Oil & Gas Industry
Oil & Gas industry consists of the companies that produce and supply energy. Energy can be produced using non-renewable sources (e.g., oil, gas, nuclear) and renewable ones (e.g., solar, wind, hydropower). The activity in Oil & Gas industry can be split into the following broad groups.
- Upstream – oil & gas drilling and production (pumping the fuel out of the ground). Reserves, or how much of oil and gas is still in the ground to pull out, indicate the level of possible future production. Companies should constantly look for new oil and gas to replace what they are producing. The commodity prices are very important factor for the upstream companies as they should cover production costs and possible profits.
- Midstream – oil & gas are delivered from the production site to the refineries. There it is refined into the final product. Companies in this segment usually have long term, fee based contracts for the use of their pipelines and the processing facilities.
- Downstream – oil and gas are processed into the commodity (e.g., gasoline) and the specialty products. The profitability of the downstream companies depends on the income from sales of their produced products and the costs of inputs (e.i.,oil and gas) they use to produce those products.
Many energy companies are involved in all three types of activity and are called integrated energy companies. Key integrated energy companies in Europe include Royal Dutch Shell (RDS.B), BP Group PLC (BP) and Repsol S.A. (REP).
Headwinds of the Industry
Oil & Gas industry undergoes the major transition and is currently out of favor of investors. It heavily underperformed general market last year. In 2019 pan-European Stoxx600 index returned over 23%, while its version for Oil & Gas industry, Stoxx600 Oil & Gas (SXEP) was up only around 6%. Investors do not love this industry for two major reasons.
Sensitivity to commodity prices
As mentioned above, energy companies in the upstream business are known for their dependence on the oil and gas prices. In 2016, when Brent crude oil price went down to $28.8, many oil companies had to freeze or even cut their dividends. Since then Brent oil price was back around $60 per barrel ($58 on January 30, 2020) and was down again. Oil prices are difficult to predict as there are too many factors affecting them – current market oversupply; geopolitical tensions in the Middle East; the progress in US-China trade war and its effect on the demand for crude products; Covid19; OPEC decisions in the production cut and many others. How each of them would unfold in the near future? How much of those effects are already factored in current oil price?
The industry is struggling in recent years and low oil prices are one of the main reasons for it. Commodity prices are the source of major uncertainty companies should deal with.
The climate change poses high risk to Oil & Gas industry. In recent years the industry has been under the pressure to reduce carbon emissions in order to tackle the global warming. Oil companies are criticised as the major contributors to carbon emissions. As a result companies move away from a coal to a gas as natural gas is cleaner than a coal. Energy companies become more focused both on the natural gas and on the Liquefied Natural Gas (LNG). LNG can be transported to the places pipelines cannot reach.
Despite that companies are under constant pressure to move to the alternative energies. Even though the demand for sources of the renewable energy is increasing, the transition to the greener energy will take time and be costly. At present the renewables are far away in meeting the demand in the energy. In the meantime the world needs energy from oil and gas for the foreseable future as the world‘s population and its middle class are growing. So, the energy companies have to invest in the oil&gas exploration and production. Also the profit margins in fossil fuel business are much higher than in the alternative energies. In fact, the energy companies have to balance between the need for greener energy, on the one hand, and stable, strong profits on the other.
Sectors of the Industry
According to the Industry Classification Benchmark (ICB), Oil & Gas industry is divided into the following sectors.
|Oil & Gas||Oil & Gas Producers
|Exploration & Production
Integrated Oil & Gas
|Oil Equipment, Services & Distribution||Oil Equipment & Services
|Alternative Energy||Renewable Energy Equipment