Energy: Oil & Gas 2023

Energy: Oil & Gas 2023 – A Global Overview

Global energy markets have always been susceptible to broader economic trends and political developments impacting supply and demand, and 2023 has been no exception. Commodity prices have been impacted (both positively and negatively) by (among other things) concerns over the health of the global economy, the Russia-Ukraine war, OPEC+ production cuts, reductions in capital expenditures for long-term development projects and shifts in global economies to alternative energy sources.

Commodity prices in 2022 soared. They have since fallen dramatically, but continue to remain relatively strong. This has allowed many oil and gas companies to generate significant free cash flow that has been used to shore up balance sheets and return cash to investors, but generally has not been used to increase production or fund long-term development.

Energy M&A, like other sectors, has been down in the first half of 2023, but there have been transformative transactions (eg, Civitas Resources’ USD4.7 billion acquisitions in the Permian Basin).

For the remainder of 2023, oil and gas companies are expected to maintain a disciplined approach to spending, returning capital to investors and looking for acquisition opportunities to grow production. However, energy M&A will likely remain steady, and economic uncertainty will continue to impact investor appetite.

Beyond 2023, we expect to see increased government regulation on hydrocarbons, transition to alternative energy sources, consolidation of traditional oil and gas companies, and a global energy realignment of Eastern and Western counties.

Short-term trends

Economic and commodity price uncertainty

Ask five economists for their predictions on the economic and commodity price outlook for the remainder of 2023 and you will get five different predictions. The only consistent answer you will receive from the economists is that no one will guarantee their prediction.

Concerns over inflation (including central bank interest rate hikes to combat inflation), possible global recession, the reopening (but lower growth) of the Chinese economy and the Russia-Ukraine war have weighed heavily on oil prices, but not as heavily as in 2022. The result is that commodity prices are not as high as they were (on average) in 2022, but remain relatively strong.

The drop in commodity prices from 2022 to 2023 has helped reduce some inflationary pressure, but core inflation is still persistent in many countries.

These factors create uncertainty in the future of commodity prices, which ultimately impacts investment in oil and gas, future production and M&A.

Cautious production expansion

While most oil and gas companies remained disciplined on capital expenditures, higher commodity prices in 2022 allowed companies to moderately increase budgetary spending. According to the International Energy Agency, upstream oil and gas investment is “expected to rise by 7% in 2023 to more than USD500 billion”. An illustrative example is the March 2023 US government auction of federal waters in the Gulf of Mexico for oil and gas drilling, which generated USD263.8 million in high bids: “the most of any sale in the region for years and the first test of demand for investment since the Russian invasion of Ukraine”.

OPEC production decreases

In June 2023, Saudi Arabia announced that it would be cutting oil production by 1,000,000 barrels per day. In most years, this would have immediately resulted in an oil price spike. But 2023 has been an anomaly. Prices have remained relatively steady since the Saudi Arabian announcement, further evidencing broader uncertainty of what will happen to the global economy in the second half of 2023.

Long-term trends

Social and government pressures

Concerns regarding the potential climate effects of conventional sources of energy have become more embedded and widespread, and there is an increasingly negative focus on hydrocarbons. Governmental regulation and political pressure continues to mount against oil and gas companies. Increased climate awareness and accompanying heightened scrutiny of environmental impact have also affected traditional energy financing, as certain investors shift away from investment in this sector.

However, the supply disruptions precipitated by the war in Ukraine and the resulting commodity price spikes in 2022 have resulted in a greater appreciation of the significance of traditional sources of energy and our reliance on them.

In the short term, efforts have centred around bolstering and diversifying sources of conventional energy, as well as some enhanced efficiency measures in more acutely impacted jurisdictions. This reflects an acknowledgement of the superior scalability and infrastructure compatibility of oil and gas compared to renewables, given current technologies and infrastructure build-out.

In the long term, social and governmental pressures and concerns over climate change will continue to drive energy transition, but the supply disruptions and commodity price spikes in 2022 may cause governments to focus on a more balanced transition that continues to rely upon hydrocarbons as well as alternative energy sources.

Accelerating investment in energy transition

Although the capital deployment required in order to meaningfully impact aggregate hydrocarbon consumption is enormous, significant capital deployment into energy transition is underway, both on the electric power generation side and in terms of carbon capture, utilisation and storage (CCUS) technology. The Inflation Reduction Act of 2022 is also expected to accelerate investment in clean and renewable energy production and manufacturing through reformed energy tax incentives.

Energy player consolidation

Pressure on public companies continues to drive consolidation, which is aimed at driving profitability through synergies and cost reductions. Public companies are also pursuing acquisitions as a way to increase production without having to spend capex. A number of private capital sources (private equity) have also retreated from traditional energy investments.

The public consolidation and the private capital retreat have meant fewer sources of capital for new investment. In the long term, this will have a negative impact on oil and gas production.

Access to capital

Larger oil and gas companies with investment grade balance sheets continue to have access to debt and equity financing that can be used to fund acquisitions and exploration and development. However, smaller oil and gas companies continue to face challenges in accessing financing. Traditional financing institutions have been reducing their lending exposure to smaller oil and gas companies, leading these smaller companies to look for alternative financing. As a result, alternative financings, such as asset backed securitisations, have become (and will continue to become) more prevalent in the oil and gas industry.

Higher interest rates have also negatively impacted the capital available for oil and gas investment. Not only have the higher interest rates increased borrowing costs for companies, but they have also made it more difficult for new exploratory projects to hit investment hurdles. The result has been fewer new investments.

Global realignment

The Russia-Ukraine war has accelerated a global energy realignment, with the United States and Europe on the one hand, and Russia and China on the other.

European counties have long relied on Russia for energy needs. Russia’s invasion of Ukraine and resulting sanctions are a stark reminder of the fragility of the global energy infrastructure. Desperate for alternative hydrocarbon sources, European countries have been paying premiums to source hydrocarbons from the United States and the Middle East. This has had a dramatic effect on Russian exports and left Russia to increasingly sell its oil and natural gas into the Asian markets.

These shifts have also led to the acceleration of large-scale LNG projects in the United States (and LNG-receiving projects in Europe) as well as increased renewable investments across Europe.

Political pressure and sanctions are also having an impact on investment. Political tensions between the United States and China have caused many state-owned Chinese companies to begin withdrawing from energy investments in the United States. Western investors, on the other hand, have swiftly pulled their investments in Russia. As the world’s second-largest oil producer prior to the invasion of Ukraine, Russia was the recipient of significant investments from a number of Western firms. The loss of this capital and know-how continues to have a negative impact on the Russian energy sector.

The long-term implications of this realignment remain to be seen.