A co-authored article by Simon-Kucher and OilX.
Most industries are adversely impacted by the current crisis in the world.
The healthcare crisis from the rapid spread of the COVID-19 viral infection has touchpoints with most countries and industries. In addition, the near total lockdown of trade is causing further complications.
Reduced end consumer demand for oil due to COVID-19 has led to excess supply of oil which is leading to unprecedented stock builds and spectacularly low (and even negative prices). A historical agreement between OPEC+ and various other producing countries to reduce supply from May onwards, by some referred to it as ‘too little too late’ is an attempt to curtail supply in order to ‘flatten the curve’.
Performance of oil industry pre-COVID-19
We have conducted market research on the top 300 companies globally. We leveraged financial KPIs like revenue, EBITDA, RONA, ROCE to draw insights about the industry. In that analysis we also take leads from the chemical industry that is very impacted by end consumer demand. We draw parallels to what could be in stock for the oil companies. One the key finding is: the crisis that oil companies are facing today are not just the result of COVID-19. Rather problems have been brewing for some time.
Key findings from a Simon-Kucher survey
We recently conducted a survey with oil industry executives (in collaboration with RICE University) to understand their pain points, strategic agenda and potential mitigation strategies. Here are some of the key messages from that survey results:
- Companies focus on cutting their CapEx by up to 30% in the near-term
- It is expected that it could take up to 3 years for the Brent crude price to go back to $60/bbl
- The new focus will be on operational efficiency and capital use, rather than on top-line growth
- Oil executives realize that pricing initiatives yield the highest ROI, yet they are under-investing in pricing projects and focused on cost cutting. One possible reason is that industry experts underestimate the true impact of pricing
So in short the industry is repeating its tested formula of cost savings in order to hibernate trough the price winter. From working with pricing in the industry for the past 35 years we are convinced that the prospect of negative supply price spikes will be a more and more frequent phenomena.
At the European Power Exchange the number of hours with negative electricity prices has increased from 15 hours in 2008 to 211 hours in 2019. Last year, the power producer paid the buyer a (negative) price per megawatt hour for almost ten days. We see it occurring more and more frequently occurs in our daily lives, if its cashback for cars, negative interest loan or simply cash incentives to switch your bank.
In the market study the participants stated that their break even Oil Price was close to 40 USD. With significant risk for more near zero price shocks and a long recovery period for the Oil price we recommend a different perspective. In short, we challenge the notion that Oil companies will be able to save themselves out of this crisis. Instead we recommend a set of topline measures.
Where next? Some key commercial and pricing decisions that can be taken now
We believe that oil companies should adopt the following measures to counter the prevailing challenges:
- Shy away from signing long-term customer contracts, especially with large customers. Instead, push volume through spot transactions and to spot customers.
- Closely track and monitor the Brent Crude price. Leverage historical models to scenario plan and decide on the commercial strategy in each case. Forecast models should be used, however they may not be able to predict in all the scenarios.
- Focus on protecting market share with large customers. Redirect volume from small or spot customers as needed to ensure supply and contractual obligations with large customers.
- Rebalance the customer mix between large, medium and small. Take tactical and commercial steps to increase the balance towards large customers.
- Fix the drop in volume through sales strategy rather than drop in price. The prices should be linked closely with the Brent Crude prices. However, additional discounts or rebates would not arrest a slump in demand.
- Focus on managing net working capital and cash. Raising from the market will continue to be tough. This temporary credit crunch will hit small and medium Oil companies more than the large ones
Times are tough for oil companies and will likely get even worse by June and July 2020. It is imperative that oil companies take certain commercial decisions to manage the impact and future proof themselves.
- Oil industry has been facing a downturn for a few years now. The current COVID-19 induced crisis is accelerating and exacerbating the problem
- Oil industry’s business models haven’t changed in a long time. We reckon this is a good opportunity to do so (e.g. implement digitalization strategies)
- Oil companies can’t deal with this crisis with just cost cutting. There is a limit to the cost cutting before it starts to adversely impact business. Instead, oil companies should focus on commercial strategies, like pricing