Are we in a new oil cycle? Or a different kind of cycle, or perhaps there's no longer a cycle at all? The advent of tight oil has already changed the supply side of oil markets; the threat to demand from climate change policy and technologies like electric vehicles also challenges the traditional view of oil market fundamentals.
These secular shifts increase the risk that oil prices might be lower for longer and mean companies need to think differently about their business and how they run it.
The oil price has always proved impossible to predict consistently. That hasn't driven forecasters out of business and Wood Mackenzie mixes with the best of them in fundamental market analysis. We expect prices will rise to the marginal cost of supply, US$85/bbl (real), by 2020, before easing as new supplies come on stream. Pundits less sanguine on price typically believe cheap supply will be plentiful for the foreseeable future.
These divergent views illustrate the dilemma: oil companies must have a view on oil prices to plan, yet cannot base a long term strategy on a singular oil price forecast. If companies are to attract capital, an upstream portfolio has to perform profitably, and be sustainable, at low oil prices as well as high.
The industry has adjusted to a tough external environment plenty of times before. Low oil prices in the late 1990s led to a decade of strategic conservativism. Mega-mergers among Majors opened up a phase of rationalising and cost cutting, and the opportunity to manage more effectively combined portfolios. High grading was all the rage - of producing assets, project hoppers and exploration prospects. Essentially these mergers were about economies of scale and keeping competitive on costs.
There was also a prevailing, grand view that oil prices would rise, sooner or later. The ultimate 'winners' in that scenario would be those that captured a dominant chunk of the world's accessible, undiscovered resources - think Latin America, Sub-Saharan Africa, the Arctic or Russia. The Basin Masters would be kings, and volumes counted because the world would soon need the supplies and be prepared to pay for it.
The cycle would look after the 'value' side of the equation. Even high cost reserves could pay off handsomely, like a call option in a rising stock market. Few oil and gas companies are feeling so bold as they peer into a future muddied by tight oil and with longer term demand growth less sure.
The new mantra emerging is 'managing for margin'. It's a good sound bite at a time of low prices and high uncertainty, and a reassuring message to investors about risk appetite. There's an implied focus on the minutiae of the business and, importantly, profit. But what does 'managing for margin' really mean?
We think it's about running the business at the lowest cost and capturing the maximum margin as a price taker. At a basic level companies need to refocus on day-to-day control of the detail - allocation of human capital and right-sizing; analysing individual asset performance and profitability; understanding the supply chain and contractors; managing operations and processes more efficiently. Big data, analytics and technology have bigger roles to play.
Upstream portfolios today, built up in the super-cycle, may not be fit for future. Rationalisation and high grading are crucial to reposition lower down the cost curve; targeted M&A can strengthen advantaged positions. Diversity across resource themes will be an advantage, providing investment optionality. Short-cycle and flexible investments, characteristic of unconventionals are in the ascendancy. Long life assets such as domestic gas or fixed fee oil contracts may also be at a premium, generating acceptable returns but with low sensitivity to oil prices and visible cash generation. Renewables could feed into the latter category.
Turning round the proverbial oil tanker won't happen overnight. But the sharp end of the industry is already 'managing for margin'. Tight oil and shale gas producers lead the industry in driving down costs and maximising efficiency. 'Value' is becoming the key determinant for investment decisions rather than volume: companies are sanctioning smaller fields, near existing infrastructure and with short, achievable lead times. Screening of exploration prospects has shifted to lower risk opportunities that could be developed quickly if successful.
That's another implicit part of the message: 'managing for margin' is not about scale, but profitability. And that's exactly what the industry needs to do to win back investor confidence.