Energy Visions spotlight
In this podcast episode, we bring together energy experts to get their insights into what the next decade might hold for oil and gas globally—and some next steps for Canadian energy organizations to attract investment back to the sector.
The global oil market is beginning to stabilize after several months of unprecedented disruption—we’re now starting to navigate the challenges of operating in a low-growth or no-growth world. In this episode, we explore what actions Canadian organizations need to take to shift to a successful low-cycle operating model. What is the energy investor of today looking for? And what are the right moves for Canadian energy businesses to attract investment? Join us and learn more.
Adam: Welcome once again to PwC's Energy Visions Spotlight Podcast. My name's Adam Crutchfield, PwC Canada's National Energy Leader. Today's podcast, Attracting Tomorrow's Energy Investor Today, marks the start of our re-imagined Energy Visions program for 2020. Because the safety of our community is our top priority, we've decided to make our 11th Energy Visions entirely virtual, so in the coming weeks and months, we'll be releasing a series of articles, blogs, and podcasts as part of our re-imagined program. We'll also be holding several round table virtual discussions. As in previous years, our goal is to engage you with thought provoking content, provide access to global viewpoints, and show how, as an industry, we can move forward together.
Things are starting to stabilize in the global oil market, following the unprecedented entry into negative territory in April. At the time of this recording, oil has hit its highest price in the last three months, with speculation that Saudi Arabia, Russia and other OPEC+ members will agree to an extension and production cuts at their next meeting.
Meanwhile, as our industry emerges from the crisis, things are going to look very different from how they were before as we navigate challenges of operating in a low growth or no growth world for oil and gas. We'll look at the impact on demand and changes in behavior that will either be permanent or will last for an extended period of time.
What does a low cycle operating model mean? And more importantly, how, tangibly, do Canadian energy businesses get there? In their recently released report, the IEA declared that the impact from COVID-19 will see the largest decline in energy investment on record, a reduction of one-fifth, or almost $400 billion US dollars. How do Canadian energy businesses make the right moves today to attract investment back into their businesses? What is the energy investor of today and tomorrow looking for? And most importantly, what steps do Canadian businesses need to take to do more than just survive?
Joining me on the podcast today are Dr. Alexis Crow, who leads PwC's geopolitical investing practice based in New York, and Reid Morrison, PwC Global Energy Advisory and US Energy and Chemicals Advisory leader based in Houston. Alexis, Reid, welcome to the podcast.
Reid, I'd like to start with you, and I'd like to talk about what's going to happen in oil and gas over the next decade, and we're starting to get some pretty good indications of where we're moving based on the demand changes. Maybe just take us through the story from now up until 2030 in terms of what you're seeing.
Reid: It's interesting when you see how important energy is to the world and then how quickly the narrative can shift from peak demand to peak supply, and all these kinds of things. So when you kind of just take a step back and you think of the next three years, we're going to have a heavy recession that sticks across the world, and you're going to have the next three years being a recovery, and then you're going to get back to that growth cycle. So what that means for oil and gas is, the next three years, there's a lot of oil in storage, and the demand isn't a hundred million barrels. It's probably going to be more in that 90 million barrels.
The good thing for the industry is there's not a lot of exploration and development going on, so all of that oil that's in inventory is going to get used over the next three years, and rational market behavior, and especially in recessionary time, companies and economies will seek the lowest cost of energy in all their materials. So the hydrocarbon, natural gas, those are very much part of the base load, then you get to the next three years and you'll just start to see the story shift to demands getting into that 95 to 100 million barrels, and how much do we have in inventory? The realization will be, we haven't been developing the next set of reserves.
You're going to start to see some price escalation around that, and you get to the next three to four years, you're going to see that demand probably going well above 100 million, because the other part of the story is the energy transition and the move to clean energy sources requires a huge amount of capital, and the reality is, over the next three to six years, that capital is going to be used to stimulate economies, and it's not until the fiscal reserves are rebuilt can you have that investment for the full energy transition, which means the hydrocarbon and natural gas will have to fill not only the current demand, but then that increased demand when you get into the growth side of the economies that will probably start in that six years from now, and that's where you see that next boom cycle for oil and gas.
Adam: So Alexis, you deal a lot with global investors around the world. How are they looking at this next decade? And given what Reid just said, how is this narrative starting to play out in that investor mind?
Alexis: Thanks so much, and it's a privilege to be with you all today. Firstly, I think it’s important to take a step back in terms of the wider macroeconomic environment and the role that oil and gas play. I would say that leading into Q4 2019, we saw an industry that was marked by extensive secular decline. What I am seeing is some investors, particularly those that are in hydrocarbon exporting countries, to consider their platforms and moving from petroleum and branding from petroleum to energy, and to think that there is some arbitrage movement for low cost oil and gas, given the increasing preference for nat gas is a cleaner, cheaper fuel, alternative for coal, as well as the use of oil for transport.
So I would say that at the moment, coming out of the unprecedented demand shock that we've witnessed from the coronavirus pandemic, that demand shock both to manufacturing activity as well as to services related activity, you will see a significant arbitrage moment, not just on the balance sheet side of things, but in terms of the demand destruction will create significant opportunities in how investors are going to balance that in terms of communicating either to, if it's a pension fund, to their pension holders or to their shareholders in terms of public companies, I think, is going to be a very delicate balance.
So one of the things that we talk a lot about is, so what do we do about this? As a company, as an organization, how do we adjust the way we operate to meet the challenges that are on the horizon and well ahead of us? And Reid, one of the things that we've been talking about for a while is this low cycle operating model. So maybe take us through the concept, and what does it really mean for a business? And then maybe tie it back to that concept of, what does it do for the investors that are looking at your business, and how are they going to look at you differently because you've taken on this low cycle model?
Reid: Certainly. And we talked about the next 10 years from a cycle standpoint. We're going to have all three: Low, mid, and then a high cycle, and what's different is in the past, the industry had easy access to capital, so you were able to essentially have the privilege of other people's money. Well, now you're not going to have that, and you've got to deliver a dividend. So you're going to have less room to mess up and use other people's money and be accountable for that, because you're going to have to self-fund and-or prove that you're a good steward of capital in all cycles. So when you internalize that, the implications are, there's a set of activities that are necessary at a low cycle.
Most organizations have designed their business based on the activity set that is represented in the mid cycle, and one of the things that I always hear from clients when we're talking about this is, when I drive them towards the low cycle activity set, the capabilities you need, the cost structure you need, it looks like a smaller company. And now to attract the capital, it's going to come from an investor who doesn't really have a position on oil and gas, because they're industry agnostic. They're a value investor. They're looking at a return and a steady dividend.
So when you use that as the calculus, then the picture becomes really clear. You look at the low cycle, the activities that are there, you understand the mid cycle activities, and what are the capabilities that are necessary, and then what are those things that you don't need in the low cycle but you can access through different market options? You can rent it, you can partner, or you can hire into the recovery, but you don't need to carry it all along the cycle. And when you get into it, you look at things like workforce strategy. What's their relationship with their suppliers? Is it three bid and a buy, or is it, "We're going to outsource some of the core operations with the service level agreement?"
Those are the kinds of things that other industries who have gone through these kind of cycles have done, and our industry just has never had to do that, but now I think the conditions are setting up to where not only is the low cycle going to stick, there's other parts of the value chain where there are companies who do really well and there's a cost burden if you intend to do it all yourself with a lot of those capabilities being average, and having that fixed cost move to variable cost and improving the capability is going to be part of that design. It just requires some hard decisions, some true leadership, but also some humility to realize you're going to have to be a good steward of capital, of the assets, and on the ESG side, you're going to have to raise your game. So that low cycle recipe is there. I see some companies moving towards it, and those are the ones that I think are going to set the precedent for, "How do you survive all cycles?"
Adam: Reid, we're going to put a link on our website to the article you wrote around this notion of the value investor, and then you wrote it in November of 2019, which is well in advance of the impacts we've had as a result of COVID, so I think it's not only interesting, but it's timely, because it told a story of where we were going.
Alexis, I just sort of want your take on this notion of the value investor. This might be an investor that's never invested in oil and gas before, but they're looking for the returns. Talk about how that type of investor is coming into an industry like oil and gas and just put a finer point on what they're looking for and how they look at it from the outside.
Alexis: Sure. So I would say that I'm looking back to 2011, when we really started to see the US shale boom take off, and what we saw were the flood gates open for an unprecedented amount of virgin energy investments from Wall Street. And I happened to be working in between Calgary, Houston, and New York at the time, and I remember going through the airport security in Midland, and ended up being sort of swamped by various swanky investment bankers that had clearly been making their maiden voyage to Midland.
Alexis: What was interesting when I spoke with a lot of these investors, and those even representing pools of institutional capital, was that for the first time, they were able to invest into real assets with a nice yield, potentially very nice structure, building up enterprise value, that did not have geopolitical risk. So I think you're going to see distress and consolidation likely to come out of this low price environment, negative territory, and demand destruction. What we're advising clients to do is to be able to adopt an offset mentality, to consider that the cost of capital is just going to get more expensive, and Reid spoke to that, and I think that it's kind of looking at, "Okay, if I'm going to be investing in an up, mid, downstream, not gas or oil investment, and I'm also going to be thinking about carbon capture or offsets, or increasingly moving into renewables in the way that we've seen Total do, and also BP.
Adam: Alexis, you touched on it earlier in your comments there around the market difference between where the investors were heading a few years ago, with the bulk of them flying into Texas versus looking at Canada. Maybe just give us a quick comment on how that might be shifting, or where the Canadian oil and gas picture is showing up now with these investors. Because as I've looked at it over the past number of years, when the debt and equity markets dried up for Canadian oil and gas companies in '14, '15, we saw a number of Canadian companies make some very difficult decisions, and I think over time emerge as quite strong players. And Reid, to your point, these were organizations that were capable of paying a dividend. They were growing within their own means, their own cashflow, and they were being good stewards of the capital that they were able to access.
Maybe, Alexis, just a quick comment on that delta of Canada, the US, and the message for our Canadian clients in terms of how they show up in the world.
Alexis: Yeah. I mean, the key here is that the juniors and many of the extraordinary engineers working in the juniors who cut their teeth with the majors on the global stage are Canadian, they're not American, which is really beneficial for when you're operating in some territories. Just from that standpoint, from a perception standpoint, I think it looks much better when you have some companies operating in places like FSU, where the perception of being American is not great.
As you say, you have extraordinary balance sheet health. That's something I've seen that's consistent across sectors. I speak about this with some Canadian CEOs. It probably hinders Canada's growth in the tech sector, simply because you don't have that venture capital aspect. In the energy space, you don't want the venture capital, you want PPP, proven possible reserves, and you want stewardship, as you say, and keeping cash on hand for these inevitable downturns in low cycle territory. So if I was sitting in Calgary right now, I would advise be very aggressive. Don't be shy, don't be coy on this balance sheet health and the culture that it represents. And I think conveying that to investors firsthand is, I think, going to be incredibly important.
Adam: So Reid, before we pivot entirely into the investor conversation and where the industry is going, maybe just step us back into this low cycle model and the concept of the workforce of the future. And for a long time, that phrase has been a conversation, but I think over the past three months, it's become less of a conversation and more of a call to action. And so maybe just describe, as you're thinking about that low cycle model and the architecture of the organization, what does the workforce of the future mean, and what does that mean specifically for oil and gas?
Reid: It's a really fun conversation, but it has some dimensions to it that aren't politically acceptable, because you have to take a view of, what are those activities that are going to be necessary in the low cycle? What's the capabilities, and then what are those capabilities that are necessary to win? And when you do that ranking of the capabilities, you'll start to see there's usually five to six that really differentiate the company. There's about eight to 10 that are necessary to be competitive in that industry, and then there's a lot of foundational ones. A lot of companies had good intentions over the years of being best employer, best talent. Well, if you do that across all the areas, that's really expensive, but that's representative of a mid-cycle mentality.
When you narrow in on those top five or six capabilities, and then you look at the employee segmentation, you'll start to see, what's the muscle you have to have in all cycles? And that's where you do want to have your best talent. That's where you want to pay above market. That's where you want to decide, "Are we going to buy experience or are we going to develop it?" But you get into those next two traunches of capabilities, there's a lot of workforce options these days. You can do things like use the gig economy, so you don't carry that cost. You can access that talent pool and that expertise as needed. You can do things like low cost country. That is a prerequisite of you first have to have standardized processes, automate as much as you can, but then once you have that repeatable delivery model for back office functions, then you could take advantage of a labor arbitrage.
And when you do this right, you'll see that fixed cost of labor, both full time and contingent, is usually around 35% to 40% of a company's costs. About 20% of that cost will disappear, and at PwC, We did that to ourselves. We call it our 60-30-10 model. 60% of our workforce is traditional investment, but 30% is low cost country. Still highly talented, but the cost is just different, and 10% comes through contract labor that's used when we have the work, but it isn't a cost that we carry. And when you think of how you can take 20% of a fixed cost and have it disappear but not lose the capability, you're now on the right path, because that is what is a low cycle workforce strategy.
Adam: It delivers the requisite results as well, Reid. It brings those value investors back in because you're creating the opportunity for them to invest in a company that can return something to them.
Reid: Yep, exactly.
Adam: Okay. So let's move directly into the investor conversation and the questions that we get asked a lot about, "Where are the global investors today? How do I compete on that stage?" So maybe Alexis, let's just start with, where are the big pools of capital today that may be interested or are starting to look at oil and gas? And specifically taking that Canadian lens. Where are they, how are they looking at the industry, and what do you think has changed potentially over the past number of months or years for these larger pools of capital?
Alexis: So I would say that just witnessing this transition of the world from oil and gas to energy and that branding shift is critical when some investors look at traditional energy companies. You're going to have some investors that may not be entirely environmentally activists, but have some concern. Canadian companies will need to be demonstrating the extent to which they're investing in greater efficiency, carbon capture, clean tech, and the like. Some of the largest investors that I deal with are still on the fence in terms of oil and gas investing, and they do recognize that here we are in 2020, and we're likely to see extensive use of oil and gas for transport and manufacturing activity through probably 2035.
Where Canada can excel is to be able to amplify those balance sheet characteristics that we talked about, the concept of being a stewardship, keeping cashflow on hand, constantly being able to reinvest in new skills, technology, and people, as is the optics of being Canadian and not US, I think is also a discount at the moment, but also highly important. It's just going to be interesting also to see some of the high net worth individual and family office pools of capital that may prefer to start investing in real assets beyond property. You've seen a huge propensity for Chinese capital to come into the major gateway cities of Canada, driving up real estate prices. You could possibly see that capital in the extractive industries.
I know that there is some sensitivity around that, but I think when it's in a family office structure, a high net worth individual fund structures, and an attractive opportunity, you might begin to look at some of the family office pools in Brazil and in India. For those that are interested in building up enterprise values, having a steady IRR, some of these pools of capital would be virgin pools, much in the same way that the USPE capital went to the Balkian and the Permian in 2011, you might begin to see some family offices start to get a little bit more adventurous, particularly as it relates to countries like India, where you have a hunger and a demand for resources of all kinds to fuel manufacturing activity, as well as Brazil, where there is fluency with energy is driving wealth, but deterred, I would say by the high cost of capital from some of the pre-sell, as well as just the Petrobras implications, I think are leading some to think further afield.
Adam: That's really interesting as we start to think about these potential new pools of capital, and I've got to think that part of that is being able to tell our story in a very compelling way. And one of the elements that I think we need to work on is that ESG story, and obviously this was a big part of the narrative heading into 2020. It's taken a little bit of a step back because of COVID and what it's done with the global market, but Reid, maybe just for the benefit of our Canadian listeners, talk to us about how the bigger US companies and some of the super majors are looking at ESG, and how this becomes an advantage for the industry in terms of leveraging regulatory systems that are in place to better report and tell the story of oil and gas.
Reid: It's been interesting. As Alexis was saying, it's an issue that really got traction in Europe, but now I can think of no oil and gas company that does not have a serious commitment to making the world a better place. What they're looking for is a little bit of a balanced conversation, and they have an uphill road on that one, because the narrative and the playing field got set before they came to the game. So what's that mean? First they have to get their head around, what is the problems that they can solve? The emission side of it is something that is the most obvious part of our industry that needs to be solved for, but the reality is, you can have a car, you can have a oil well, you can have a chemical plant that has zero emissions, but it just takes money, and that's where you have to work with the regulators and decide, is this going to be a tax incentive? Who's going to pay for it? But if you have the message that you're committed to the zero emissions, you at least are getting to be part of the conversation.
And then when you get further into it, you'll start to see that there are pools of capital that don't necessarily need you to go abandon the carbon industry. They need to see a serious commitment to it and have the right reporting measures, and that's one of the things, I look at the industry, there's no global reporting standard right now on ESG. There's a lot of them, but what you're seeing is certain industries are using their own associations to define what is the standard for them. And once all of those participants agreed to it, the investors now have confidence that this is a standard for this industry and it's built for purpose, and they are able to use that and to be able to measure against the different performance levels that they're looking for.
And then lastly, as it relates to the ESG theme, you're starting to see also a appreciation of what it means to their own workforce, and this is where it can get actually really fun, and I love having this conversation with my colleagues who are walking in, assuming that the world's going to live perfectly without hydrocarbons. I just go, "What are you seeking?" They're like, "Well, actually we want all solar panel. We want a way to have the storage of that." And I was like, "You realize Mother Nature created that, and it's called the hydrocarbon?" And they think that I'm literally making it up. And I go, "Do you actually understand the physical properties of a hydrocarbon and the source material and where they came from?" Just doing a little science explanation for them helps them to understand that this thing called a hydrocarbon is the best design for storing power. We just have to solve the emission side of it.
And not only that, it's movable, it's transportable, it's fungible, and the industry has an important role to play, and it's a really hard, complex side. And the industry's over-delivered on the core of reliable energy for the world, but they've opted out of the other part of the conversation, and opting in and having a little bit of that salty conversation around, "The hydrocarbon is actually Mother Nature's storage device for power," gets you to kind of just understand where people are coming from and then own the emissions side of it. And that's one of the things I do see pretty much every company looking at and taking significant steps for. The one constraint is, "Who's going to pay for it?" And if the return is they can get access to capital, I think you're going to see more momentum moving that way.
Adam: So Alexis, last word to you here on the ESG conversation and just what you're hearing around the world, and I guess more importantly, what's changed, if anything, over the past few months?
Alexis: As Reid was mentioning, you have the energy transition, what I would say would be the ESG risk, which is mounting increasingly across the board. Sometimes the way that I look at it is an almost secular religion. I would say that the EU is the Mecca for this, and we've seen that play out with the Green New Deal. Ironically, on the fund side, it's being led very clearly by the Norwegians, which, and I would say slightly ironic given the source of their wealth, and in the financial world being led by Mark Carney, with his task force on climate disclosure, obviously no stranger to the Canadian community. The confluence of that with astringent reporting mechanisms is changing the way that investors are looking at this. I actually went to the Middle East in the fall with two different messages, one on China, which would be a totally different podcast, and the other on the extraordinary escalation of the ESG, particularly the climate aspect of it, that phenomenon, and how my clients in the Middle East were navigating this.
I would also say just connecting that to our future of work discussion, that is certainly resulting in a very different type of talent recruiting, where I'm seeing obviously a lot of the investment banks, the non-bank financial institutions, start to really beef out their ESG and climate and sustainability teams, and it's interesting to see the cross-fertilization and the specialization of knowledge that's required. So I think that's also interesting from a talent standpoint and a human capital standpoint, as the Canadian companies navigate this new field. As Reid was saying, we just need to get the emissions part right. Many people talk about energy efficiency being the fifth fuel, and I do believe that there is a great amount of innovation to be done in things that aren't strictly renewable, but that are more efficient, and we've seen that historically over time, and I think those will be critical investments, not only to be made, but also to be broadcast.
Adam: Well, Alexis, Reid, I mean, there's no shortage of challenges for our industry. What's changed for me as we've recorded this podcast, even versus where we were a few weeks ago, is we're very much starting to talk about the future and the opportunities that exist for oil and gas in general, and oil and gas in Canada specifically. So really to thank you for your time today, I think the insight has been incredible. I know you're both very busy, so on behalf of myself and the rest of the Energy Visions team here in Canada, thanks for joining our podcast today.
Alexis: Thank you.
Reid: Absolutely appreciate it.
Adam: For all of our listeners, thank you for tuning into this Energy Vision Spotlight Podcast. Once again, I'd like to remind you all about our upcoming three-part Energy Visions Report Series that we will be releasing over the coming weeks, where we'll delve further into how the global energy transition will continue given the new environment, the opportunity for Canadian oil and gas, and what skills workers will need to support this transition.
Finally, I need to mention that this podcast has been produced by PricewaterhouseCoopers, LLP, and is for informational purposes only. Contents discussed are for general guidance on matters of interest and should not be taken as professional, legal, business or investment advice. For more details, please visit our website at pwc.com/ca/energyvisions. Thank you for listening.
Dr. Alexis Crow, Lead, Geopolitical Investing Practice, PwC US
Reid Morrison, PwC Global Energy Advisory & US Energy & Chemicals Advisory Leader