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Oil price risk re-awakens

2015

Roland Berger's study discusses how OPEC's decision to abandon its role as market manager amidst the current low price environment and oversupply context creates a new and increased level of risk for upstream operators – especially marginal North American tight oil plays and select offshore projects. In addition to traditional price risk, operators now need to consider how they manage the inherent volume risk created given OPEC's ability to push additional lost cost barrels into the market. In the article we also outline a set of key questions that marginal operators should consider as they look to navigate these tumultuous waters.

OPEC recent decision to maintain production levels indicates they are no longer interested in managing the global crude market

  • For several years, OPEC has been managing the global crude market to maintain oil prices within a well-defined band – notionally USD ~85-100 bbl. Brent
  • Upstream operators have relied on the stability of this pricing model as they ventured into projects with higher capital requirements and operational costs (e.g., deepwater and tight oil)
  • OPEC's decision to maintain production levels given the low price environment and oversupply context indicates a move away from being the market "manager"

OPEC's decision has left the market oversupplied and driven down price – creating a heightened level of price and volume risk for marginal operators

  • OPEC's move creates an abnormally risky market for operators with projects "on the margin" – far right on the supply total cost curve
  • Marginal projects will be exposed to price volatility due to being on the steep exponential portion of the cost curve as small shifts in supply and demand create large movements in price
  • In addition to traditional price risk, operators also face volume risk as OPEC has the ability to push incremental low cost barrels into the market and push marginal projects out of the market
  • Combination of price and volume risk is already putting tremendous pressure on financially weak operators and those with suboptimal land positions

Risk fundamentally affects asset value – are operators asking the right questions with regards to this fundamental shift in the global crude market?

  • Valuations on marginal assets have significantly eroded over the last six months – forcing financially weak operators into distress
  • Operators need to make sure they fully understand the fundamentals and implications of the market risk
  • We have developed a set of key questions for operators to consider as they chart their path forward

Key questions

  1. How should projects be evaluated in an environment where commodity prices can move +/- 50% in a matter of months? What are the key decision criteria?
  2. Given the new risk context, how should marginal projects be evaluated in the context of an overall portfolio?
  3. How can technology and operating practices make an operator more apt at delivering real value from marginal projects?
  4. What are the operating and capex decisions that can lower overall corporate risk and the resultant cost of capital?

Roland Berger is currently engaged with oil & gas clients on these and other critical issues facing the industry.

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