E&P and service-sector players are increasingly challenged to attract investors due to their financial performance, concerns about price and oversupply, and growing global emphasis on emissions reduction. The actions that companies and resource holders take over the next few years will shape the success of individual entities and the industry for the coming decades.

Financial Resilience and Strategic Choices

E&P companies face many of the same business challenges as in 2020, but company balance sheets are now more leveraged than ever with credit ratings for many companies under threat of downgrade. Companies must decide how to create more resilient portfolios to attract investment post-COVID-19, in a world increasingly focused on Environmental, Social, and Governance (ESG) issues and the energy transition.

E&P companies (E&Ps), integrated oil companies (IOCs), and national oil companies (NOCs) will continue efforts to boost operating efficiencies and cash flow through project selection and investments to increase remote operations. Executive teams face choices on exploration spending and basin focus, as well as their emphasis on short-cycle and brownfield development. Some, particularly European Majors, will pursue aggressive transformation as they try, albeit with varying degrees of urgency, to reinvent themselves as broader-spectrum energy players. Adjustments to NOCs' strategies will depend on the remits set by their governments, with most likely limiting changes to greater efforts to reduce operating emissions. Some companies will see opportunities to acquire discounted assets or struggling companies.

License to Operate, and to Sell

Oil and gas companies are increasingly establishing ambitious goals to reduce the GHG emissions associated with their operations and to reach net-zero targets in the coming decades. While pressure to deliver is being exerted by a range of industry stakeholders (e.g., financial institutions, governments, workforces themselves), companies fully recognize that not only is their license-to-operate at risk if they fail to meet these targets, but also their license-to-sell their production into the market.

Technology and broader forms of innovation will play an essential role in companies' efforts to deliver on emissions reduction targets; their efforts are focused on decreasing the GHG-intensity of their operations as this is the area over which they have the greatest control and can provide the most immediate returns. Carbon capture, utilization and storage (CCUS) is also gaining renewed interest in the oil industry as not only a means to capture and offset emissions, but also as a potential new business area. From only 21 large-scale projects deployed globally to date, an additional 36 are now in various planning and construction stages.

Government Responses

Governments face increasing challenges to attract investment in their E&P sectors. Market flux and investor constraints pushed many upstream operators to delay planned FIDs in 2020, while governments concluded 20 of the 55 exploration bid rounds that were scheduled at the start of the year. Governments' actions to increase competitiveness will depend on the extent of their remaining hydrocarbon resources, as well as the degree to which each has the institutional state capacity and government political legitimacy to design and implement upstream policy changes.

Few have the motivation in addition to the institutional ability and credibility to make significant improvements to investment terms. However, more will lower investment barriers by reducing entry fees, establishing permanent offering areas, and assigning licenses via direct negotiation rather than organizing license rounds. Countries that have both significant E&P industries and ambitious national GHG emissions targets will increasingly couple support of the industry with more stringent environmental regulations and incentives to reduce national GHG emissions. Governments of some mature producing countries will implement moratoria on E&P activities in new geographic areas or may completely ban future exploration, as Denmark recently did.

Redefining the Supply Chain

The E&P service sector had already been suffering severely compressed profit margins before 2020. The ongoing global COVID-19 health pandemic, combined with the acceleration of the Energy Transition, will force service companies to re-examine almost every aspect of their business operations in 2021. As ESG requirements on operators increase, setting up the systems, processes, and tools to track pertinent metrics over time will become crucial. Moreover, until the achievement of widespread global COVID-19 vaccinations, the virus will continue to create logistical challenges for getting employees to the right place at the right time and managing the health and safety of crews, generating additional costs.

The E&P industry faces a potential "Green Crew Change." With young professionals becoming increasingly vocal in their support of climate-related issues, many of the brightest new minds may shun the upstream industry, opting instead for careers in clean energy and technology. Upstream and service companies will need to aggressively maintain recruiting during these difficult times and make good on their promises to operate more responsibly. Beyond the benefits of improving business performance, maintaining R&D spending and investments in technology will be critical to attracting new talent to the industry.

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Posted 23 Feb 2021

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.