Deloitte report shows lack of standard metric behind oil price, shareholder return disconnect
Despite crude oil prices rising 25% since January 2017 and significant productivity gains made in recent years, shareholder returns on average for upstream companies have still been negative – even for those operating in the Permian Basin hot spot, according to Deloitte Consulting‘s recent report, “The portfolio predicament: How can upstream oil and gas companies build a fit-for-the-future portfolio?” .
Deloitte’s report, the second in its Upstream Diversification Index (UDI) series, reviewed asset portfolios of the top 230 global upstream companies to examine the disconnect between the actions of companies and the verdict of financial markets. The report identifies a primary contributor to the disconnect as a lack of consistent, shared success metrics that both investors and exploration and production companies (E&Ps) can agree on. A comprehensive portfolio analysis is required not only to make a portfolio fit for an uncertain future, but to also present a more attractive and complete narrative to financial markets.
“Upstream strategists need a simple-yet-consistent, relevant and comprehensive approach to assess and benchmark the performance of their portfolios,” said John England, Vice Chairman and US Energy and Resources Leader. “Our new analyses now provide investors and E&P companies a common yardstick to help measure success in a world of diverse metrics and an uncertain price environment.”
The report highlights Deloitte’s new universal performance metrics for industry and investors, which suggest that upstream companies need to place greater emphasis on the long-term, future readiness of the entire portfolio versus focusing on shorter term successes or trends of select assets that are heavily “hyped.” Consensus views are not necessarily valid for all companies.
Consensus metrics say: More work to be done
Deloitte’s establishment of the UDI in 2016 successfully standardized the measurement of portfolio changes made across five dimensions – fuel mix, resource type, region, basin and investment cycle. Realizing companies could also benefit from having a simple-yet-comprehensive approach to assess and benchmark the future readiness of their portfolio, Deloitte has created the Shield, Sustain and Scale (3S) metrics to help standardize measures of an upstream company’s future viability across a range of future business conditions over the next five years. Applying these tools to evaluate 32,000 assets of the top 230 upstream companies provided an intriguing answer as to why the market has not rewarded the upstream sector, despite their claimed portfolio adjustments: more work needs to be done.
Deloitte’s analysis suggests that 77% of the upstream portfolios, consisting of producing, underdevelopment and discovered projects, would still face challenges in sustaining current production levels, funding future growth, and maintaining shareholder payouts at $55/bbl over the next five years.
“Upstream companies generated never-before-seen operational improvements, efficiencies and productivity gains during the extended downturn from 2014-2017,” said Andrew Slaughter, Executive Director, Deloitte Center for Energy Solutions. “Despite these remarkable efforts, our consensus metrics tell us more needs to be done to future proof portfolios, which in turn, should appeal more broadly to the investment community.”
Narrow the gap by future proofing
Using the 3S and UDI models, the report identifies and studies the top 30 companies that have a fit-for-future portfolio. While every company has its own priorities and goals, the following characteristics of the top 30 portfolios could serve as a good starting point for those looking to optimize their portfolio in the long run.
- Prioritizing operational excellence over location. Most of the top performers in the analysis refrained from chasing the newest hot plays, focusing efforts instead on achieving operational excellence.
- Right-sizing balance sheets without going overboard. Of the 61 oil and gas companies listed worldwide with a low net-debt-to-capital ratio of less than 25 percent, only six make it into the top 30 portfolios, refuting the notion that the strongest balance sheets necessarily translate into the strongest portfolios.
- Managing resources by focusing on investment cycles. Traditionally, the focus was on growing resources where attaining a balance in investment cycles was more of an afterthought. However, now, top performers are overturning this notion by leveraging investment cycles to optimize their portfolio.
- Following a consistent strategy, actively. Approximately 75% of the top 30 portfolios were consistent in either concentrating or diversifying their assets while maintaining a healthy pace of change and churn in their portfolio.
- Learning the role of natural gas. Natural gas makes up at least 25% of overall production volumes for 25 out of the top 30 performers. While natural gas has not taken a mainstream role yet, it might be an essential to a fit-for-future portfolio.
“The nascent recovery from such a long market downturn needs to be a phase of adjustment,” concluded Slaughter. “Delaying the adjustment does not seem like an option, but nor would random shuffling of a portfolio lead to success. UDI and 3S offer a consistent and rigorous framework for portfolio analysis to the market and enable the future goal setting of a company, as our industry continues to evolve.”