A closer look at the US sanctions on the Russian energy industry and operational excellence in unconventional oil & gas.
US expanded sanctions in relation to the Russian energy industry. This in substance involves participating or assisting with new energy projects, the most notable one being North Stream 2, a parallel pipeline for additional Russian exports to Germany with a an additional projected capacity of 55 billion cubic meters.
The European leadership generally disapproved of new US sanctions. The European courts meanwhile upheld Gazprom's rights to take up additional spare capacity in an OPAL pipeline, which is a land extension of the existing North Stream 1 underwater pipeline allowing Gazprom to increase direct exports to Germany bypassing transit countries by pumping at close to maximum capacity of 55 billion cm per year.
Unconventional Asset Class Evolution
The unconventional asset class has evolved through 3 distinct phases. The first phase which lasted until mid-2014, can be described as the Aggressive Growth Phase. During this phase the capital market rewarded E&P companies that demonstrated an aggressive land acquisition strategy and production growth. As commodity prices dropped in late 2014, the industry entered the second phase, best described as the survival phase, where E&P companies made cuts to their capital programs and divested lower economic assets to shore up their balance sheets. The companies fortunate enough to survive phase 2, are now moving into phase 3 where the focus has moved toward profitable production. Capital markets are no longer rewarding just production growth, but are investing in E&P companies that can demonstrate differentiated performance.
Stable Commodity Prices and Cost Inflation
To drive differentiated performance operators are looking to either increase production recovery or reduce cost of operations. Over the past 5 years' capital cost to develop unconventional assets have decreased approximately 25%. Due to the aggressive ramp up in activity from 2012 to 2014, operators saw cost decline by approximately 10% due to learning curve improvements and economies of scale. From 2014 to mid-2015 cost dropped another 15% bringing the break-even costs in premier shale basins to the $30 USD range. However, this cost reduction was mainly driven by supply chain price reduction due to oversupply of services as E&P companies cut capital programs. As the unconventional asset class moves into phase 3, there is significant indication that supply chain cost will revert back to pre-2014 levels, which will erode current margins and bring break-even points closer to the $50 range. With commodity price forecast suggesting a lower for longer price environment $50-60/BOE, the ability for unconventional E&P companies to deliver profitable production becomes extremely challenging.
Operational Excellence to Drive Profitable Production
Although many E&P companies have made strides in improving operational performance in the past, this new industry environment requires “step change” improvements in operational efficiencies in order to counter the supply chain cost inflations and realise profitable production. E&P companies can learn from other industries that have faced similar challenges and implement these 4 cross-industry best practices into their operations.
We believe the next phase for the unconventional asset class will be even more challenging than the previous phases. Adopting these best practices will help unconventional E&P companies counter the supply chain cost inflation and protect the economic assumptions of their current capital programs. Those E&P companies that aggressively adopt these best practices and realise “step change” improvements in operational efficiencies will succeed in this phase of the unconventional asset class and will be rewarded for demonstrating differentiated performance in the market.
- Todd Blackford, Director, Strategy, KPMG in the U.S.
Note: The forecasts/analyst estimates identified are an indication based on third party sources and information. They do not represent the views of KPMG.
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