5 energy trends to watch in 2017
INSIGHT ARTICLE |
Commodity price volatility continues to be a primary concern for the energy industry. Although there appears to be some stabilization at this point, lower oil and gas prices over the last two years have resulted in significant asset impairments, reduced capital investments and substantial workforce reductions. However, technical innovation has resulted in greater drilling efficiencies and improved well production and recovery. Along with cost reductions brought on by the lower price environment, this has resulted in lower breakeven prices for many U.S. plays. Production and exports from the United States are also serving to converge global prices and refining margins.
Power and utility companies face varying market conditions. Abundant natural gas supplies in the United States and environmental concerns have resulted in significant plant retirements and bankruptcies for many large coal mining companies. Capacity associated with coal and nuclear plant retirement is expected to continue, being replaced by natural gas and renewable generation. Although there is much uncertainty regarding the future of the Clean Power Plan and a potential withdrawal of the United States from the Paris Agreement; state renewable portfolio standards, a global movement away from carbon, and declining levelized costs of electricity will continue to drive investment in the alternative energy sector.
Following are highlights of trends to watch in the coming months.
- Pricing and margins
- Regulatory and legislative environment
- Importing and exporting
Oil and gas
Oil is a global commodity, and prices are determined by world supply and demand. OPEC’s late 2016 decision to cut production (along with some non-OPEC countries, such as Russia) propped up and stabilized the price of oil; although it remains to be seen whether certain countries will actually hold production to agreed-upon amounts, and OPEC has limited mechanisms to guarantee compliance. Even if certain countries hold to their stipulated cuts, the United States and other countries without production limits in place will likely increase supply and gain market share.
Every business needs to manage its costs, and in this respect, energy companies are no different. The lower oil and gas price environment has forced exploration and production (E&P) companies, as well as oilfield service and equipment (OFSE) companies, to undergo dramatic cost reductions. While significant cost reductions were initially the result of workforce layoffs and decreased capital expenditure, technological innovation (e.g. pad drilling, longer horizontals) has also served to lower costs per barrel of oil equivalent recovered.
However, it should be noted that certain cost reductions on the services side are not sustainable over the long run. The oilfield service industry has been in a Darwinian phase, where survival of the fittest is determined by vigilant pricing and margin management. Rig counts rose in the second half of 2016 and in time, along with higher prices, it is expected that OFSE costs will increase as well.
Midstream companies are generally not directly affected by the lower commodity pricing; however, many of these companies have been affected indirectly, as these transportation, processing and storage companies feel the impact when an upstream client goes under or attempts to renegotiate tariffs and other costs. Further, investments in infrastructure made by a number of midstream companies did not generate anticipated returns when production from certain wells or fields was either reduced and/or halted.
Downstream in refining, retail and transportation is a different story. Lower prices mean lower feedstock costs for refiners, and lower prices can also trigger increased demand for gasoline and other refined products. The downstream sector of the industry can remain profitable, though demand for refined products can vary significantly by geographical region and by product (such as asphalt, gasoline, jet fuel and waxes). Nonetheless, lower crack spreads for refiners based in North America, for years more profitable than other refiners, have led to a convergence of refining profits around the world.1
Power and utility
Early in 2016, natural gas supplanted coal as the predominant fuel for U.S. electricity generation for the first time.2 The abundance of natural gas supplies and correspondingly low prices are among the reasons this cleaner-burning resource is displacing coal, even before consideration of the Clean Power Plan.3 Natural gas prices, as well as prices for other fuels such as coal and uranium, have generally declined over the last several years.
Fuel costs for utilities are typically pushed through to customers, but electricity demand has generally been flat over the last several years, and other costs continue to rise in the industry. A substantial portion of U.S. power and utility infrastructure is old and must be replaced. Grids are also becoming smarter and more hi-tech, which requires additional investment and cybersecurity measures.
Learn more about energy pricing in this brief video interview with Steve Sprenger, energy practice principal, and Joe Brusuelas, chief economist, at RSM US LLP.
Oil and gas
As in earlier years, the Obama administration’s fiscal year 2017 budget contained a number of tax proposals that targeted the oil and gas industry.4 Among these were a new oil fee, repeal of expensing intangible drilling and development costs, and repeal of percentage depletion.5 These types of proposals are not expected to continue under the incoming administration, which has clearly expressed pro-oil and gas, as well as pro-coal, positions, even though these positions are somewhat in opposition (see below).
Anti-fracking bans placed by a number of local governments in Texas, Oklahoma, Colorado and elsewhere have been overturned or prohibited in recent years.6 Courts have ruled that the power to regulate the oil and gas industry is held at the state and not the local level.7 Nonetheless, the industry must be compliant with various Environmental Protection Agency (EPA) legislation, including the Clean Water Act, the Safe Drinking Water Act, the Oil Pollution Act and the Clean Air Act. Even if the Trump administration is successful in rolling back newly enacted or proposed rules, it is unlikely long-standing legislation will disappear. Midstream companies should benefit, however, and it can be expected that projects such as the Keystone XL pipeline will now face little federal opposition.
Power and utility
The Clean Power Plan—the Obama administration’s effort to cut carbon pollution in the United States—is still awaiting judicial review and would not have been fully enacted until 2030, and it is now anticipated that intervening congressional sessions and the incoming presidential administration will cut or eliminate its impact. Similarly, details have yet to be worked out regarding how companies will comply with the U.S. commitment to the Paris Agreement and its focus on cutting greenhouse gas emissions.8 That is, if the United States maintains its commitment.
Despite this, there is clearly a global desire for cleaner energy. The demand for coal in the United States and abroad has not met the industry’s expectations, leading to the closing of coal plants across the country, and bankruptcies for a number of large U.S. coal-mining companies. At the moment, there are no domestic plans to build more coal plants. Likewise, in the wake of Fukishima, there has been limited interest in increasing (or even maintaining) nuclear capacity in the United States, and other countries such as France are limiting nuclear capacity in favor of renewable generation.9
While there is concern over the incoming administration’s policy toward renewable generation, it must be remembered that many states have standards mandating a significant mix of renewable sources of energy in their portfolios, including wind, solar and biomass. Regulatory plans and worldwide environmental agreements may be good for the natural gas and renewable sectors, but not for coal.
Learn more about the impact of natural gas and the future of coal and nuclear power generation in this brief video.
The energy industry is capital intensive, and many companies—whether they are engaged in oil and gas extraction, coal mining or power generation—carry debt on their balance sheets. Regulated utility companies are generally allowed to earn a reasonable return on their assets and typically pose less risk to creditors. However, firms that are directly affected by underlying commodity prices have struggled in recent years.
With the drop in oil prices, highly levered sectors—particularly upstream E&P and OFSE—saw well over 100 bankruptcies each during the 2015-2016 period.10 Confidence from the banking sector has been low, making it difficult for these companies to refinance their debt, though many were able to defer interest payments. However, private equity has expressed significant interest in these sectors, especially on the E&P side, and a great number of companies have been successful in refinancing debt with preferred equity and other derivatives.
Likewise, the coal industry has experienced great financial difficulty in recent years, with a number of large U.S. coal-mining companies, including Peabody Energy, Arch Coal, Alpha Natural Resources and Patriot Coal, declaring bankruptcy.
The United States has long been an importer of oil. However, U.S. dependency on foreign oil has declined dramatically over the past decade, and in December 2015, Congress lifted the 40-year ban on U.S. crude oil exports. The United States has been a net exporter of refined petroleum products since 2011.11 Late in 2016, the United States became a net exporter of natural gas for the first time in 60 years and, according to the Department of Energy, the United States will be the world’s third-largest producer of liquefied natural gas for export by 2020.12
The United States has been a net exporter of coal for decades and is expected to remain so for the foreseeable future. Net coal exports peaked in 2012, however, and have declined each year since. Coal from the United States is primarily exported to Europe, though South Korea and Brazil import significant amounts of U.S. coal as well.13
Learn more about the influence of OPEC in this brief video.
The oil and gas workforce is leaner than it was a few years ago and is generally stratified between older, experienced individuals and younger, more recent entrants. In the late 1970s and early 1980s, amid high prices and plentiful job opportunities, the industry attracted new petroleum engineers and other experienced personnel. But depressed prices from the mid-1980s through the 1990s did little to continue that trend.
Today, many of the recruits from the late 1970s and early 1980s are nearing retirement, and it will take more time for their successors to gain a similar level of experience. According to the U.S. Department of Labor, employers expect that up to half of their current workers will retire over the next few years. As such, there are doubts that advancements in drilling technology and well recoveries will continue at the same rate once the majority of this more aged and experienced portion of the workforce retires.
Management concerns regarding long-term development and succession planning will require attracting and retaining the necessary skill base.14 But the longer prices remain at lower levels, the more difficult this becomes.
The power and utility workforce is aged as well, and many of these individuals are also nearing retirement. In 2015, it was estimated that more than one-half of the current utility workforce would be eligible to retire within six to eight years.15 The ever-evolving smart grid is forcing utilities to transform their business models, which will require new skill sets to meet the new focus on technology, distributed resources and customer interaction.16
1. “Narrowing crude oil price differences contribute to global convergence of refining profits” (Sept. 8, 2016) U.S. Energy Information Administration
2. Content, T. “Power shift: Natural gas to top coal, gas prices at 12-year low” (March 8, 2016) Milwaukee Journal Sentinel
4. “FY2017 Budget Calls for Over $400 Billion in Targeted Tax Increases on America’s Oil & Natural Gas Producers” (Feb. 2016) American Petroleum Institute
6. Gold, R. “Texas Prohibits Local Fracking Bans” (May 18, 2015) The Wall Street Journal
7. Yardley, W. “In the fight over fracking, Colorado state laws trump local bans, court rules” (May 2, 2016) Los Angeles Times
8. Bradsher, K. “The Paris Agreement on Climate Change Is Official. Now What?” (Nov. 3, 2016) The New York Times
10. Haynes And Boone Oilfield Services Bankruptcy Tracker
11. “U.S. petroleum product exports exceeded imports in 2011 for first time in over six decades” (March 7, 2012) U.S. Energy Information Administration
12. Yang, S. and Sider, A. “New Milestone: The U.S. Is Now a Net Exporter of Natural Gas” (Nov. 28, 2016) The Wall Street Journal.
13. “U.S. coal exports declined 23% in 2015, as coal imports remained steady” (March 7, 2016). U.S. Energy Information Administration
15. Bennet, A. “Solving the aging workforce dilemma in today’s utility industry” (April 1, 2015). Electric Light & Power