The oil and gas industry is undergoing a transformation as it grapples with attracting new investors, a lack of pipeline infrastructure, competition from other energy sources, political pressure, relatively low commodity prices and investor demands for reduced carbon emissions.
As political pressure and concerns over climate change gain pace, further institutional funding cuts and share divestment from fossil fuel projects is expected. On September 23, around 130 international banks at the UN Climate Action Summit in New York committed to decreasing their support and investments in the oil and gas sector in the coming years, promoting renewables instead.
The oil and gas industry is undergoing a transformation as it grapples with attracting new investors
Despite these pressures, demand for oil and gas remains high. While some companies, including Shell, BP, Total and Equinor, have increased their spending on renewable energy and introduced carbon reduction targets. The sector must continue investing in new projects to meet future demand for oil and gas as economies in Asia grow.
While there is not a reduced appetite for investment in oil and gas, investors want to see attractive returns. This means exploration and production companies must maintain tight budgets and focus on efficiency. Continued innovation and new ways of working will be needed to ensure investors are paid the returns they expect.
Small and medium-sized producers, which are more exposed to debt markets and reduced financing, can struggle to get new projects off the ground. As a result, oil and gas companies must design more flexible and innovative financing packages, seek new sources of capital for their worldwide operations and communicate a compelling business plan if they are to maintain a healthy cash flow for returns on investment.
One of the most significant changes in the finance cycle is the dramatic reduction in lending from banks. While this doesn’t impact bigger players, which have a high credit rating and strong balance sheet, new and small players have it tougher as they will struggle to borrow capital for large infrastructure projects.
Hydrocarbon exploration – the process of digging deep into the Earth to find deposits of oil and gas – has traditionally been too risky for banks to finance, meaning companies have used alternative sources of finance, such as government funding, the bond market, project partners, private equity and export credit agencies. Private equity-backed companies and independent oil companies, such as Aker BP, are funding themselves by trading shares on the offshore stock exchange.
For midstream assets, the industry has seen a surge in investment from private equity firms and infrastructure funds focused on the upside potential of such assets. According to private capital tracker Preqin, oil and gas investments accounted for almost the entirety of activity in 2018, which saw 77 funds raise $89bn.
In the case of Africa, where GPB Global Resources operates, recent growth in the continent’s economies has boosted investor interest in African projects, with a wide range of financial incentives and structures being employed. International oil and gas companies are currently financing projects across Africa and allowing investments to carry, with loans repaid using cash flow from the project. If there is insufficient cash flow the repayment interest and the principal loan is prioritised.
Another popular method of financing is through corporate loans and bonds. Large, credit-worthy oil and gas companies can borrow money using their corporate balance sheet, allowing for relatively cheap loans. Consequently, the joint operating agreement structure often involves a large oil company financing its share of exploration and production costs by issuing corporate bonds or directing cash flow from more profitable projects.
The most common means of financing projects in Africa is through joint ventures with large international oil companies. Joint ventures tend to be formed between smaller exploration or production companies and large international oil companies.
Across all segments of the industry, there are opportunities to attract investment, reduce costs and mitigate risks. There is considerable scope for governments and international bodies to support innovation in these areas.
The oil and gas sector is a key source of economic growth for nations and the backbone of the energy sector, with their products underpinning modern society
For oil and gas companies in developing countries, perceptions of commercial and political risk play a significant part in investment decisions, especially if the country’s financial systems aren’t well developed or are characterised by weaker institutions. Good government leadership is therefore critical to reducing risks and allaying fears for private investors and state-owned enterprises.
Given the cyclical character of the oil and gas market and the long-term nature of investments, governments can facilitate investment by establishing clear regulatory and fiscal policies. In some cases, governments looking to stimulate investment may offer incentives to reduce the risks of exploration.
This can be done in the form of licensing exploration blocks onshore and offshore, agreeing favourable development rights with tax incentives and offering public-private partnerships. For example, in an attempt to incentivise and facilitate investment by oil and gas companies, the Bahrain Government has announced that it will allow foreign companies to own 100 percent of oil and gas drilling activities in the country.
The oil and gas sector is a key source of economic growth for nations and the backbone of the energy sector, with its products underpinning modern society. Though renewable and sustainable energy initiatives are gaining traction, they are still evolving and cannot produce energy at the volume or level of reliability required to satisfy demand.
The outlook for the sector is broadly positive, partly because many oil and gas companies are becoming leaner and more competitive. As the energy sector develops, so will the finance sources available.
To continue to attract investors and capital, the oil and gas industry must develop a value proposition that is consistent and favourable – one that combines cost reductions and margin increases. If it is to continue meeting investors’ expectations, the industry must prove that it can provide high returns on investment.