Transcript - Episode 2: Innovation in Energy

Steve: Hello, My name is Steve Jennings, I lead PwC’s Energy Practice in the UK.

Welcome to the next instalment in the series of podcast by PwC, looking at the implications of the energy transition for companies, investors in the oil and gas, and utility space.

Just to be clear, when we talk about energy transition, we are referring to the ongoing shift from the current energy system, based predominantly on fossil fuels to a lower carbon, smarter and electrified energy system.

Today, we will be focussing on the impact of the energy transition on the oil and gas industry, and I am joined by Drew Stevenson, the Partner leading our UK Energy, and Oil and Gas Deals Team; and Rebecca Jones, Upstream Oil and Gas Director, also in our Deals Team.

This team recently produced a view point on energy transition and the implications for mergers and acquisitions, which you can download from our website.

Steve Jennings: So, Drew, if I may start with you. Tell us what the findings are from this report.

Drew Stevenson: Okay, thanks. Thanks Steve.

I mean, in overview, of what we are seeing in the deal making market place in the energy sector, is deals becoming increasingly more dynamic, and that’s impacted by an accelerating range of economic, regulatory, and fiscal, and technology led factors. That impacts on all aspects of deal making. So, from, you know, initial strategy through the evaluation, through financing and partnering options, right through to deal execution.

But really importantly what we see is an acceleration, that acceleration being key to how energy companies view their portfolio of assets, with an increasing willingness needed to continually challenge existing, sometimes long-held views on the balance of the portfolios, and to take actions based on those views.

Companies and investors now have to grapple with the opportunities and challenges of a much more volatile environment, with the frequency and impact of external events can quickly change business models. In particular, an increasingly technology led energy world, businesses may need to acquire or divest on much more diverse range of assets to help position themselves and to hedge for future growth pathways. Those investments will encompass traditional sources of energy, say hydrocarbons, but increasingly newer ones, which may include extensions across the low-value carbon chain, and the technology to unlock and distribute energy more efficiently.

I think, also, partnership and venturing with other businesses will also increase in importance. So, for example, giving access to the capabilities in technology to deliver long-term sustainability, and that collaboration applies equally to partnership with an increasing range of other investors to enable financial agility that’s necessary around that portfolio rebalancing.

Steve Jennings: So Drew, my sense from what you have said in a sector often known for very large, sometimes complex, long-term investment decisions, businesses and the Deals Team need to adapt to mind sets and processes to be far more agile, including how they view existing asset portfolios, responding sometimes very quickly to market event.

Drew Stevenson: I think that’s exactly right Steve.

Steve Jennings: Rebecca, Drew talked a lot about volatility and disruption in the market. Haven’t we always seen this? So, tell me what’s changed?

Rebecca Jones: Steve you are right. There has always been disruption in the oil and gas sector. Look at the oil price crashes over the last 30, 40 years. 1985 saw a huge drop in oil prices; redundancies, and people say it was the end of oil. We saw a lower price virtually throughout the whole of the 1990s, and then an upsurge again in the 2000s.

But, my sense is that, at the moment there is an acceleration, and there is a different sentiment, both economic and environmental. There is increasing frequency of announcements and the urgency towards transformation is definitely increasing, especially in a regulatory sense.

Look at the wave of initiatives sweeping the market since this recent oil price crash in 2014. We’ve got the Paris agreement, limiting global warming. Saudi Arabia has announced their vision 2030, which marks a diversification, away from a dependence on hydrocarbons. We’ve never seen that 10 or 20 years ago.

Volvo have announced that they will only produce fully electric cars from 2019; and even in the UK, diesel and petrol cars will be banned from the UK in 2040.

Interesting statistics actually from the international energy agency. For the first time in 2016, global investment in electricity, that means, networks, renewables, thermal, was actually greater than in oil and gas.

What we see, as the momentum for a lower carbon world builds, it becomes increasingly challenging for traditional E&P companies to be doing what they have always done. They need to position themselves for growth.

Steve Jennings: So, it’s clear Rebecca, there is a significant transition; in fact, one could say seismic shift in what’s happening in the market, but are there not models and approaches emerging to help companies manage through this transition.

Rebecca Jones: Oh, definitely. Oil and gas companies are adapting in many, many ways, depending on their size, their strategy, and where they fit. We have seen a dash for gas, which has half the carbon dioxide content of coal, and 30% less than oil, so that’s a cleaner future based on fossil fuels. We see that with Shell taking over BG, and ExxonMobil taking InterOil last year.

Some of the large independent oil companies have even established renewable business units, and are investing in clean technologies, from wind and solar, to battery producing. Some of these are even setting targets, such as Total, which aims to have 20% of its asset base by 2035 in renewables. Companies like Statoil is blending its energy mix, outlining a plan to develop a wind farm with E.ON in the Baltic Sea, and recently Shell has entered the UK electric car sector, by buying NewMotion, the company that specialises in vehicle charging points.

We must remember that about 20 years ago, BP did initiate a change and a focus on renewables, but what Bob Dudley announced recently, was that the regulatory change now is much more supportive for that change to begin. So, it seems to be something that companies are taking much more seriously with Government support.

Other companies are taking a more radical stand. We’ve all heard that Dong has sold its oil and gas assets, and completely withdrawn from exploration and production, and has rebranded into clean technology.

Steve Jennings: So, is this the end of oil and gas megaprojects in the way that we’ve known and seen for many years in the past.

Rebecca Jones: Well, Steve, we are not seeing the end of oil and gas. We know that a lower carbon future is out there, but it’s not going to be tomorrow, and it’s probably post 2040. But, we are seeing a change and an evolution, and the consideration of pre-sanctioned megaprojects that a 110, 120 dollar oil indulged are increasingly unattractive.

Shell has pulled out of the arctic BP has withdrawn from the Great Australian Bight, because it’s an extraordinary difficult place to operate, frontier areas, and the attraction of what was materiality, which is the size of the prize, the amount of oil and gas that is there, is now invalidated, because in order to access these projects, there is a huge amount of risk. Those companies are focussing now on reducing cost. They don’t want to tie up their capital for decades.

Complexity used to be something that was a goal, and something that defined these companies, but now complexity is seen to be high risk and high cost, and many companies are battening down the hatches and rationalising their portfolios. They are withdrawing from these areas as I have mentioned or they are farming out.

We see generally a shift to low cost and high return, technically and reputational high-risk projects are not attractive. There is a reinvestment in what we could term advantaged oil. So, that’s oil that offers a high rate of return, a low cost of entry, low above ground and regulatory risk.

Look at the Permian in the Delaware Basin specifically. Loads of E&P companies, not just niche players are flooding in now, including ExxonMobil, which divested out of the Barents Sea, and is now in unconventional in the US.

Other oil and gas companies are just refocussing or harvesting their core hydrocarbon operations. They recognise that this lower carbon future is out there, but in the meantime, they are going to make as much money as they can, because after all economies do depend on oil and gas and will do for a long time to come.

Steve Jennings: And Rebecca, to add to that, this optimisation does allow shareholders to use their dividends to invest elsewhere if required, and we are seeing significant movement in the asset market associated with this trend, and I know that you explored this in more detail in the report.

Rebecca Jones: Yes we do.

Steve Jennings: So, Drew, if I may return to you, against this backdrop of change and disruption, what would you advise our clients to do.

Drew Stevenson: Clearly, there is no one answer to that question. As Rebecca has highlighted, there are number of models emerging to position businesses for the change. I think, from our perspective, and fundamentally companies need to have a dynamic perspective on how they see the future in the lower carbon world and what they see as the most likely future outcomes.

The strategies will need to be dynamic, to allow them to thrive across different outcomes with an evolving portfolio of assets, including the right mix of hydrocarbons to match that.

I think, embedded in all of this is the need for a clear deal making and execution approach that allows you to successfully invest in businesses with potential to create value as well as, perhaps, letting go off some assets that no longer fit your criteria.

I think in this environment, agility is key, as is the regular and frequent review of your business portfolios to assess its relevance in this dynamic environment.

Drew thank you, Rebecca thank you for sharing with us your thoughts on the energy transition, and particularly the impact on the oil and gas industry.  Clearly, it’s presenting enormous challenges, and we can see how some of our clients are responding to that.  In our recently released report, energy transition and the implications for mergers and acquisitions, we examined these themes in great detail, and I would encourage you to read this.

Thank you all for listening to this podcast, and look out for the next in this series.

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Steve Jennings

Steve Jennings

Leader of Industry - Energy, Utilities & Resources, PwC United Kingdom

Tel: +44 (0)7704 564513

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