What do upstream companies need to leverage in order to grow, and where must investors and developers focus in 2021 and beyond?
energy capital
Technology Upgrades, M&As and Farmout Strategies in Upstream
Last year was undoubtedly a challenging one for the energy industry. Hit in various fronts; like the rock bottom crash of oil prices, plunged demand of petroleum subproducts, and an increased push towards energy transition; the upstream sector needed to embrace resiliency particularly.
The vaccine rollout across the world, plus a strict production discipline from top producers, helped shape a substantial recovery. With prices back at a healthy $60 per barrel average and demand slightly going back; there are several business opportunities to leverage in 2021 in the upstream sector. According to IHS Markit, North American onshore E&P CAPEX spending in 2021 will reach $108 billion. In fact, more compared to the $84 billion spent in 2020.
In addition to the vaccine’s distribution enthusiasm, most experts agree that economic recovery will happen in the second half of this year; and demand for crude oil and petroleum subproducts will increase. However, these trends will depend on financial health factors and new statutes derived from the energy transition.
In this regard, what do upstream companies need to leverage in order to grow; and where must investors and developers focus in 2021 and beyond?
Offshore opportunities in the U.S. Gulf of Mexico
Oil production and overall offshore upstream activities in the U.S. Gulf of Mexico were perhaps the most resilient of all. The zone experienced both the COVID-19 strike and the most disruptive hurricane and tropical storms in recent history. However, the GoM remained relatively unscarred during 2020. According to Wood Mackenzie, production just dropped 4% compared to 2019 levels, and no major projects were canceled.
The Energy Information Administration (EIA) forecasts that production in the GoM is set to increase for the next two years. During 2020, crude oil output averaged 1,6 MMb/d. Over 2021 those levels could reach 1.71 MMb/d; and even further 1.75 MMb/d in 2022.
The oil and gas drilling services market had a 57 billion size in 2020. Besides, it is expected to grow to $183,9 billion in 2021; which is more than a 100% increase. Its compound annual growth rate (CAGR) for this year is expected at 25,5%; in fact, mainly due to companies rearranging their operations and recovering from the COVID-19 impact. By 2025, the market will reach $227.77 billion, at a CAGR of 5%, according to a Reportlinker’s report.
Technology improvements
Notably, one novel trend in the sector has been 3D visualization use. These systems can generate a 3D model of a wellbore and real-time drilling data to monitor and optimize drilling processes. With such technology, companies can hit substantial cost savings of up to 20%; and reduce non-productive drilling time by 20 percent.
Remarkably, these systems integrate themselves with the asset via software. Therefore, to make more precise and accurate placement of drilling rigs, thus making extraction safer. Some major companies offering 3D visualization technology are eDrilling, Hexagon, Mechdyne, and Landmark.
One success story of this technology is the drilling of the Puma West project, located in the GoM, more precisely in the Green Canyon Block 821. Conducted by Talos Energy, Chevron, and bp, the companies drilled the well to a depth of 23,530 feet and found high-quality oil in the site. Through advanced seismic 3D imaging, the companies managed to drill efficiently and safely at such depths with a small environmental footprint.
Canada’s M&A trend: from the sector’s growth to financial consolidation
Upstream projects in Canada are expected to rise in 2021. However, this increase would probably be modest considering 2020’s demand crash due to the global health pandemic. Accordingly, the Canadian Association of Petroleum Producers forecasted a 14% increase in upstream investment this year, thus, amounting to about $3.36 billion.
Mainly, near-term forecasts provided by the Canada Energy Regulator (CER) signal production will remain stable for the next five years due to growing heavy oil output in Saskatchewan and tight oil in Alberta. The latter trend follows producers’ preference to target wells with a quicker return on investment (ROI), higher tight oil production rates, and a low decline of heavy oil reservoirs.
Condensate production in the country will mainly come from Alberta and British Columbia. Newfoundland will gradually decline its offshore oil output since no discoveries were forecasted in the evolving scenario by 2025. Nevertheless, CER pointed out that additional discoveries and developments could change these trends.
In this regard, investment is moving differently from previous years’ trends. While rising oil prices would have been a cue to increase upstream investment and look for growth in past years, most companies are currently focused on quickly returning capital to investors through share buybacks or dividends.
Some examples
Thus, the sector is now looking after fast revenue opportunities, and M&A moves are now highly on-trend. For instance, Cenovus Energy Inc.’s $4.8 billion takeover of Husky Energy Inc. in October 2020 and Whitecap Resources Inc.’s acquisition for $550-million of Torc Oil and Gas in December 2020 signal that companies may look for growth through consolidation rather than upstream investment.
Environmental concerns are also influencing companies’ approach to the sector. For instance, oilsands operators are expected to remain cautious for ecological reasons and leverage technology to lower greenhouse gas emissions instead of growing production.
Through carbon capture, use, and storage, pure solvents use, in-pit extraction, and energy efficiency solutions, the industry could advance its sustainability efforts while remaining competitive. Therefore, opportunities are coming for sustainability providers as well.
Canadian start-up Carbon Engineering announced earlier this year that it would help Occidental Petroleum build a plant that will capture and bury 500,000 metric tons of CO₂ each year. Another example is the technology being developed by Canadian Natural Resources Limited at its Horizon Oil Sands mine to separate oil sands ore into its parts within the extraction pit of the operation, requiring less heavy equipment.
Regulatory uncertainties leading to farmout opportunities in Mexico
Mexico’s offshore segment is likely to dominate the upstream market up to 2025 since potential hydrocarbon resources in the country are abundant in shallow water, deep water, and onshore fields. In this sense, and similarly to Canada, the innovation of new technologies will trigger unconventional drilling, mainly looking to enhance oil and gas production while assisting to reduce the cost of operations.
Mordor Intelligence expects that, in turn, these technical decisions can further promote the market’s growth in the coming years. For instance, companies such as Chevron Corporation, Royal Dutch Shell Plc, Total SA, Repsol SA, and Premier Oil PLC., among others, have already secured blocks in the country to explore and produce oil and gas.
Through these investments, Mexico’s oil and upstream gas market is expected to grow at a CAGR of more than 1% during the next five years. Nevertheless, the high volatility of oil prices can hinder market growth.
Besides oil prices’ volatility and market uncertainties, upstream companies in Mexico should be aware of regulatory changes. Particularly, under the country’s current administration. According to the global law firm Mayer Brown, considering this factor may lead companies to embrace cross-border M&A consolidations. However, potential sellers and purchasers should acknowledge new risks. The latter, associated with antitrust clearance and adverse effect provisions related to timing and anti-corruption processes.
Regulatory uncertainty
In fact, regulatory uncertainty is currently a major threat for investments in Mexico. Although the National Hydrocarbons Commission (CNH) has remained a neutral player in this regard, the Environmental and Energy Security Agency (ASEA) and the Federal Electricity Commission (CFE) have fiercely contended other participants (such as TC Energy, Carso, Fermaca, and Ienova) with environmental and anti-corruption claims to declare null and void clauses in awarded contracts.
Nevertheless, and as Mayer Brown states, there are some silver linings within this regulatory revisionism. Thus far, CNH’s performance has been vital in defending investment interests, holding an open approach to promoting discussions among industry participants. Also, the fact that E&P contractors have been able to continue with their operations without any major obstacle despite anti-corruption revisions is a good signal for upstream players interested in participating.
Finally, companies in the sector could leverage farmout opportunities with Petróleos Mexicanos (Pemex). Even though farmouts are not the first choice for the current administration; there may not be many other feasible alternatives given Pemex’s current financial status. Thus, CNH is currently working to approve new farmout opportunities in the Burgos, Tampico-Misantla, and Sabinas-Burro Picachos Basins.
Conclusion
The U.S. Gulf of Mexico area represents a key business opportunity in North America, particularly in the drilling services market and the 3D imaging technology delivery. For upstream companies in Canada, fast consolidation opportunities will trigger M&A moves; a healthy option to achieve resiliency and secure immediate deal value; and infrastructure upgrades to reduce environmental impacts.
Mexico’s ample deep-water reserves will lead well-fitted companies to comply with the regulatory revisionism that the current administration is embracing. Moreover, this could be an opportunity to establish long-term strategic and beneficial farmouts.
In brief, low-cost production, technological improvements, and creating a solid platform for M&As will be critical for upstream companies in the following years. The most efficient, technologically competitive, environmentally friendly, and low-cost producers will most likely be the ones in a position to harness the opportunities that a transitioning economy is giving them.
