the capital trail in oil and gas

Figure 3. Ratio of capex and dividends to OCF (E&P and resources that are among the most expensive to
IOCs, past five years) develop (for example, pre-salt, liquefied natu-
Brazil ral gas [LNG], and oil sands). Such resource
developments are difficult to stop and start in
Australia
response to commodity price fluctuations.
Canada Chinese O&G companies, the biggest buy-
Spain
Aggressive ers of foreign assets, primarily relied on debt to
growth
finance the country’s growing energy secu-
Italy rity needs, pay dividends, and refinance old
France debt. Over the past five years, PetroChina, for
Capex/OCF example, took $50 billion of new debt to fund
China
its $250 billion capital expenditure (capex) and
Dividends/OCF
United States pay $35 billion in dividends.5
The Netherlands Colombia’s O&G companies, dominated
by state-owned Ecopetrol, face challenges
United Kingdom
around maintaining their high payouts to the
Argentina Colombian government. Dividends constituted
A ratio of 1.0 about 45 percent of the country’s operating
Colombia
means internal
cash generation
cash flows (OCF) activities during the past
Russia equals outflow five years.6
Norway Similarly, many nations in the Middle East
and Africa depend heavily on their closely
India
held (unlisted) state-owned entities for their
0.0 0.5 1.0 1.5 2.0 2.5
national budgets. About 30 percent of the
Note: Capex includes net purchase of assets. Middle East and North Africa’s gross domes-
Source: FactSet and Deloitte analysis. tic product (GDP) depends directly on the
O&G sector.7
Graphic: Deloitte University Press | DUPress.com
Clearly, 2015 and 2016 will be challeng-
ing years for the O&G sector. Analysts predict
Internationally, the situation has become
spending cuts of 20–30 percent in upstream
problematic for Brazilian, Australian, and
alone, along with sizable asset write-downs
Canadian upstream and integrated oil compa-
and project deferments across the value chain.8
nies (figure 3). Over the past five years, compa-
Uncertain interest rate movements, currency
nies in these nations have aggressively invested
fluctuations, and deflation concerns will create
and locked their capital in large, long-lived
additional complications.

6
 Navigating the new environment

Finding a new balance

A T a global level, the challenge for O&G

companies is to respond to this new
environment of lower oil prices. The Energy
cycle is far shorter. Spud-to-well completion
takes two to four months, compared with
offshore projects that take two to five years
Information Administration projects oil prices to produce first oil.10 This shorter investment
to remain below $75 per barrel over the next cycle, coupled with high production decline
few years.9 Smaller cash flows, as a result, will rates, makes production from shale highly
likely challenge companies’ ability to fund responsive to short-term price fluctuations. As
committed and in-progress projects, which shale’s “swing” production impacts global sup-
have already seen a substantial reduction in ply and prices, companies operating outside
their capital values. Issuing new equity to shale are also impacted by the increased vari-
either fund these projects or reduce debt will ability in production and prices.
likely be difficult, especially when stocks are At a segment (or company group) level,
down by up to 50 percent. Refinancing old or the impact is not limited to exploration and
maturing debt will likely come at a higher cost production (E&P). Any change or adjustment
and with greater restrictions. by E&P companies will necessitate a change by
At a regional level, North American shale- segments or company groups directly related
focused O&G companies face an additional to E&P. For example, spending cuts by E&P
challenge of operating in a new, short-cycled, companies and variable production from
price-sensitive resource and capital environ- shale directly impact the revenue and service/
ment. Shale investments are not only granular asset intensity of oilfield service providers
($8–12 million per well), but their investment and drillers.

7
Following the capital trail in oil and gas

Options for O&G players

T HE implications of operating in this new

environment will differ by company
groups across regions and segments, requiring
capitalization), which are relatively new to
deploying and managing large amounts of
capital (figure 4). For instance, about 150 US
new strategies from, or presenting new options E&Ps with less than 10 years of listing experi-
to, each. This report provides insight into ence on public exchanges collectively spent
these strategies and options for all company more than $115 billion in the past five years
groups: independent, integrated, and national (about 25 percent of the US E&P total).11
oil companies (NOCs, both resource-rich and E&P companies operating in shale, how-
resource-poor), focused on E&P; oilfield ser- ever, can conserve cash or optimize their
vice providers and drillers (OFS); crude oil and capital by retooling their short-term capital
natural gas transporters and storage provid- management and financing strategies. Shale’s
ers (midstream); and refiners and marketers shorter investment cycle has made the fixed
(R&M). costs of drilling and completion highly adjust-
able to market events, essentially making them
variable. With more adjustable fixed costs,
Independent E&P companies:
capital could become companies’ biggest lever
Back to fundamentals for more responsive production and more flex-
Over the past five years, E&P companies ible capital and hedging programs.12
worldwide outspent their OCF (that is, reg- Apart from capital flexibility, shale invest-
istered negative free cash flow, which is OCF ments offer location flexibility and present
minus capex) by approximately $150 billion. several cost reduction options. Shale drillers
The majority of this money was spent by small can quickly move their capital to the highest-
and medium-sized E&P companies (by market quality plays because of their lower sunk costs

Figure 4. E&P companies' free cash flow annually over the last 10 years
30

20

10

0
$ billion

-10

-20

-30

-40
Large Medium Small
-50

-60
LFY-9 LFY-8 LFY-7 LFY-6 LFY-5 LFY-4 LFY-3 LFY-2 LFY-1 LFY
Note: Small, medium, and large consists of companies with a market capitalization of below $5 billion, $5 billion to $25 billion,
and more than $25 billion, respectively, as of June 30, 2014. LFY means last reported fiscal year.

Source: FactSet and Deloitte analysis.

Graphic: Deloitte University Press | DUPress.com

8
 Navigating the new environment

and varied production profile. Compared with cushion for covering both investments and
conventional onshore plays, too, shale drillers dividends because of junior upstream returns,
have far more cost reduction options, such as a less economical downstream, and relatively
optimizing fracturing and lateral stages, scaling higher leverage levels.15 But their upgraded
back held-by-production acreage and moving portfolio, following $125 billion in asset sales
toward efficient pad development, implement- during the past five years of high oil prices, will
ing new completion designs, understanding help them lower their cash flow break-even
restrictions in a well, improving wastewater rates and support their long-term strategy of
management, standardizing and modularizing favoring shareholder distribution and balance
processes, and consolidating service providers. sheet strength over growth.16
Spears & Associates expects a 15–20 percent Operating in today’s low-priced oil condi-
fall in shale’s drilling and completion costs by tions could reinforce the benefits of integra-
late 2015.13 tion for large IOCs. It could also prompt some
Although E&P companies focused on con- IOCs to reconsider their recent oil-heavy focus
ventional plays have less capital flexibility than and encourage others to keep balancing their
their shale-oriented counterparts, they have investments in both crude oil and natural gas.
a more diversified inventory of projects and But most importantly, the shorter cycle of
investments to manage. These E&P companies shale developments would endorse the recent
could seek to free capital through actions such decisions of some IOCs to have a separate
as consolidating minority stakes in capital- upstream business unit or subsidiary for
intensive projects that are far from completion; operating in the competitive North American
focusing on increasing repeatability in select shale market.
projects and/or regions to drive down costs; It would also highlight the need for IOCs
identifying cost efficiencies within the current to review their megaprojects (offshore and
development concept; and reviewing alterna- LNG) by having standard and leaner designs
tive designs with contractors. (design one, build many); deeper supplier col-
laborations (vendor consistency); and better
IOCs: Position for the future leadership and governance for large projects
(consistent practices and standards for both
Integrated oil companies (IOCs) have many
up-front planning and daily task execution).17
more capital levers to pull than independents
A leaner and a more dynamic approach to
due to their relative capital discipline, low
megaprojects could put IOCs in a strong posi-
leverage, portfolio flexibility, and integrated
tion when future supply growth starts again.
asset base. Given the size and scope of their
projects, IOCs have more bargaining power
with suppliers to negotiate cost reductions. Exporting nations/resource-
Their strong balance sheets also allow them rich NOCs: Diversify to
to tactically defer or delay projects to improve maintain a balance
supply chain efficiency and free up more short-
The new environment of low oil prices will
term cash.
put severe pressure on the finances of oil-
Because of their low net debt levels (aver-
exporting countries. Nations such as Yemen,
aging approximately 12 percent), US IOCs
Algeria, Iran, Venezuela, and Nigeria require
could buy smaller competitors or a portfolio
oil prices of above $115 per barrel to finance
of synergistic assets by marginally adding
their planned expenditures (figure 5).18
to their debt.14 In fact, the greater relative
Apart from impacting global prices and
decline in the equity values of independent
thus the finances of oil-exporting nations,
E&Ps makes stock deals more attractive to US
increasing production of shale has led to a
IOCs. European IOCs have a relatively smaller
rush (or competition) among these nations to

9
Following the capital trail in oil and gas

Figure 5. Break-even fiscal oil prices (2014)

$40–$80/bbl
$81–$120/bbl
$121–$160/bbl Saudi Arabia Kuwait
Iraq Russia
$106/bbl $54/bbl
$104/bbl Iran $105/bbl
$131/bbl
Bahrain
Algeria
$126/bbl
$134/bbl
UAE
Yemen $78/bbl
Venezuela
$153/bbl Oman
$115/bbl Nigeria $103/bbl
$123/bbl Qatar
$58/bbl
Brazil
$80/bbl

Source: Barclays Commodities Research; IMF; APIC; and Wells Fargo Securities LLC.
Graphic: Deloitte University Press | DUPress.com

undercut each other in an attempt to retain Asian oil-importing nations, given the United
market share. Iraq’s Oil Marketing Company, States’ lower oil import needs because of
for example, sold its Basrah Light stream to shale and the lack of projected future demand
Asia in January 2015 for $4 a barrel below the growth in Europe. India, Indonesia, and
benchmark grades.19 In trying to stay ahead Japan held their general elections in 2014, and
of falling benchmarks, exporting nations risk Thailand, South Korea, and Taiwan will hold
shifting from being some of the biggest distrib- theirs in 2015 and 2016. Based on the results of
utors of capital to being the biggest markets for the 2014 elections, Asian voters are supporting
refinancing. Rosneft, for example, has to repay reforms and development, which augurs well
almost $30 billion in loans by the end of 2015, for O&G exporters to these nations.
while Petrobras has $130 billion in long-term Operating in this new environment would
debt to service and refinance.20 also require oil exporters to become more flex-
With shale playing the role of swing pro- ible in setting their terms around contracting,
ducer and exporters undercutting each other grade, delivery, and payment in the consumer
on prices, it becomes important for exporting market. For example, Saudi Aramco’s purchase
NOCs to increase operational efficiency and of a majority stake in South Korea’s biggest
diversify their investments both within and refiner, S-oil, not only reflects a renewed inter-
outside the country by partnering with private est in downstream participation but also sug-
companies, either for technology or capital gests a change in oil contracting strategies. The
or both. NOC has a 20-year agreement to supply almost
Additionally, exporting NOCs may consider all of the 600,000 barrels a day (bbl/d) of crude
locking in future growth in demand by build- that S-oil processes—an unusual agreement in
ing relationships with the new governments of

10
 Navigating the new environment

an oil marketplace where one-year terms are Overhanging debt and the degraded value
more common.21 of past acquisitions may, of course, erode some
of these potential gains. Many Asian NOCs
Importing nations/resource-poor hold high-cost foreign assets for which they
paid a premium, such as oil sands in Canada,
NOCs: Seize the opportunity heavy oil in Kazakhstan, and pre-salt in Brazil.
Resource-hungry nations such as India, Higher spending commitments for acquired
China, Thailand, and Indonesia are the big- assets will most likely increase these Asian
gest beneficiaries of this new environment. NOCs’ debt and refinancing requirements. For
Lower oil prices mean that they pay less for example, PetroChina, which generates about
oil imports and oil subsidies, which in turn 85 percent of its core E&P revenues from crude
reduces their fiscal deficit and supports invest- oil, refinanced about $90 billion of long-term
ment. For example, a $50 per barrel drop in debt in 2013; it has generated negative free
prices has reduced China’s and India’s collec- cash flows for the past two years.23
tive annual oil import bill by about $175 bil- But despite the high cost of past acquisi-
lion, based on current oil import levels of 9.75 tions, the current buyer’s market bodes well
MMbbl/d.22 In addition, falling oil prices create for resource-hungry nations and companies
downward pressure on inflation, allowing meeting their growing energy needs. Rather
oil-importing countries to reduce interest rates than buying companies in the early stages of
and boost growth. exploration and development, which have high
In late 2008 and early 2009, oil-importing capital needs and uncertain cash flow, these
countries attempted to take advantage of the nations and companies could consider acquir-
plunge in oil prices to $30 per barrel to shore ing producing assets or buying into resources
up their NOCs’ finances through energy sector with greater capital flexibility, such as shale. In
reforms. A quick rebound in prices eliminated addition, engaging in joint ventures, not just
that opportunity. This time, however, the price at the wellhead but across the oil supply chain,
decline may be more prolonged, presenting can help reduce their capital risk, increase their
another chance for reforms. Governments can technical expertise, and secure supplies.
seize this opportunity by easing the subsidy
burden on upstream companies, rationalizing
cross-subsidies between fuels, revisiting the
Oilfield services: Weigh
pegging of natural gas pricing to a cocktail new options
of crude prices, and encouraging competi- Just as E&P companies ceded value to the
tion and private sector participation in the service sector as oil prices and activity rose,
hydrocarbon sector. they will look to reclaim some of that value as
In addition, a favorable equity market offers oil prices fall. Spending cuts by E&P custom-
governments a chance to rightsize the debt- ers will lower demand and shrink margins for
heavy capital structure of their NOCs. The service firms and drillers. On the other hand,
combination of more capital at their disposal, shale’s variable production and E&P compa-
the subdued values of O&G assets available for nies’ greater focus on costs will make their
sale, and a potential capital crunch situation resource planning more complex and their
for resource-rich nations provide an advantage asset utilization highly variable.
to resource-poor NOCs in negotiating deals or Global diversified service companies
entering joint ventures on favorable terms. The can respond early due to their lower capital
equity market and institutions will most likely intensity and high service orientation, and
respond favorably to these changes, helping they also have the capital strength to withstand
these NOCs to increase shareholder returns reduced demand. Their low leverage and high
even in a weak oil price scenario. cash levels, though, may force them to choose

11
Following the capital trail in oil and gas

between deploying capital through acquisitions onshore contract drillers’ business—reflected

and distributing capital through dividends or by their near-record-low revenue growth in
buybacks. While large acquisitions may make 2013 and 2014—are now compounded by a
business sense in light of weak organic growth highly variable rig count and drilling intensity
prospects, antitrust regulations and related of producers.25
divestitures are likely to significantly influence Drillers and equipment providers can adjust
the nature of many deals. This would limit to this new environment by offering dynamic
large global diversified service companies’ rig designs and development options to
options to pursuing organic growth, focus- operators. By replacing low-specification with
ing on small or specialized acquisitions in high-specification rigs, they can not only retain
well completion and production businesses, their contracts and relationships but also help
and using excess cash for share buybacks. E&P companies to reduce the capex associ-
Schlumberger, for example, increased share ated with platforms and vertical well sections.
buybacks by 40 percent, to $2.2 billion, in the Additionally, by automating and integrating
second half of 2014.24 processes, they could also develop a new set
With fewer restrictions on mergers among of offerings that plug customers’ applications
midsized firms, into their software.
service majors “If you’re a drill-
face the challenge Service majors may also ing contractor,
of defending or you’ve got your
increasing mar- consider positioning own applications;
ket share of their let’s go, here’s
highest-margin themselves for future how you plug in.
businesses. You’re a direc-
But within this growth by developing tional company
challenge lies an and you want to
opportunity to new information-centric plug in? We’ve got
rightsize these all the hardware
businesses’ costs service lines that help their you need,” says Joe
and assets. While Rovig, president of
service majors customers to reduce costs. National Oilwell
are prone to Varco. “We want to
addressing the be the iPad; if we
downturn in energy prices through standard want your apps, you get in there, and you run
measures, such as reducing headcount, they that.”26
may also consider positioning themselves for Acquisitions in a related service can diver-
future growth by developing new information- sify a driller’s service offerings, while new
centric service lines that help their customers investment vehicles such as master limited
to reduce costs; consolidating vendors; reor- partnerships (MLPs) can reduce the cost
ganizing cost units; and leveraging fixed costs of capital and provide drillers with much-
through improved efficiency, greater repurpos- needed financial flexibility in this dynamic
ing, and reduced asset intensity. capital environment. By dropping contracted
Capital-intensive contract drillers, on rigs to an MLP, a driller immediately obtains
the other hand, face the bigger challenge of funds for meeting dividend obligations or for
withstanding the downward business trend funding assets that are under construction.
and adjusting to the shorter capital cycle of Both Seadrill and Transocean, for instance,
shale producers. Drilling efficiency gains have improved their financial flexibility
in shale, which were already cutting into with MLPs.27

12
 Navigating the new environment

Midstream: Break the “internationalization” of the midstream seg-

ment, at least in the Americas.
boundaries On the other hand, only a handful of pure-
The midstream segment’s revenue sources play, publicly traded midstream companies
are fee-based, and thus capital flows are largely exist outside the Americas, and their share of
contracted. However, the rout in the oil market global oil revenue is just 25 percent of that of
raises questions about its growth and pricing. their Western counterparts. As trade in natural
For example, shale plays with high break-even gas expands globally and demand due to trans-
prices are on the margin now.28 The prices portation and electricity generation increases,
of oil-linked LNG contracts have fallen by developing economies will need to make sig-
40–50 percent, diminishing arbitrage for US nificant investments in their midstream sector,
natural gas producers eyeing exports.29 The elevating midstream’s status from an ancillary
price differentials between inland and water- business to one of a country’s core industries.
borne crudes across key supply and trading Regardless of how forces shape the O&G
regions have either narrowed or become highly market, having a diversified network of aggre-
variable. This, in turn, has led to a steep fall gated supply (supplies sourced from more
in monthly lease rates for oil rail cars from a producers, shale plays, fields, or nations) and
high of $2,450 a year ago to about $1,300 by segregated distribution (higher segregations in
early 2015.30 a pipeline and targeting a variety of customers)
Variable capital program and production will become all the more important for mid-
growth of E&P companies will likely limit the stream companies in this new environment.
organic growth that US midstream companies
have experienced in the past, especially in the
businesses of gathering and processing, and
R&M: Explore new avenues
liquids pipelines. Seeing this, midstream play- Refiners have fast emerged from the shad-
ers may look at inorganic growth to maintain ows of low growth and significant refinancing
or grow their distributions—paving the way needs. In the past five years, refiners, primar-
for consolidation in this fragmented segment. ily in the United States, have seen a marked
In early 2015, for instance, Energy Transfer increase in their spending and distribution
Partners acquired Regency Energy for $18 because of advantaged price spreads. Now
billion, and Kinder Morgan acquired Hiland lower crude oil prices benefit refiners by reduc-
Partners for $3 billion.31 ing their feedstock and energy costs, boosting
The contango in the oil market, coupled demand, and reducing working capital require-
with expected growth in liquids exports ments (although at the cost of one-time inven-
(refined products, natural gas liquids, con- tory losses). That may explain why R&M is
densates, and likely crude oil), may require a one of the only energy industries with positive
shift of capital toward the liquids storage and 2015 earning revisions.32
terminals segment. This segment could also The recent past has brought US refin-
enable some midstream majors to extend their ers their best years ever as well as multiple
integration and diversify their operations. growth and valuation options. Few other
Growth and consolidation opportuni- types of companies have improved operating
ties are not limited to North America. cash flows, increased dividends, and reduced
Colombia, Chile, Mexico, Peru, and Trinidad debt to the same extent as have US refiners.
and Tobago have already seen merger and In other regions, meanwhile, refiners have
acquisition inflows of about $10 billion from taken on debt to fund capital spending and
Canada, the United States, the Netherlands, pay dividends. As a result, during the past five
and Spain in the past three years. The growth years, the top 250 financial institutions world-
in cross-border investments highlights the wide have cut their equity ownership of Asian

13
Following the capital trail in oil and gas

refiners by about two-thirds, to 15 percent, is driving imports in Latin America, the less
while doubling their investment in US refiners efficient European refining segment is making
to approximately 75 percent (figure 6).33 way for imports from the United States.
While the current feedstock advantage Asian refiners, on the other hand, could
of $5 per barrel to $10 per barrel continues benefit from a reduction in subsidies and
to play out, shale is creating a new theme of deregulated pricing for petroleum products,
unlocking logistics flexibility and value for US which would help them to refinance debt at
refiners. By leveraging the tax-friendly MLP a lower cost of capital. The situation is more
structure for logistic and retail assets (which advantageous for refiners with integrated
account for 15–25 percent of their business chemical operations that are focused on
mix) and accelerating the drop-down of assets domestic markets rather than on exports.
into those MLPs, US refiners can improve An Asian integrated company also benefits
cash flows, boost valuation, and thus gener- from higher naphtha realizations because
ate higher shareholder returns than their of the improved competitiveness of naph-
international counterparts.34 tha crackers. Governments can extend their
Considering the uncertainty of crude price reforms and capitalize on this opportunity
differentials and a ban on crude oil exports, by reducing their stake in domestic refining,
US refiners can mitigate their risks by retain- which would not only provide the government
ing the option to import advantaged barrels with a cash infusion but also drive efficiencies
from different sources as well as by extending by attracting investment from financial institu-
commercial agility in both inbound logistics— tions and foreign O&G companies.
having flexible crude sourcing contracts with Although the composite margins of
domestic producers and limiting dependence European refiners have recovered from the
on a shale play or a specific grade of crude decade lows of about $1.75 per barrel in 2013
oil—and outbound logistics targeting new and the first half of 2014, the region’s long-
export markets. While limited refinery capacity term outlook is darkened by declining local

Figure 6. Ownership of the top 250 financial institutions in R&M

$20B $38B $46B $67B $23B $35B $50B $57B $107B $133B $139B
100%
14% 15%
90% 19%
25% 3%
38% 29% 41% 31% 3%
80% 35% 4%
47%
1% 44%
70% 1%
1% 6%
60% 1%
3%
4% 4%
50% 56% 76% 75%
56% 69%
40% 52%
49% 53%
41%
30% 32% 38%

20%

10% 18% 17%

12% 16% 12% 16% 13% 10% 8% 7% 8%
0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Asia Pacific South America North America Europe Middle East & Africa*

* Middle East & Africa represent 0% across all years.

Source: FactSet and Deloitte analysis.

Graphic: Deloitte University Press | DUPress.com

14
 Navigating the new environment

demand, relatively low asset complexity, and niche markets, and providing greater supply
a lack of supply advantages. Speaking at the chain control to offset the margin volatility of
Oil & Money 2014 conference in London, energy commodity traders. European energy
Total’s CEO said, “We cannot sustain plants commodity traders such as Vitol and Mercuria
when we are losing more than €100 million a could monetize new trading or margin safety
year of cash. It is not sustainable, and it’s not opportunities by repurposing refining, stor-
responsible.”35 age, and terminal assets, as they did in 2008
In this buyer’s market, European refiners, and 2009 when the oil market reversed
however, can create lucrative opportunities by to contango.
pooling assets with the midstream, building

15
Following the capital trail in oil and gas

A new path forward

T HE reversal of oil prices in 2014 has been
among the swiftest in history. The fall
of $50 per barrel and a bearish outlook have
forms of sourcing, deploying, and optimizing
capital. Such strategies include sourcing capital
through new low-cost investment vehicles;
diminished the allure that O&G has held for deploying capital in assets and markets that
investors over the past five years. They have offer greater portfolio and operational flexibil-
all of a sudden changed the discussion in the ity; and optimizing capital by adopting leaner
sector from raising capital, to driving growth designs and displaying higher commercial agil-
in the long term, to seeing capital as the ity in supply chain and contracts.
biggest lever of adjustment in today’s low- Because this is just the beginning of the
priced, cost-focused, and highly competitive new environment, it is important to care-
market environment. fully study the dynamic nature of the shale
Navigating this new environment might be business and its repercussions on the global
painful for many O&G companies, but they O&G industry. Although each company will
understand from past experience that adapting be developing a personalized action plan and
will only make them more efficient, dynamic, addressing a unique set of questions across
and innovative. The environment may ques- their decision-making cycle, the list of ques-
tion their traditional capital strategies and tions in figure 7 can get the ball rolling in the
present several new capital choices, which will changing O&G world.
likely force many to explore and consider new

Figure 7. The capital decision-making cycle

SOURCE
SO • For refiners and drillers, what are the pockets/areas to explore in order to unlock value and reduce cost of
ZE
UR
I
OPTIM

capital through new low-cost investment vehicles?

CE

CAPITAL
CYCLE • What noncore refining and midstream assets can be repurposed to generate new revenue sources and
improve capital utility?
DE
P LO Y • What sources of international capital are still viable for independent E&P companies?

DEPLOY
SO • Where are the prospects of energy reforms in Asia that provide downstream investment opportunities,
ZE
particularly for IOCs and resource-rich NOCs?
UR
I
OPTIM

CE

CAPITAL • What  producing assets can be acquired that provide greater portfolio, operational, and financial flexibility to
CYCLE
resource-poor NOCs?
DE • What are the most promising areas for midstream investment outside the United States and Canada?
P LO Y
• What are the new, related service offerings that can diversify the revenue mix of onshore and offshore drillers
and become new avenues of growth for service majors?

OPTIMIZE
SO • Which megaprojects or modules of a megaproject should be prioritized for revamp in light of the change in
E
Z

UR

commodity and supplier markets?

OPTIMI

CE

CAPITAL
CYCLE
• What investment opportunities can eliminate bottlenecks that are limiting commercial agility of refiners
across the supply chain?
DE • What opportunities does shale’s shorter capital cycle offer independent E&Ps in terms of financing,
P LO Y
contractual, and talent planning?
Graphic: Deloitte University Press | DUPress.com

16
 Navigating the new environment

Appendix: Research
methodology
T HIS research studied annual net equity
(equity raised minus share buybacks) and
net debt (long-term debt issued minus long-
metals and minerals, paper and packaging,
and process and industrial products

term debt retired) among 39,273 publicly listed • Energy: oil and gas (E&P, integrated
companies across the globe in nonfinancial oil, midstream, R&M, and oil field ser-
industries. The data set includes 3,246 com- vices) and power and utilities (alternative
panies that were acquired during the period. power, water and electric utilities, and gas
It excludes publicly listed subsidiaries where distributors)
the publicly listed parent holds more than 50
percent ownership. • Real estate: homebuilding and real
The data were downloaded on November estate development
4, 2014, from FactSet and aggregated using
company fiscal years. All nonfinancial compa- • Technology, media, and telecommunica-
nies were classified as belonging to one of the tions: telecommunications services and
following industries: equipment, wireless and wireline telecom-
munications, media, advertising services,
• Consumer business: consumer goods movies and entertainment, print media,
and home products, retail, wholesale and broadcasting, satellite and cable televi-
distribution, apparel and footwear, food and sion, information technology services,
beverages, and leisure software and hardware, and electronics
and computers
• Life sciences and health care: pharmaceu-
Figure 8 gives the count of companies by
ticals, biotechnology, hospitals, and services
regions and industries. Of the 2,864 compa-
nies in the energy industry, 1,982 were in the
• Manufacturing: aerospace and defense,
O&G sector.
automotive and transportation, chemicals,

Figure 8. Number of companies studied in each industry and region

Consumer
Regions LSHC Manufacturing Energy Real estate TMT
business

North America 1,357 1,223 4,092 1,375 147 2,123

Asia 3,505 991 9,458 704 903 3,811

Europe 1,302 492 2,906 599 425 1,366

Middle East 234 92 452 63 208 170

Africa 142 20 291 33 29 75

Latin America 134 17 343 90 54 47

Total 6,674 2,835 17,542 2,864 1,766 7,592

17
Following the capital trail in oil and gas

Endnotes

1. BP Statistical Review of Energy and US DOE/ 16. PLS M&A database.

EIA. 17. Petroleum Economist, “Time to change,”
2. Conglin Xu, “Decomposing shocks to oil January 14, 2015.
prices,” Oil & Gas Journal, January 5, 2015. 18. Rowena Caine, “Factbox: Oil prices
3. Deloitte, Oil prices in crisis: Considerations below most OPEC producers’ budget
and implications for the oil and gas industry, needs,” Reuters, August 15, 2014, http://
February 2015, http://www2.deloitte.com/ uk.reuters.com/article/2014/08/15/
content/dam/Deloitte/us/Documents/ opec-budget-idUKL6N0QL1VY20140815.
energy-resources/us-oil-prices-in-crisis- 19. Jake Rudnitsky, “Crude rises amid speculation
considerations-and-implications-for-the-oil- over US shale-oil supply growth,” Bloomberg
and-gas-industry-02042015.pdf. Business, December 9, 2014, http://www.
4. Randall Tom, “Bankers see $1 trillion of bloomberg.com/news/2014-12-09/oil-drops-
zombie investments stranded in the oil fields,” as-deeper-opec-discounts-signal-fight-for-
Bloomberg, December 18, 2014. market-share.html.
5. FactSet. 20. Ksenia Galouchko and Stephen Bierman,
6. Ibid. “Russia’s oil giant battles debt after $55 billion
deal,” Bloomberg Business, November 28, 2014,
7. World Bank, “World development indicators: http://www.bloomberg.com/news/2014-11-28/
Contribution of natural resources to GDP, russia-s-oil-giant-battles-debt-after-55-billion-
2014,” http://wdi.worldbank.org/table/3.15, deal.html; FactSet; Deloitte analysis.
accessed March 31, 2015.
21. April Yee, “Saudi Aramco to spend $2bn on
8. Moody’s Investor Service, “Moody’s: Global becoming majority owner of South Korean
oil and gas players enter a challenging 2015,” refiner,” National Business, January 12, 2014,
January 6, 2015, https://www.moodys.com/ http://www.thenational.ae/business/industry-
research/Moodys-Global-oil-and-gas-players- insights/energy/saudi-aramco-to-spend-
enter-a-challenging-2015--PR_315965. 2bn-on-becoming-majority-owner-of-south-
9. Energy Information Administration, Short- korean-refiner.
term energy outlook, March 10, 2015. 22. Deloitte analysis.
10. Statoil, Shale facts: Production cycle, April 2013, 23. Barclays, PetroChina: Emerging stronger from
http://www.statoil.com/no/OurOperations/ lower oil? November 27, 2014; FactSet.
ExplorationProd/ShaleGas/FactSheets/Down-
loads/Shale_productionCycle.pdf. 24. FactSet.

11. Deloitte analysis; FactSet. 25. Transocean, Q314 Transocean Ltd. earnings
call, November 10, 2014.
12. Goldman Sachs, The new oil order: Lower for
longer to keep capital sidelines, January 11, 26. National Oilwell Varco, “2014 Analyst Day:
2015. Day 2,” November 19, 2014, https://www.nov.
com/.
13. Spears & Associates Inc., Drilling and produc-
tion outlook, December 2014. 27. Matt DiLallo, “Offshore drilling: Dividends
in danger?” USA Today, September 21, 2014,
14. FactSet; based on 2013 total debt to total http://www.usatoday.com/story/money/
capital ratio of US supermajors. markets/2014/09/21/offshore-drilling-are-
15. FactSet and company filings. dividend-investors-in-trouble/15899469/.

18
 Navigating the new environment

28. Jeffries, Pragmatic uncertainty: Key themes from 32. Morgan Stanley, “Upgrading industry to attrac-
the Jefferies 2014 Energy Conference, November tive,” December 2, 2014.
17, 2014. 33. Deloitte analysis of the equity ownership
29. “Asian LNG prices seen falling by up to 30 of top 250 financial institutions in the
pct in 2015,” Reuters, December 10, 2014, downstream segment.
http://in.reuters.com/article/2014/12/10/ 34. J. P. Morgan, US refining sector: Primer
asia-lng-idINL3N0TP35K20141210. and industry outlook, September 23, 2014;
30. Jarrett Renshaw, “US oil railcar market Deloitte analysis.
collapses as foreign crude makes comeback,” 35. Tim France, “Majors to keep shedding refining
Reuters, February 2, 2015. assets in Europe,” International Oil Daily,
31. PLS M&A database, accessed on February 24, December 11, 2014.
2014.

19
Following the capital trail in oil and gas

Acknowledgements

The authors would like to acknowledge the following individuals for their extensive review, feed-
back, and suggestions throughout the drafting process: John McCue, principal, Deloitte Consulting
LLP and US Energy & Resources industry leader; Jim Balaschak, principal, Deloitte Services LP;
David Anders, partner, Deloitte Tax LLP; Andrew Slaughter, director, Deloitte Services LP, Deloitte
Center for Energy Solutions; Debra Everitt McCormack, deputy managing director for energy and
resources, Deloitte Services LP; and Annette Proctor, operations leader, Deloitte Center for Energy
Solutions and marketing leader for energy and resources, Deloitte Services LP.

Special thanks to Parthipan Velusamy, senior analyst, Market Insights, Deloitte Support Services
India Pvt. Ltd., and Deepak Vasantlal Shah, senior analyst, Market Insights, for their research and
analysis support.

Thanks are also extended to the following Deloitte professionals for their consistent support and
contributions to the paper:

Suzanna Sanborn, senior manager, oil and gas, Deloitte Services LP

Junko Kaji, acquisitions editor, Deloitte University Press, Deloitte Services LP

Alexa Junex, senior marketing specialist, Deloitte Services LP

Emily Koteff-Moreano, manager, Deloitte University Press, Deloitte Services LP

Aditi Rao, editor, Eminence, Deloitte Support Services India Pvt. Ltd.

Ramani Moses, editor, Eminence, Deloitte Support Services India Pvt. Ltd.

Ashish Kumar, senior analyst, Deloitte Support Services India Pvt. Ltd.

Vivek Bansal, analyst, Deloitte Support Services India Pvt. Ltd.

20
Contacts

John England Curt Mortenson

Vice Chairman, US Oil & Gas leader Oil & Gas Consulting leader
Deloitte LLP Deloitte Consulting LLP
+1 713 982 2556 +1 713 982 2607
jengland@deloitte.com cmortenson@deloitte.com

Paul Horak Coleman Rowland

Oil & Gas Audit leader Oil & Gas Advisory leader
Deloitte & Touche LLP Deloitte & Touche LLP
+1 713 982 2535 +1 713 982 2948
phorak@deloitte.com corowland@deloitte.com

Jeff Kennedy Jeff Wright

Oil & Gas Financial Advisory Services leader Oil & Gas Tax leader
Deloitte Transactions and Business Deloitte Tax LLP
Analytics LLP +1 713 982 4940
+1 713 982 3627 jeffwright@deloitte.com
jefkennedy@deloitte.com

About the Deloitte Center

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