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Consequences of barrel prices on Oil & Gas and Petrochemical projects

What are the main reasons for projects cancellation

Since the WTI and Brent barrels prices have lost 20 to 25% of their value in a couple of months we assist to a frenzy of publications and speculations on the consequences of this dip on the Oil & Gas and Petrochemical projects that could be cancelled or postponed as a result.

Every day we receive this same question and there is no way to start a meeting without addressing this point first.

As we trace the 1000 largest projects upstream, midstream and downstream for nearly 20 years, we had the opportunity to observe this phenomena a couple of times and we are pleased to share our experience here below on such a topic.

Barrel_price_impact_on_Oil&Gas_Petrochemical_Projects_mapSo far if we consider the main causes for a project to be cancelled or postponed the Top 5 is by far concentrated on:

 – N°1: Spiraling costs

 – N°2: Geo-political uncertainty

 – N°3: Local Content regulations instability

 – N°4: Tensions with local inhabitants

 – N°5: Environmental impact

Since the painful experiences in Australia or around the Caspian Sea with projects capital expenditure running out of control, the operators and especially the international oil companies (IOCs) which are listed, have been extremely shy in engaging upstream projects calling for more than $10 billion investment.

But we can notice that the decision to put on hold these giant projects because of their spiraling costs were made far before the barrel price decrease.

For all the companies the projects costs running out of control are unacceptable regardless the barrel price as it questions the fundamental expertise of the company and the capability of its management to handle complex projects.

So to answer straight forward to the critical question of the day, we do not see any negative impact of the current barrel price evolution in projects decision and we see number of good reasons for that.

Still high price

Even if the WTI and Brent crude oil historically considered as the reference for the barrel prices have decrease by nearly 25% since last June the current price around $80 is still a high level in absolute value.

If we compare this price with production costs in the worst operating conditions, including shale oil, $80 per barrels remains very attractive.

Barrel_Price_CurveIn addition the production sharing agreement (PSA) signed these last years between the companies and the producing countries have introduced a lot of flexibility where excessive profits generated by high barrel price stay in the country while depressive prices will anyway guaranty minimum return to the companies to cover their costs.

Therefore the minimum barrel price level that the market can accept is governed by political agenda, especially between the biggest producers USA, Russia and Saudi Arabia for which nobody can predict where it is.

Light crude vs Heavy crude

All the world put its eyes on the WTI and the Brent barrel prices, but currently these light crude oil indexes represent less than 50% of the world consumption.

Most of oil consumed in the world belongs to the heavy crude traded in conditions far below the light crude.

In addition nearly all the new projects are about developing heavy crude oil fields since new light crude oil fields become very rare or hard to reach.

Heavy_Crude_Oil_PricesThe global market switch from light crude to heavy crude had a positive impact on the projects activities over the last five years since the companies invested heavily to revamp and upgrade their refineries in North America, Europe and Middle-East to accept heavy crude oil in competitive conditions.

This trend should continue on the next five years and contribute to boost the great number of refining projects in world at this moment.

The light crude is mainly interesting commodity traders and hedge funds who speculate on every $ up and down generating billions good will.

The fact that Tony Hayward, former BP CEO, was appointed as Glencore Chairman in May 2014 indicates how much crude oil is becoming a playground for the commodities trading companies. 

But this trading activity based on daily fluctuations has nothing to do with the long term trends driving the fundamentals of the oil & Gas and Petrochemical business

At least we can notice that the interest of these commodities trading companies is boosting storage and terminal projects more than ever. 

In the same time the disconnection between the light crude and heavy crude markets reduces the reliance of the downstream sector and favor investments as well.

30 years project life cycle

All investments in the Oil & Gas and Petrochemical projects are calculated on a period of 30 years minimum.

On that long period of time the barrel prices may comes down to $10 but on a such short period at the scale of the project that it cannot be relevant in the decision to cancel a project.

Unless to discover suddenly a substitute to the oil for transportation applications, the overall trends in demography and the global economical development can only push the prices up on the next 30 to 50 years.

IOCs vs NOCs

When the barrel price goes down, the experience has shown that IOCs and the national oil companies (NOCs) react differently.

The IOCs are listed and must respond to stock exchanges expectations in term of revenues and profits.

IOCs_Crude_OilEven if a lower barrel price may affect their revenues, it may not impact their profits in the same way because of the nature of the production sharing agreements introduced some 15 years ago and  giving more flexibility to the profit and loss sharing with the producing countries as mentioned above.

Anyway to preserve their cash-flow capability to finance new projects, we can observe that IOCs prefer to optimize their assets and spin off the less attractive ones than to cut investment.

In addition 90% of the projects are today driven by NOCs, even of IOCs are getting involved.

For NOCs the agenda is far different and has nothing to do with barrel price.

The NOCs invest to support their home country economical and social development in a long term perspective far beyond any quarterly results.

The barrel price is just a non-issue for NOCs and even less when it goes down since they are structured around an integrated upstreamdownstream business model.

NOCs_Crude_OilThis balanced model allows the NOCs to save on the downstream side what they lost on the upstream side and vice versa, thus reduces their reliance on barrel price.

Even a company such as Saudi Aramco has become one of the largest petrochemical company after the last five years investments in this area.

In Asia we can even observe the NOCs speeding up their downstream projects in that respect.

The advantage of the integrated business model

Over the last two decades all the IOCs at the exception of ExxonMobil concentrated their activities on the upstream business while divesting from refining and petrochemical activities.

In parallel the NOCs were doing the opposite in investing downstream to reduce their reliance on exporting only crude oil and gas, to increase the local value and to create jobs.  

Integrated_upstream-midstream-downstream_business_modelThe low gas price driven by the US shale gas development has changed the game leaving no chance to major companies to make money only on the upstream side.

For companies such as Shell making 50% of their revenues from the natural gas the strategic U-turn in favor the integrated upstreamdownstream business model has become a priority.

Curiously we can notice that the last CEO appointed in major companies (Shell and Total) are coming from the downstream branch.

This overall trend is also materialized by some chemical companies such as Basf, Dow Chemical and Ineos investing in upstream projects to optimize their value chain.

Even it is too early to predict the same course to the shale oil as the shale gas, we can see that the pressure of the oil and gas prices has a significant impact on the companies’ strategy with positive effects on the projects numbers where the profitability is no longer measured on one side of the process but all along the hydrocarbon value chain, as the NOCs do.

Conclusion

The revolution of the US shale gas triggered already a couple of years ago all the companies, IOCs, NOCs and traders, to rethink their strategy in the Oil & Gas and Petrochemical sector as a whole.

Today we can measure the consequences with a number of projects upstream, midstream and downstream above $100 million capital expenditure bigger than ever.

As a side effect the labor costs went to the roof in beginning with Australia and expending all over the world in engineering companies and contractors because of the scarcity of the competent resources.

Project_Smart_Explorer_Oil_and_Gas_and_Petrochemical_projectsIn this context, any stress about the crude oil prices going down is only accelerating this in-deep conversion of the sector.

Of course some projects may be announced to be cancelled or postponed because of low crude oil prices and we shall be very pleased to analyze these cases to assess fundamental reasons of these decisions.

But for now we never saw so many projects being executed on fast-frack, where the engineering, procurement and construction (EPC) contract is following the front end engineering and design (FEED) conclusion without call for tender.

For more information about oil and gas and petrochemical projects go to Project Smart Explorer

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