Downstream Oil & Gas: Project Recommendations for 2021
By Kai Y. Wan with contributions from Ivan Parra Tepedino
The COVID-19 pandemic has impacted many industries, especially the Oil and Gas industry. This sector simultaneously experienced a price collapse, a supply glut, an unprecedented demand decline and a health/economic crisis. Additionally, the sector’s poor structural and financial health caused the oil and gas industry to be caught unprepared for a completely changed market of grounded planes and parked cars. Demand for transportation fuels fell by up to half (according to the US EIA) and storage tanks filled. Refineries were forced to cut rates or even stop production, with seven refineries being shut down since June, 2019 .
Oil and gas downstream operators experienced their sharpest shock ever, one likely to be prolonged. In 2020, most downstream refiners and their upstream suppliers, operated at up to a 45% decrease in production with prices hoovering on 30-year lows. Consequently, cost structure changed significantly, forcing some operators to curtail or shut down their operation, layoff staff, shorten hourly operator hours and endure eroded margins. As of today, the industry is entering an era of intense competition, technology-led rapid supply response, flat to declining demand, investor skepticism, and increasing public and government pressure focused on the impact on climate and the environment. However, oil and gas will remain a thriving market for decades. Given its role in supplying affordable energy, it is too important to fail. The search for ways to create value in the midst of the new conditions is therefore fundamental.
So, what should the refiners do at this time to brace the storm and ensure long-term success? All companies are predictably acting to protect employees’ health and safety, and to preserve cash, in particular by cutting or deferring discretionary capital and operating expenditures and, in many cases, distributions to shareholders. These actions will not be enough for companies financially hard-pressed. The leading companies will focus on continuous improvement projects with high ROI and short breakeven or payback periods. Launching initiatives and efforts to extract every last cent of value from optimizing refineries and their supply chains is the best response. By investing in these projects, these companies can quickly recover their investment, release more cash, and build future resilience. The winners will be those that use this crisis to reposition their strategies and transform their operating models. Companies that don’t will end up restructuring or inevitably deteriorate. Downstream operators need to right size their large, inflexible technical and engineering functions, refocus on controlling administrative costs and seize new opportunities for margin improvement through digitizing refineries.
As many healthcare experts, especially epidemiologists and infectious disease specialists, anticipate global recovery from COVID by the end of 2021, there still are major challenges that conventional fuel suppliers, as well as their upstream business partners, must be aware of:
- A twofold challenge due to sudden travel interruptions –and longer term demand decline due to the economic downturn– coupled with an increased appetite for telecommuting: COVID-19 has sped up the process of remote working adaptation. Some companies have already announced to shift a significant portion of their employees from the commercial office space to the home office permanently to reduce office spending and promote work-life balance. While the transportation fuel market may still grow in the coming few years, the rate will be significantly lower than anticipated. Airline-miles traveled are projected to remain down 15–20% in the near term, including a 50% reduction from 2019 to 2020. Road-miles traveled will also feel the impact of the substantial increase in telecommuting.
- Increased focus on protecting environment and an increasing shift to greener energy: the UK recently announced its 2030 plan to stop selling gasoline/diesel-powered vehicles while EU countries follow similar footsteps. Environmental concerns will gradually pressure refiners and their upstream suppliers to provide higher quality fuel with lesser pollution and higher production cost. Regulatory compliance costs have increased threefold while health and environmental governance and corporate social-responsibility impacts are driving conservatism.
- Challenges from electric vehicles: Recently, Tesla has become the largest car manufacturer globally, and its stock price and sale continue to soar. At the same time, Tesla has been investing in building a similar ecosystem like Apple to include the battery, charging station, software, and autopilot. Traditional transportation fuels will be disrupted by these new technology advances and eventually have to face demand decline as EV infrastructure matured.
- High inventories of crude and products as a result of the abrupt demand shock result in margin pressure. For example, processing more barrels when cracks turn positive will extend supply surplus. Significantly curtailed jet-fuel demand is also likely to cause crack and yield challenges as rates increase while reopening markets could cause geographic arbitrage and short-term instability, all of this in an environment of limited price stability.
In summary, we recommend the following types of projects that Oil and Gas operators should focus on during the next decade:
- High ROI, short payback period projects to generate healthy, positive cash flow coupled with cash-management readjustments to preserve cash until the market breaks
- Create value through precision, limiting product exceedances of minimum-quality requirements by improving product-demand forecasting, blending processes, or using in-line measurement tools. Refiners with optimized operations planning spend less on the components that make up their finished products, from gasoline to asphalt.
- Free up working capital and reduce energy consumption trough improved production planning, including a rigorous calculation of the refineries’ material balance closure. The worst performers cannot account for as much as 5 percent of their throughput. That contributes to sub optimized operations and subpar commercial decisions.
- Environmental projects to achieve a lower carbon footprint and pollution cost in compliance with new environmental focus
- Long-term transformation projects to shift future production profiles to build resilience against the disrupted, fast-change transportation fuel market”