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Energy Storm: head-winds for most and tail-winds for few!

Energy Storm
Energy Storm

The oil & gas (O&G) sector has been hit by a perfect storm.

It has witnessed a steep fall in commodity prices, a drastic reduction in demand and, to add to its woes, a growing negative public perception, especially in Western countries, against use of fossil fuels.

Large international energy majors, once the darlings of the stock markets and dwarfing other companies in terms of market capitalization, no longer enjoy the special market-following they once commanded. This has compelled majors to rethink their business models and to switch from being a “growth” to a “dividend yield” stock to maintain shareholder loyalty.

Smaller to mid-size O&G players, some of whom have barely kept their heads above water, are even more vulnerable with serious doubts over their future role. Such companies followed the “find and flip” model where they explored new oil and gas discoveries and flipped them out at a premium to a larger player to develop. However, as investment fundamentals for O&G have shifted from “peak supply” to “peak demand”, the model’s sustainability will be severely tested.

Carrying on as is, is not sustainable and no matter how good O&G companies’ intentions are, no wind can help you if you don’t know where to sail!

Each international energy company is seeking to figure out what’s next for them, from small steps to reduce carbon footprint to a fossil-free future. Amidst this hubbub, the Middle East (ME) national oil companies (NOCs) have several competitive advantages, namely:

  • Vast resources that outstrip international majors;
  • Unlike international players, States and state-owned entities get two bites of the energy value pie, which is magnified in low oil prices;
  • Close geographic proximity to, and strategic and political relations with, fastest-growing energy consumers in Asia;|
  • Strong financial market-following, as they’re viewed “quasi-sovereigns” (and therefore safer); and
  • A single shareholder, which exposes them less to the sometimes conflicting demands of the public markets.

In contrast to the yet-to-be-decided destiny of international O&G companies, the ME NOCs can steer their own course! They have the financial strength and a single, long-term minded shareholder to take advantage of the crisis.

The time is ripe and ingredients nicely in place: asset valuations are compelling, pressure on international players to lighten balance sheets is high and, for Middle East NOCs, ample liquidity is available for a shopping spree.

ME NOCs have a rare opportunity to:

Use the “wall of liquidity”

A shift in mindset where value is ascribed to owning the molecule rather than owning the metal, which is merely a means to an end, will go a long way to attract infrastructure funds to O&G.

With yields at historic lows and a huge wall of capital available for infrastructure assets, the timing could not be better to separate the ownership (but not the use) of metal from the molecule to raise funds.

Capital so raised: 

  • Achieves a far higher valuation than otherwise possible for O&G investments;
  • Brings in a new pool of investors to the region, which historically has not ventured outside OECD markets; while
  • Retaining upside for the ME NOCs.

Such capital raising has started in the region, but this is just the beginning. There is a lot more potential for the ME region, not only to take advantage of this competitive pool of liquidity but also to stretch the boundaries of how it is used to fund growth, including acquisitions.

“Buy rather than build” to leap-frog gas and LNG ambitions  

Gas and LNG are transition fuels. While “peak demand” for oil is getting closer, global gas demand is expected to grow, fuelled by Asian markets which outweigh declining mature gas markets of Europe.  

Whilst growing gas/LNG footprint presents an opportunity, some shareholders of international O&G players are reluctant to ascribe a growth premium to it. 

This tension, fuelled further by the capital-intensive nature of gas/LNG, may prevent some majors from growing gas/LNG businesses as fast as they would like. This presents an opportunity for selected ME NOCs.  

Several ME NOCs, besides Qatar, are for the most part “pure play” oil companies. This will change as there have been abundant gas discoveries in the region.  

By buying a meaningful share in a major’s existing LNG platform, ME NOCs would “hit the ground running” and fast-track their own developments. Not only would this enable ME NOCs to play their part in energy transition, it would be at compelling valuations.  

For majors, a ME NOC represents a long-term strategic partner who would free up capital as well as share the burden of future capital requirements. It also enables the major to retain a sizeable presence in gas/LNG while figuring out its new energy model altogether.

Morph to a more vertically-integrated international player to extract better value

The fastest-growing markets for energy, notably in Asia, are either sub-investment grade or border-line investment grade. Local downstream players in these jurisdictions will inevitably feel the pain of a shortage of capital.

This presents another opportunity for ME NOCs to grow internationally.

One way of growing is to invest equity overseas. This is time-consuming, complex, and limits the number of investments that can be made.

An alternative to investing equity is for ME NOCs to buy long-term capacity in local refineries/petrochemical facilities instead.

For ME NOCs, this would be a quicker-to-market solution to secure captive shorts for the supply of crude and, unlike equity, can be more widely used and unwound if required.

A “one-stop-shop” solution could also be offered by bringing in their relationship banks so the target gets funding and the ME NOC grows its international footprint without the pitfalls of investing equity overseas. 

The current crisis is a rare turning point – both for energy majors to fast-track their energy transition and for ME NOCs to expand their market share and international reach.

ME NOCs have strong foundations to weather the storm and the mindset to catch the tailwinds…