COVID-19 and the oil price collapse: Considerations for corporate boards of energy companies
COVID-19 has brought about a wide range of issues that companies are dealing with, but combined with the oil price collapse, there are some specific issues critical to companies in the energy sector. In these challenging times, energy company board members should be proactive and agile, and they should respond with strong leadership.
Cash flow protection and cost reduction
Energy companies are faced with many operational and strategic challenges, not the least of which is surviving the current downturn in oil and gas prices. No one can predict the duration or severity of this downturn. Nevertheless, it is the right time for companies to position themselves for success when prices recover.
Directors should understand what management is doing to protect cash flows and lower costs. Directors should probe whether any actions taken are sufficient and at the same time sensible. There should be no sacred cows. Companies should consider options, including:
- Reduce or eliminate dividends
- Seek deferrals of income taxes, royalties and severance taxes
- Undertake a comprehensive review of workforce considerations from redundancies to furloughing
- Review asset portfolios against a lower breakeven commodity price and making decisions accordingly
- Consider divestments of assets that were previously off limits
Board of director questions
- What types of operational/financial levers has management considered pulling to help protect cash flow? How has management considered the pros/cons of each lever?
- In terms of cost reduction, which internal/external costs have been considered by management? Which elements of the company’s cost structure do not present an opportunity for reduction? Why not? What elements of the supply chain have been considered?
- What has management done to evaluate the resilience of the company’s asset portfolio? Have they performed stress testing? If yes, what are the results of the stress testing? What types of stress testing has been completed?
- What are the results of scenario planning laying out different recovery trends? Depending on the scenario, what may be the right levers to pull to help protect cash flow — now, in three months, six months, etc.?
- What opportunistic/protective strategies has management considered implementing within the company’s cash, credit and operational constraints?
Risk management “risks”
The extreme volatility we have experienced in the energy markets over the last few months has created a need for greater transparency and oversight of corporate risk management programs. Large-scale moves in market prices can rapidly generate significant gains and losses. Historically, times like these have exposed weaknesses in governance and oversight in risk management programs. Furthermore, there is the potential for cascading failures if key players in the value chain are exposed to counterparties that cannot fulfill their contractual obligations.
To avoid failures of otherwise stable risk management programs, directors should understand how current operations have changed, have good transparency into risk exposure, programs and contingencies and have a strong governance structure to stay informed as the situation changes. To prevent failures in risk programs, directors should probe the details by asking the right questions to understand nuances in assumptions, contracts and markets.
Board of director questions
- Given extreme market swings, how has management evaluated the company’s current hedging strategies against changing market and liquidity risks? What other risks now exist that may impact liquidity, and how effective are the company’s tools for evaluating such risks? How has management considered the impact on liquidity?
- How has management assessed the company’s financial risk in the current market environment (market price risk, liquidity risk, credit risk, potential defaults by our customers and suppliers, etc.)?
- How resilient is the company’s risk management capability in handling the next potential shocks? What planning scenarios has management considered, and what are the range of possible outcomes?
- How has management considered the appropriateness of the company’s objectives for its hedging program? What changes to such objectives/priorities have been considered (cash flow, debt service, earnings, capex, etc.)?
- How is our risk portfolio collateralized? What risks may come from credit and balance sheet changes?
- Where do we have an advantage, and how can we use it to capture potential opportunities?
