The structural decline in oil price — with current prices at less than half of their 2014 peak — has triggered immense pressure for national oil companies (NOCs) to transform. Having developed along with the rest of the industry in an environment where maximization of production and hydrocarbon reserves were the key objectives, they have had to shift rapidly to targeting returns to their state shareholder. Simply put, the focus has shifted from volume to value.
In many countries oil and gas accounts for the bulk of government revenue. For example, in the Middle East, oil is the primary source of government revenue for the majority of countries. In 2014, the share of oil revenue in total revenue ranged from 47% in Yemen to 94% in Iraq and averaged 77% across the region. Here, the oil price is not just an issue for the NOC but for the entire country, and therefore restructuring efforts are having to take place within the context of crucial external stakeholder requirements.
This has required the NOCs to enter an ongoing dialogue with their state shareholder on how they should balance their financial and nonfinancial contributions to their host countries. The result has been the announcement of many restructuring measures. These have included changes in asset portfolio, in the capital structure (including the attraction of external capital) and investment priorities. Operational performance improvement programs supported by the implementation of new digital technology are also underway.
In areas where oil and gas accounts for a lower share of government revenues, such as Asia-Pacific, the response has had more in common with that of the international oil companies (IOCs). Here, the majority of NOCs in the region have announced a major scale-back in capex due to steep declines in operating cash flows. Also, in this region, governments have directly (or indirectly via their NOCs) taken the opportunity presented by lower oil prices to reduce or remove fuel subsidies and remove the financial burden on themselves or the NOC.
The future success of NOCs like that of IOCs now depends on their ability to restructure themselves to deliver competitive returns in a structurally lower oil price environment. This involves the transition from production focused to commercial NOCs. This journey will require elements of the following:
– Balancing national objectives with commercial objectives and establishing a well-structured contract with the state
– Enhancing vertical integration and pursuing multiple revenue streams from a diversified portfolio
– Diversifying funding between external commercial finance, equity investors and free cash flow
– Adopting leading technology and digital solutions
– Attracting and retaining the right people with the right capabilities for the future
– Potentially creating an international presence with investment in major high-growth potential markets
Industry transformations are never simple — especially when it comes to an industry so heavily relied upon by government. The coming years will be defining for NOCs as they carve out a new model that maximizes both their potential enterprise value and, as a result, the contribution to their country.
Andy Brogan is the EY Global Oil & Gas Transactions Leader. He is based in London.
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