Despite all the challenges, upstream has kept resilient, and it is strategically adapting to a new environment. Indeed, the sector is proving that petroleum and fossil fuels will not simply disappear.
ENERGY CAPITAL
The upstream sector is currently facing major challenges. From demand destruction provoked by the Covid-19 pandemic to the exponential growth of renewable energy sources, the century-old and traditionally fossil-based industry now faces a significant urgency to change.
In the United States, President Joe Biden has vowed to make energy transition the culminating target of its administration, with a transcendental shift from traditional fossil fuels towards cleaner alternatives. Notably, one key policy is making the sector crumble: the federal lands drilling ban.
On Canada’s side, the country is currently facing the difficulties of both the pandemic and the changing political landscape of its southern neighbor, which is also its largest energy partner. They share a bilateral energy relationship valued at $1,96 trillion (a cumulative value from the last two decades). Besides, according to the Canadian Energy Center, between 2000 and 2019, the oil market delivered a nearly $1,12 trillion energy flow between the two countries.
Despite all the challenges, upstream has kept resilient, and it is strategically adapting to a new environment. Indeed, the sector is proving that petroleum and fossil fuels will not simply disappear. Several strategies are currently underway, and they might make us reconsider how this sector is transitioning and surviving.
The challenges
Demand destruction and financial loses
As we now know, the Covid-19 disease shook the world entirely. In fact, it is still striking economies despite the vaccine rollout efforts pushed by governments around the world. Particularly in the energy sector, the coronavirus pandemic prompted a significant crash in oil prices.
Around April-May of 2020, oil prices historically fell below zero levels, crashing domestic and worldwide supply chains. Global oil demand fell by a record of 9,3 million barrels per day on a year-on-year basis in 2020.
According to the International Energy Agency (IEA), oil demand in April 2020 was around 29 mb/d lower than in 2019, a level not seen since 1995. This market landscape prompted a series of millionaire financial losses from the oil majors and supermajors.
In fact, during the third quarter of 2020, oil bankruptcy filings increased 21% compared to 2019’s same period, according to Haynes and Boone. For instance, oil major Occidental Petroleum reported a net loss of $1,3 billion for the fourth quarter of 2020.
Similarly, ExxonMobil had a year-on-year loss of $20,1 billion, compared with $5 billion in 2019. For bp, its upstream wing reported a full-year loss of $17 billion, compared with an $8 billion loss in 2019.
Finally, Chevron reported a full-year loss of $5,5 billion, compared with earnings of $2.9 billion in 2019. Shell reported a net loss of $18,3 billion, only in the second quarter of 2020, down sharply from a net profit of $3 billion in 2019’s same period.
Changing political and economic landscape in the US
Joe Biden assumed the US presidency on January 20, 2021. His Republican counterpart in the presidential race and now former US president, Donald Trump, had an “oil and gas at all costs” agenda during his administration. Under Trump, the country lived a shale boom, with an eight-fold increase between 2007 and 2019.
As a result, the US became one of the world’s largest oil and gas producers, surpassing Russia in 2011 for natural gas and Saudi Arabia and Russia in 2018 for oil. In fact, in 2017, American Petroleum Institute’s CEO, Jack Gerard, said that Trump’s first 100 days in office were America’s “energy renaissance.”
It was precisely the API one of the institutions that challenged Joe Biden’s vow to end federal lands drilling. API’s Chief economist, Dean Foreman, released a study in which he claimed that Biden’s move would trigger a $700 billion gross domestic product (GDP) decline through 2023. Similarly, new API’s CEO, Mike Sommers, vowed to take the issue to courts, as millions of jobs would be lost on states that heavily rely on oil and gas income.
However, on his first day in office, President Biden axed the Keystone XL project and signed a series of orders to stop fracking and new oil and gas auctions.
By mid-March 2021, fourteen states had sued the president’s decisions in this regard. Indeed, “we believe that the president’s actions are illegal and unlawful, and we’re going to hold him accountable for them; therefore, we’ll try to make sure that the gains that we’ve made over the years to help protect domestic oil and gas and energy continue,” said Louisiana’s Attorney General Jeff Landry.
For instance, the states joining Louisiana’s lawsuit included Alabama, Alaska, Arkansas, Georgia, Mississippi, Missouri, Montana, Nebraska, Oklahoma, Texas, Utah, and West Virginia.
The opportunities
Energy trading
Amid this political and economic landscape, how did upstream companies adapt? Energy trading was one strategy that helped upstream companies recover after the pandemic’s hit and the president’s new energy paradigm.
One of the 2020s most effective trading strategies was buying out oil stocks during the price plunge and then re-selling them when prices got stable. According to a bp presentation seen by Reuters, the company made around $4 billion on this strategy alone. Furthermore, in August 2020, bp’s Chief Financial Officer, Murray Auchincloss; told analysts during an interview that in the second quarter of 2020, the business was “exceptionally strong from oil trading”.
Similarly, Shell’s oil trading operations earned the company $5,995 billion in 2020, while over 2019’s same period; total revenue from oil trading only accounted for $1,3 billion, according to the company’s 2020 annual report.
This unusually high contribution from selling oil stocks shielded major companies from the hit of the worst recession in modern economic history. However, this strategy had a unique approach; mainly, as the income would help companies finance their shift towards a new business model, in shape with a lower carbon economy.
Hydrogen as a critical pathway for transition
In this regard, making upstream cleaner represents the biggest challenge for the industry. Reducing emissions, offsetting carbon, capturing it, and acquiring a comprehensive portfolio of renewable energy assets; all of those aspects are key elements to advance the sustainability agenda. In fact, the net-zero goal is being practically universally adopted.
Accordingly, one commodity is making its way as a made-to-fit strategy for companies to transition: green hydrogen. In early March 2021, major energy companies, labor unions, utilities, NGOs, and developers committed to this commodity’s advancement. Besides, they launched the Clean Hydrogen Future Coalition (CHFC).
The CHFC features companies like Chevron, Duke Energy, Sempra Energy, and Siemens Energy; altogether, they intend to promote hydrogen as a critical pathway to achieve global decarbonization.
The group vowed to work closely with President Biden’s administration, stakeholders, and policymakers. Notably, to ensure a pathway for clean hydrogen, as it has the potential to decarbonize all industrial sectors. Specifically, those in which electricity has a hard time, like transportation and manufacture.
Upstream facing energy transition
Drilling, resilient hydrocarbons and new technology adoption
Other strategies from upstream companies to adapt to this new environment have been an increase in drilling activities and a focus on resilient hydrocarbons. It may seem contradictory, but in late October 2020; the US and Canada rig count rose to levels not seen since 2018.
Rig count monitoring agencies, like Baker Hughes, noted that, back then, the U.S raised its total rig count to 287, while Canada did to a total of 83. Such growth hadn’t been seen since June 2018.
Furthermore, in late March 2021, Baker Hughes’ data showed that the rig count increased for the past seven months. Accordingly, the US total rig count was at 310; with the most active drillers being EOG Resources, Pioneer Natural Resources, Occidental Petroleum, and ConocoPhillips.
In this regard, how could upstream companies increase their drilling during a global pandemic and the energy transition? Indeed, the answer relies on the way these hydrocarbons are drilled and delivered.
When the pandemic arrived, companies were almost compelled to align to social distancing measures; leaving their assets with less personnel and productive support. Nevertheless, the adoption of technologies like drones, augmented reality, and remote work paved the way for more agile and safer production methods.
Other examples with upstream development
bp’s Atlantis project in the Gulf of Mexico is a perfect example of that. According to the company, in July 2020, Atlantis’ delivered its production on schedule thanks to technology adoption. In particular, bp’s crew used advanced seismic imaging to identify the field and develop a new subsea system. Such innovation allowed the company to boost Atlantis’ production up to 36,000 barrels of oil, with costs and time reduction.
The increased use of methane capture systems, flaring reduction, and injecting carbon dioxide into wells are also critical components of this “resilient hydrocarbons” trend.
A quick example of these measures’ adoption is the creation of the Environmental Partnership; an association that represents about 70% of the total onshore US oil and gas production. With major companies like Chevron, Devon Energy, and API’s members’ participating; accordingly, the Partnership focuses on adopting best practices and emissions reduction efforts across the entire value chain of the upstream and midstream sectors.
In December 2020, the Partnership launched a Flaring Management Program to identify ways to reduce flaring; or at least improve its efficiency and reliability. For instance, one of the Partnership strategies was the broad adoption of thermal oxidizers or combustors; indeed, they allow a 98,5% gas destruction efficiency. Moreover, this practice allows reducing significantly the amount of methane released into the atmosphere.
Therefore, with strategies like these, upstream companies are improving their operations, better aligning themselves into a low carbon economy and society. Indeed, events in recent months have proved (like the winter storm in Texas) that total electrification of the industry endangers national energy security. Therefore, hydrocarbons like oil and natural gas are still essential to the industry. In brief, a greener upstream sector is shaping, ensuring its presence for the years to come.
