The oil and gas industry started the fourth quarter of 2018 with high hopes. Oil prices had risen in the last half of the third quarter and indicators were pointing upward. As is often the case, events took over and oil prices erased all the gains made since the beginning of 2017.
Financial Leverage Definition, Advantages, and Disadvantages
Analyst themes of quarterly oil and gas earnings Q4 2018
1. Questions
raised by results
Analyst themes of quarterly
oil and gas earnings
Q4 2018
Overview of Q4 2018 themes
• Even as oil prices fell abruptly and natural gas prices remained in a narrow range, the macro
environment and oil prices continue to reside at the bottom of our list of themes. Apparently, the
investment community sees the interruption in the commodity price recovery as a bump in the road
rather than a longer-term problem. Operating income of our sample of 12 companies has shown
remarkable strength and resilience. Although Q4 profits were 28% lower than Q3, they were 45%
higher than in Q4 of 2017. It may be that analysts see what we see: an industry that has adapted and
will continue to adapt to whatever the market throws at it. Costs are lower than ever and execution,
aided by the rise of digitalization, continues to improve. Companies are closely managing their
portfolios. We expect those trends to continue.
• “Business as usual” on execution seem to be the dominant thinking. The fundamentals of cost control,
capital spending, operational excellence, cash flow and capital return were front and center. Analysts
were keen to learn the details of individual projects from a cost and performance standpoint.
• LNG projects were a topic of interest for more companies this quarter. The surge in LNG demand,
the widening of LNG spreads and a general sense oil and gas majors will play an increasing role in
the production and marketing of LNG have created more awareness of companies’ plans for putting
capital into that part of the oil and gas value chain.
• Country risk is always a factor for IOCs, both from a portfolio management and operational
perspective. Companies with exposure to the deteriorating political situation in Venezuela were asked
questions about plans, contingencies and the impact on operations and earnings.
• Acquisitions, capital spending and the return on capital remain of primary interest. There was some
reshuffling of the financial themes, but it would surprise us if any of them fell off the radar completely.
Growth versus returns are always in tension and it seems the balance has tipped in favor of a focus
on returns.
• In the last five years, the oil and gas industry agenda has been dominated by a short-term challenge
of structurally low oil prices and the longer-term specter of climate change, decarbonization of the
energy ecosystem and peak oil demand. It is revealing that in the latest round of conversations
between company management and investors, those subjects weren’t dominant. In fact, they
were discussed only in passing. A small number of analysts were interested in alternative energy
investments, but those queries were few and far between and focused on returns.
• In future quarters we expect to see increasing interest in LNG investments, consolidation in North
American shale (and acquisition), and pressure on service pricing and costs as the service sector
comes to terms with returns that have yet to recover. Commodity prices may become more
interesting but there could be a shift in the direction of causation as oil company strategy moves the
markets, rather than the other way around.
Andy Brogan
EY Global Oil & Gas Leader
The oil and gas
industry started
the fourth quarter
of 2018 with high
hopes. Oil prices
had risen in the
last half of the
third quarter and
indicators were
pointing upward.
As is often the
case, events took
over and oil prices
erased all the
gains made since
the beginning
of 2017.
2. Top 10 themes from quarterly
earnings calls
Q4 2018 Q3 2018
1 Portfolio optimization
2 Major project updates
3 Cash flow targets
4 Capital spending guidance
5 Cost control
6 Shareholder distributions
7 Maintenance turnaround
8 Operational excellence
9 Production outlook
10 Macro outlook
1 Capital spending guidance
2 Major project updates
3 Cash flow targets
4 Portfolio optimization
5 Production outlook
6 Shareholder distributions
7 Cost control
8 Downstream performance
9 Maintenance, expansion and turnaround
10 Macro outlook
Key themes
Portfolio optimization
Issues of portfolio balance and
exposure to particular asset
classes as well as the appetite
for asset sales or purchases.
1
“Although oil prices continue to remain lower, we see higher levels of confidence among operators, driven by better cash flows and higher
operating incomes. We expect a focus on projects with short cycles, growing demand and better price spreads combined with inherently
lower risk. Bets on shale and LNG appear highly attractive with divestments likely from lower performing conventional resources.”
Andy Brogan, EY Global Oil Gas Leader
• ► Asset portfolios were in focus again
as the top theme in Q4 2018 (up from
fourth in the last quarter).
• ► Producers are preparing for the long-
term scenarios for oil and gas and are
aggressively scouting sources of lower-
cost crude and LNG capacity.
• ► The US continues to generate interest
as a hot-spot for asset acquisitions
as it offers both. In addition, greater
portfolio optionality is being built
through gradual investments in power
generation and mobility by the majors.
Major project updates
The execution of current
projects and the pipeline of
future projects.2
• ► Market volatility toward the end of 2018
is expected to have a direct impact on
project FIDs.
• ► A relook at the project approval process,
considering the emerging macro
conditions is likely, as companies factor
in volatility.
• ► Unwavering Asian LNG demand (due to
coal-to-gas switching initiatives in major
importing nations) is expected to put
liquefaction project FIDs in the spotlight.
Cash flow targets
Balance between sources
and uses of cash.
3
• ► The oil and gas sector is no exception to
the rule that “cash is king.”
• ► The generation of cash, the use of cash
and the return of cash to shareholders is
always top of investors’ minds.
• ► With healthy cash positions shareholder
distributions and dividend increases
appear to be sustainable.
2 | Questions raised by results Q4 2018
3. Cost control
Actions companies have taken
to reduce costs, and trends in
the cost of equipment
and services.
• ►Thelynchpinofearningsrecoveryandthe
resilienceofoilandgascompanies’results
duringchallengingmarketenvironments
hasbeentheirfocusoncostsandtheir
successinbringingcostsdown.
• Possibleeffectsonoperatingexpenditure
fromprojectstartsandacquisitionsmade
intherecentpastwereinfocus.
• Thepotentialforfurtherreductionsin
operatingcostsbystreamliningand
possiblereductioninactivitylevelsinthe
USLower48werealsoofinterestaswere
initiativesthathaveenabledoperating
costsreductions.
5
Capital spending guidance
Companies’ flexibility to
ramp up or down their capital
expenditure in response to
market conditions.
• ► Adherence to capital targets and plans
has been impressive, and comprehensive
details on planned spending have been
charted out by producers.
• ► Despite reporting strong balance sheets
because of the measures taken over the
years, a disciplined approach to capital
spending appears to be the new normal.
4
• ► With a firm commitment to capital
discipline and doubts about the role
of oil and gas, we can expect heighted
competition for cash between capital
projects and return of capital to
shareholders.
Shareholder distributions
Companies’ strategy
for returning capital to
shareholders, changes to
that strategy and potential
risks to delivery.
• ► A hint that analysts have taken note of
the recent fall in oil prices is the interest in
share buybacks and dividend policies.
• ► Many companies had announced buyback
programs and as risk around revenues,
earnings and cash flows increases, those
programs could be reconsidered, and
analysts are looking for signals.
• ► Questions were asked about breakeven
prices and conversely, the impact of price
volatility on shareholder distributions.
• ► The priorities for cash – shareholder pay-
outs, debt repayment or reinvestment
and factors that would trigger share
buybacks are always interesting to
analysts.
6
7
Maintenance and
turnaround
Management of planned
and unplanned maintenance
activities.
• ► The efficiency of scheduled maintenance
and the risk that maintenance may be
delayed or that costs could increase can
have significant impact on earnings and
cash flow.
• ► Capacity additions, timelines, new
technology and capital involved in
expansion projects are routinely high on
analysts’ agenda.
• ► In particular, the details of how upcoming
maintenance plans and the timeline for
facility restarts will impact output are the
subject of some scrutiny.
Operational excellence
Sustaining customer
expectation through the
continuous improvement of
the operational processes
and the culture of the
organization.
• ► In a highly competitive commodity
business, execution is everything.
• ► Analysts were keen to learn more
about technology being implemented
or considered and the portion of
increased returns that are attributable to
technology implementation.
• ► Obstacles to widespread implementation
of automation and digitalization in
operations were also a subject of
significant interest.
• ► Analysts were also curious about safety
as a strategic high-priority and the
efforts underway to enhance safety
processes.
8
“In the current commodity pricing scenario, top line growth for the oil and gas sector is likely to be under pressure, challenging
companies to keep their costs under control. Digitalization will continue to drive the next wave of operational cost reduction initiatives
and we can expect a tighter hold on the purse strings for service pricing and non-critical expenditure.”
Jeff Williams, EY Global Oil Gas Advisory Leader
“Forecasts of a modest commodity price recovery imply that the industry would place an increased focus and rigor on operations
performance. Digitalization, data gathering and sophisticated analytics can help better understand cost drivers across the value chain
and their interdependencies. We can expect improved decision making and efficiencies deriving from ongoing and new digital projects.”
Ioanna-Andreea Ene, EY Nordics Oil Gas OPEX Leader
3Questions raised by results Q4 2018 |