You are here

Building a fit-for-the-future upstream portfolio

14th September 2018

Andrew Slaughter, executive director for Deloitte’s Centre for Energy Solutions and Anshu Mittal, executive manager with the Industries & Insights team, at Deloitte Services

Andrew Slaughter, executive director for Deloitte’s Centre for Energy Solutions and Anshu Mittal, executive manager with the Industries & Insights team, at Deloitte Services explain how upstream oil and gas companies can build a portfolio fit for the future

The sharp rise in crude oil prices has caught many by surprise—oil has gained 38 per cent since January 2017 to $75/ bbl, far above the consensus ‘lower-for-longer’ range of $50–$60 per barrel. But this surge hasn’t translated into higher shareholder returns for most oil and gas companies—in fact, the S&P E&P index gave a -4.5 per cent return during the same period. Even companies in some of the often-considered promising plays, for instance, the Permian in the United States, reported an average shareholder return of -4 per cent.

Why does the market seem to be undervaluing all the progress claimed by most upstream companies in lowering costs and improving productivity? Why are even those companies that took actions to protect and transform their portfolios not yet seeing any rewards? Or, does the disconnect lie in how some companies are positioning their portfolio, readying it for an uncertain future and explaining portfolio choices to the market in a consistent, transparent way?

One problem could lie in the diverse and piecemeal narratives many companies use to report their performance—which can be confusing to investors and hampering the portfolio optimisation efforts of some companies. The most typically talked about ‘breakeven point’ metric has become highly incongruent not only among companies but also within a ompany— for example, there is a performance gap of $19–$33/bbl between premium assets and the overall portfolio of top upstream companies.

There may be a need to simplify this complex portfolio landscape and achive more consistency among diverse market narratives. And this is where Deloitte’s two-pronged approach that statistically normalises changes across all portfolios (Deloitte’s Upstream Diversification Index or UDI) and benchmarks their future readiness across a range of oil price scenarios (the Shield, Sustain, and Scale model, or 3S model) could help bridge the gap.

A combination of the UDI and the 3S model, when run on 32,000 worldwide assets of 230 leading oil and gas companies, provide some answers as to why the market hasn’t rewarded the industry yet. Consider this: 62 per cent of the companies would likely struggle to scale up their cashflows most efficiently and quickly in an improved oil price scenario of $65/bbl over the next five years (2018–2022).

Our consensus metrics suggest that much could still be done by upstream companies to optimise their portfolios and give investors more confidence that the industry can thrive
across a range of business conditions. However, a few companies have built a future-proof portfolio, which appears to be helping them stand out from the crowd and in the eyes of investors. What makes their portfolio futureready?

What are their collective characteristics and traits? An analysis of the top 30 portfolios using the UDI and 3S models reveals the following five traits:  

Following a consistent strategy, actively: Companies with future-proof portfolios generally follow a consistent strategy, either that of concentrating or diversifying their portfolio, with a healthy pace of change and churn in their assets. BP, for instance, has actively followed a ‘value over volume’ approach in its portfolio since the Macondo incident without digressing  from its diversified portfolio strategy.

Prioritising operational excellence over location: The future-ready portfolios tend to prioritise the ‘how’ of the drilling over the ‘where’ part of the resource. Most of these companies defy the notion that strong portfolios can be built only in the newest (or hottest) regions/basins/plays, such as the Permian in the United States.

Managing resources by focusing on investment cycles: Top portfolios often optimise their resource portfolio using the lens of investment and cash cycles. Most of the top performers have built significant investment flexibility in their portfolio, either by focusing on short-cycle projects or reducing the time-to-market for mid- and long-cycled projects.

Learning the role of natural gas both in near and long term: Most of the top portfolios have maintained a balanced oil-gas mix— neither did they aggressively buy into the premium oil story nor did they take aggressive growth positions in future fuels such as natural gas and LNG. Most companies owning these portfolios have followed the changing demand patterns in both the fuels, where oil’s weaker long-term demand potential and gas’s overpromised near-term outlook (because of infrastructure constraints) have translated into a fairly stable mix for them.

Balancing risk and returns without going overboard, either way: Companies with solid portfolios tend to maintain the right balance of growth and returns, challenging the notion that the strongest balance sheets necessarily translate into the best portfolios. A moderate yet disciplined risk-return investment strategy seems to be playing a big role in helping them manage both their shareholder returns and portfolio optimisation efforts.

Is your company displaying all or many of the above traits of a future-ready portfolio? Although portfolio streamlining for each company would be guided by its own strategic, financial, and operational priorities, performers in general tend to transform the entire portfolio and do not let it become a “prove it to me” story with a long wait for validation.

The nascent recovery from a long period of market downturn presents both an opportunity and a risk to upstream companies in making their portfolio fit-for-the-future, an opportunity to high-grade their portfolio (e.g., strategic asset divestitures and capex reprioritisation) and a risk of delaying the adjustment or randomly shuffling their portfolio in this transitory  hase of adjustment.

A company that learns and transforms across the price cycles and communicates its strategy to the stakeholders using the consistent metrics of future-proofing could take a lead in solving the portfolio predicament of the industry.

The above abstract is from Deloitte’s recent white paper, The portfolio predicament: How can upstream oil and gas companies build a fit-for-the-future portfolio?, published in April
2018. In this white paper, Deloitte explores the future-readiness of oil and gas portfolios through the lens of Deloitte’s proprietary Upstream Diversification Index framework, with the goal of identifying specific traits exhibited by companies with the highest-ranking portfolios.

Related topics: