September 19, 2017

Oil price turmoil: 2016 business strategy should include risk management

 

The oil price has dropped drastically, resulting in businesses in this sector cutting back on spending, or worse, retrenching staff, in an effort to stay afloat. With no indication where oil prices will go in 2016, the key to surviving the current downturn is to implement risk measures that minimise the impact on pressurised oil and gas businesses.

This is the view of Jenny Erskine, partner in oil and gas at Deloitte in the Western Cape, who says that, since the oil price’s downward spiral, upstream oil and gas companies have roughly faced a 70% drop in revenues. The oil price peaked in October 2014, where it was at +/- $105 per barrel, until January 2016, when it reached its lowest point at +/- $27 per barrel.

“Businesses need to adopt a long-term view now, but must simultaneously consider short term strategies to weather the storm. Ensure that if you operate in the oil and gas sector, risk management forms part of your strategy in 2016,” she says.

Erskine says that a short term strategy should include consolidating and centralising business services and processes, especially where human resources are concerned as staff requirements may mirror oil peaks and troughs.

“Assess where you can be lean. Consider whether key roles that are back-office and not client interfacing can be outsourced or centralised. Also, hire in contract workers, rather than rely on permanent staff, where possible. This way you won’t have to retrench staff if the oil price continues to lower in 2016.”

The 2016 outlook on Oil and Gas from the Deloitte Centre for Energy Solutions in the USA says that 2015 saw industry players cut capital and operating expenditures and defer major projects, as well reduce rig productions. It also reports that earnings and stock prices declined dramatically for oil companies, upstream independents, oilfield service companies, and to a lesser degree, midstream companies.

Erskine explains that it is unfortunate that upstream companies have, during this downturn, reduced their exploration spend in line with a drop in cash flows. “This is a catch-22; not spending money during the short-term turmoil will restrict taking advantage of the positive cash flows when the oil price increases.

“Generally, it takes at least five years for an oil project to take off commercially after exploration. In Africa, it often takes longer, up to 10 years. If companies cut back on exploration spending, when the cycle ticks up again, oil companies will be unprepared to tackle the demand,” says Erskine.

She says that oil companies may also consider hedging against the oil price to protect their business against future losses. “Ensure that you are fully aware of the risks however, and whether this fits into your business plan.”

Erskine foresees that should the oil price remain at lower levels, there may be an increase in mergers and acquisition activity in the sector both locally and abroad, in an effort to pool resources, services, expertise and create economies of scale.

Furthermore, she says that although South Africa competes on a global scale, our rates are much more cost-effective for oil and gas companies operating within our borders than our international counterparts, such as the UK, Europe or USA, because of the ailing rand. Therefore, it would be in a business’s best interests to also take into account the nature of the downturn.

“The current oil price behaviour is not typical of the industry. Although we don’t have a crystal ball, the oil price is representative of a cyclical pattern. The South African government recognises this, as it plans to invest in oil and gas exploration off South Africa’s coastline as well as onshore, with Operation Phakisa. Although it is early stages, it has the potential to create significant economic value for the country and businesses operating in this sector,” Erskine concludes.

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