< PreviousNEWS ANALYSIS 10 oilandgasmiddleeast.com JUNE 2020 HOW DIGITAL TECHNOLOGY CAN SUPPORT OIL & GAS NAVIGATE COVID-19 By: Bjorn Ewers, Managing Director & Partner at Boston Consulting Group (BCG) & Jean- Christophe Bernardini, Partner and Associate Director at Boston Consulting Group (BCG) COVID-19 has shaken the global community to its core, with ramifi cations for all sectors around the world as a direct result. The oil and gas industry is no exemption, and the outbreak has created a demand shock in the market as social distancing reduces movement and daily travel for more and more of us each day. With the current oil price in the low $20 per barrel range, with a further risk of falling below this range, expectations within the industry are that oil demand growth will be mostly fl at, well below the 1.2 million barrels per day (MMB/D) growth demand projected just a few months ago, and this will likely be revised down further as large gatherings are canceled, schools keep their doors closed, and companies continue to implement policies to mandate remote working. The oil and gas industry has been grappling with a range of complex issues, even before the event of recent weeks – energy transition, increasingly volatile oil prices, government regulations, disruptive technologies, intensifi ed global competition. These factors increase the risks of even the most effi cient and sustainable companies. Without a better picture soon, and COVID-19 and the challenges on oil prices adding to the list of problematic factors, fi rms in the Middle East should embrace new digital business models and adapt them more prominently across their scope of operations. Inevitably, they will come under considerable pressure in months ahead: • No restrictions on oil production will see new oil price lows, excess stock, and a daunting supply overhang • A long-lasting sub-USD 40 price environment will cause acute fi nancial and operational stress, and last year’s results suggest an average dividend breakeven for companies analyzed at -USD 61 per barrel These ramifi cations will continue to impact the oil and gas sector, and it is increasingly unlikely that the current global diffi culties will subside any time soon. The longer the situation continues, the more frequent the eff ects will be felt. To navigate this crisis, ensure continuity, and ultimately achieve sustainability, companies in the Middle East can explore the adoption of new business models to reduce costs – and digital is a viable option. How digital can help reduce costs during the COVID-19 crisis and beyond As an example case to showcase the value proposition of digital during adversity towards the industry, fi rms in the Middle East can refl ect and apply on using a Bjorn Ewers, Managing Director & Partner at BCGNEWS ANALYSIS 11 oilandgasmiddleeast.com JUNE 2020 • 20% - 30% faster well delivery and more productive wells • 20% - 40% reduced maintenance cost by improving uptime using predictive maintenance and digital twins Deploying digital is prudent and sustainable For companies in the Middle East, focusing on digital can increase performance. We have seen that organizations have been able to reduce costs with better effi ciency in time spent to interpret data using advanced computing, machine learning, and artifi cial intelligence (AI) technologies. Similarly, the Internet of Things (IoT), big data analytics, and the increased use of drones have improved operational effi ciency and reduced cost, while digital twin, machine learning, and AI have assisted major companies in improving project economics. Admittedly, adopting digital technologies alone isn’t enough, and companies will need to analyze the role they will play in the digital ecosystem, identify the partners they will need to work with and acquire the capabilities that they need to succeed. Doing so will enable companies to capture the benefi ts of digitalization, mitigate threats, and take advantage of disruptions – all of which are essential to sustainability. From a regional perspective, the oil and gas sector could well be navigating through a period of uncertainty for quite some time. However, the current crisis could be a catalyst to accelerate transformation agendas while keeping an agile approach. Adjusting priorities and digital use cases portfolio by being responsive to short term strategic directions and engaging with the profound change of operations is key to prepare for the future to ensure OPEX/ CAPEX optimization, production effi ciency, and HSE performance. combination of technologies; in this example, leveraging the Digital Twin and maintenance optimization technologies. Digital Twin technology enables companies to optimize operating processes, improve capital investment in a virtual world before applying them in the real one, while maintenance optimization help companies address a number of issues in planning and executing routine maintenance programs by taking advantage of big data sets, natural language processing tools, and failure-pattern recognition. By combining the two digital tools, Digital Twin could support the preparation of the diff erent maintenance interventions for a campaign model, and when integrated with smart planning and schedule solutions, oil and gas fi rms can deliver impactful results in better OPEX through better risk management, preparation, and schedule optimization by at least 15% of gains in productivity. The value that such insights would bring to companies in the Middle East cannot be ignored, and these digital perspectives would undoubtedly place them in a favorable position moving forward. Indeed, oil and gas companies have always made use of technology. However, they have been slower than organizations in other industries to adopt the latest wave of digital transformation – missing an integrated digital strategy, important capabilities, and concrete action plans. By correcting this, companies can enable, adapt, and upskill personnel and the organization itself to embrace digital transformation. Moreover, they can unlock tremendous value from new data and analytics, transform technology capabilities to support new digital initiatives, and leverage the power of newly established ecosystems to harness the full potential of digital strategies. As a case in point to highlight the signifi cant value that can be unlocked through digital in upstream activities: • 50% - 60% of reduction in data interpretation time and cost • Up to 70% reduction in engineering hours plus higher-value fi eld concepts Christophe Bernardini, Partner and Associate Director at BCGNEWS ANALYSIS 12 oilandgasmiddleeast.com JUNE 2020 Below are six key areas that companies should consider as they navigate through the impact of negative and/or depressed oil and gas commodity pricing. 1. Revenue & Regulatory Revenue accounting and accruals: Negative prices would trigger considerations around how to account for revenues and revenue accruals. The price typically used for recording monthly revenue and accruals is based on: • A monthly average • The month-end spot price, or • An index price, depending on what the sales contract stipulates. One-day negative price would only have a 1/30th impact on the monthly price, which is not expected to be material. There could be a situation where even if the gross commodity price is not negative; the diff erentials could be equal to or higher than the low commodity price, resulting in a net zero, or negative price. Another consideration for revenue accruals would be the volumes. It is typical to use an average of the last three month’s volumes to arrive at the volumes to be accrued, but with an expected increase in shut-ins (discussed later in the article), that may no longer be a reliable measure. Companies will need to consider the shut-ins when arriving at quantities to be accrued. Royalty Payments A negative commodity price, either due to a negative gross price or a negative net price (with the diff erentials being higher than the gross price), does not necessarily mean the royalty owners would be burdened by the operator for the impact thereof. Royalty owners may be burdened, depending on what the lease stipulates. The working interest owners, however, may be burdened, depending on the provisions of the Joint Operating Agreement (JOA). Companies will have to evaluate their leases and JOAs to better understand their legal obligations related to this matter. Shut-ins will also cause companies to pay the minimum volume commitments (or MVCs) on their midstream contracts, which they could burden the working interest owners with, depending on the JOA. On the regulatory reporting front, companies will be required to continue to submit monthly/ annual production and/or other regulatory reporting (GLO, ONRR, state, federal), severance taxes, etc. even if there is no production, unless regulatory authorities On Monday, April 20, 2020, U.S. crude oil prices traded below zero for the fi rst time ever, meaning producers or traders were essentially paying buyers to take crude oil off their hands. WTI opened for trading on Monday, April 20, 2020, at $18/bbl. By the end of the trading day it had dropped to as low as minus $40/bbl. The price crash came as the U.S. benchmark oil contract, West Texas Intermediate (WTI), headed towards its expiry date for May physical delivery, the month when lack of demand from lockdowns and travel restrictions was expected to peak. Analysts believed that a lack of available physical storage capacity at the WTI contract’s Cushing, Oklahoma delivery point set off panic among traders holding derivative contracts. Oil futures require that holders of a derivative contract take delivery of a physical barrel when that contract expires. However, no one wanted to get crude oil delivered to them in May when physical storage capacity of the commodity was expected to be unavailable. Although production has been curtailed, we may see negative oil again. These price disruptions will impact not only traders, but E&P, midstream and fi rst purchaser companies as well. To that end, we anticipate this prolonged uncertainty will likely trigger several accounting, regulatory, fi nancial reporting and lease-related issues. By Raza Rizvi, Amy Stutzman and Ken Nollsch Experts from Opportune outlinees the six key considerations for upstream companies to survive and grow as the pandemic stretches on and commodity prices remain low NAVIGATING A LOW-OIL PRICE ENVIRONMENT Raza Rizvi, vice president of accounting, OpportuneNEWS ANALYSIS 13 oilandgasmiddleeast.com JUNE 2020 eff orts will allow operators to hold leases when production is halted due to it being considered an “economic waste”. The New Mexico State Land Commissioner and the Oklahoma Corporation Commission recently announced relaxed guidelines regarding shutting in wells, and other regulatory agencies such as the Texas Railroad Commission and the North Dakota Industrial Commission are expected to issue guidance soon. This will trigger considerations around a variety of land and legal matters, including, but not limited to, lease and contract review, owner and royalty communications and shut-in payment issuance. We may also see acreage write-off s with companies no longer fi nding it feasible to hold the leases and the underlying acreage as they expire, or decide it is no longer economical to drill on a certain acreage. Conversely, some companies may see this as a potential investment opportunity because they would be able to acquire some leases at a much lower price in this environment. Shutting in a well may require capital spend at the outset, as well as restart costs when production is restored. This results in fi xed operational expenditure (OPEX) burden, which may not have necessarily been planned. 3. Derivatives & Hedging Lower commodity prices will have a ripple eff ect in company fi nancial statements and risk management strategies. The current pricing will lead to large upward swings in valuation, leading to companies refl ecting corresponding signifi cant, unrealized gains in their fi nancial statements. Financial commodity derivatives are intended to be an eff ective hedge of forecasted physical production sales. However, the current market is facing locational supply and demand imbalances. This has led to signifi cant basis volatility causing once highly eff ective risk management strategies to be less eff ective. While fi nancial commodity derivatives are intended to protect producers’ cash fl ows, there may be other factors that lead producers to shut-in wells (i.e., storage constraints, signifi cant basis discounts, announce any relaxation. 2. Potential Shut-In If current price trends continue, we will see producers starting to shut in wells. Regulatory bodies are issuing orders that allow operators to halt production without breaking contracts. In part, these Amy Stutzman, managing director, OpportuneNEWS ANALYSIS 14 oilandgasmiddleeast.com JUNE 2020 create an issue where we are required to incur expense to plug a well when operationally it is not necessary. Companies will look for statutory relief from their respective state regulatory agencies. 5. Reserve-Based Lending (RBL) Most companies with RBLs in place are currently or soon will be working with fi nancial institutions as the RBL is being reset based, in part, on revised reserve studies. This is going to cause further disruption as many companies are either at or close to their current capacity for debt. 6. Impairment Considerations Accounting Standards Codifi cation Topic 350, Intangibles: Goodwill and Other (ASC 350), requires goodwill and other indefi nite-lived intangible assets to be tested for impairment at least annually or when a triggering event occurs. Accounting Standards Codifi cation Topic 360, Property, Plant and Equipment (ASC 360), requires long-lived assets to be tested for impairment when a triggering event occurs. The market forces that have impacted the worldwide economy during the fi rst quarter of 2020 will qualify as a triggering event for both goodwill and/or long-lived asset impairment testing for some companies. As such, the longer COVID-19 disrupts businesses, the more companies will experience triggering events. This will ultimately result in more impairment charges taken on the fi nancial statements of these companies. While most segments of the economy have been hit hard by the impact of COVID-19, the energy industry has been hit particularly hard in recent weeks, which would result in energy-specifi c triggering event considerations. Full-cost companies can expect ceiling test impairments starting in Q1 and potentially even through Q4 2020 due to lower pre-tax PV10. Successful eff orts companies will be impacted by the forward curve immediately. Large impairments are likely to occur in Q1 and Q2 2020. etc.). In the event of well shut-ins, companies should evaluate their hedge coverage to ensure that they do not become over hedged. Companies with three-way collars fi nd themselves lacking adequate cash fl ow protection as current commodity prices have fallen well below many companies’ sold put strike prices. Lenders oft en require companies to hedge a portion of forecasted production. In this environment, as companies look to mitigate future risk, they will need to ensure that restrictive lending covenants are not broken, or work with their lending institutions to ease these covenants. 4. Asset Retirement & Environmental Obligations As operators look to shut-in wells, they should research and review relevant state laws, rules and regulations regarding shut- in of wells. Each state is diff erent, so it is important to research the implications. In today’s environment, we do not want to SPOTLIGHT: • A virtual face-to-face video interview • The perfect platform for your senior region- al representative to address his professional peers in the region and articulate your organ- isations unique and distinct brand message at this vital time for the industry THE PANEL: • A virtual Roundtable • Elevate the size, scope and complexity of a key topic, or challenge the industry is facing and discuss the ‘best-of-class’ solutions that the industry should be making themselves aware of with a table of your professional peers WEBINAR: • Harnessing its industry leading reputation and market leading database, OGME will de- sign, manage and promote a compelling, in- sightful and truly engaging webinar • The perfect forum to deliver tangible, busi- ness critical information FOR MORE INFORMATION, CONTACT: Pankaj Sharma Senior Sales Manager M: +971 52 89 2913 E: pankaj.sharma@itp.com We are experiencing a signifi cant increase in traffi c and engage- ment across all our digital channels, so we are launching 3 new digital Special Features to help you connect with, engage with and inspire the largest audience of downstream professionals in the Middle East at this extremely important time. Digital Reach - 247,837 - Industry Professionals Every Month CONNECT | ENGAGE | INSPIRE 16 COVER STORY oilandgasmiddleeast.com JUNE 2020 COVER STORY oilandgasmiddleeast.com JUNE 202017 COVER STORY oilandgasmiddleeast.com JUNE 2020 CLOSING THE LOOP The oil and gas industry has long struggled with image problems— protestors are a regular sight at the offices of international oil companies—as the public becomes increasingly aware of environmental issues. “This new generation is not like previous generations,” says Esra Al Hosani, a technology specialist at ADNOC Offshore. “Greta [Thunberg] and her friends, they are really concerned about the environment and they will push very, very hard on oil and gas companies. [Oil and gas firms] need to be ready when this happens, because it will happen.” Al Hosani recently worked with the University of Cambridge on a thesis studying one potential application of the circular economy to reduce waste The oil and gas value chain has always been a straight line, but the future is circular and sustainable, says Esra Al Hosani, technology specialist at ADNOC Offshore in the oil and gas industry. In a circular economy, ‘waste’ products are used to create new, useful products, sometimes across industries. It allows resources to remain in use for the longest period of time, rather than our current linear economy, in which we produce, use, and the dispose of products. She believes it has strong potential for this sector. “I find this particularly interesting for the oil and gas industry because we have been blamed for so many things, and we try so hard to improve, but that is hard to do when you are dealing with oil and gas,” she says. “We need a different direction, we need different views.” She notes that smaller initiatives like recycling paper, for example, are well-intended but are not big enough to tackle the real sustainability issues facing the oil and gas sector. Companies should address sustainability by looking at the areas in which they are creating the largest negative impact. “So far the concept of the circular economy is mostly theoretical,” Al Hosani says. “There is not much practical research, so I decided to try a practical, real-life scenario in the oil and gas industry to study the typical value chain of the oil barrel and see if we can really maximize the value of oil.” The typical measures to ‘maximise value’ include cutting capital expenditure or reducing headcount, she says, but she believes there is a better solution which also addresses sustainability issues. In her study, Al Hosani contemplates a way to use waste gas and waste water regularly produced during oil production, using ADNOC Offshore as her case study. “One issue is our waste stream, specifically flared gas and produced water” Al Hosani says. “The oil and gas industry is particularly interesting with oilandgasmiddleeast.com JUNE 2020 THE OIL AND GAS INDUSTRY … NOT ONLY USES WATER, BUT PRODUCES IT IN MASS QUANTITIES, AND CALLS IT WASTE. WATER CAN NEVER BE ‘WASTE’. AND THEN THEY CALL IT WASTE GAS. ENERGY IS NEVER ‘WASTE’. THEY ARE ONLY WASTE IF YOU LIMIT THEIR POTENTIAL TO YOUR CURRENT VALUE CHAIN.18 COVER STORY oilandgasmiddleeast.com JUNE 2020 regards to energy and water, because it is possibly the only industry that not only uses water, but produces it in mass quantities, and calls it waste. Water can never be ‘waste’. And then they call it waste gas. Energy is never ‘waste’. They are only waste if you limit their potential to your current value chain.” For many countries, the value chain CIRCULAR ECONOMY IS AN EMERGING CONCEPT, BUT IT IS LAGGING IN MANY INDUSTRIES BECAUSE IT IS DARING. IT IS A BIG CONCEPT. THE BIGGEST HURDLE IS THAT IT DEPENDS ON OTHERS, AND NO ONE WANTS TO DEPEND ON OTHERS, ESPECIALLY WHEN DEVELOPING A COMPANY’S STRATEGY.19 COVER STORY oilandgasmiddleeast.com JUNE 2020 for gas produced as a by-product of oil production ends with flaring. In a ranking of 2018 gas flaring volume, The World Bank revealed Russia as the world’s top flarer, followed by Iraq (ranked second) and Iran (3). Oman (11), Saudi Arabia (12), the UAE (24), Qatar (27), and Kuwait (29) are all among the top 30 flarers. However, in proportion to the amount of oil produced, Gulf nations on average flare less gas than other countries because they are so rich in oil. “It is much cheaper to flare gas than to re-inject it, sell it, or save it,” Al Hosani says. “It is understandable that for the short term, especially for shareholders, we need to survive. With oil prices jumping back and forth, huge ambitions can get left behind. But if you give them a tangible result, they might think of it differently.” She is quick to note that the UAE has a strong record in eliminating routine flaring, but that it is costly to deal with accommodated gas in an environmentally-friendly way, and calls re-injection a “waste of money” if there is no technical need for it to enhance oil recovery. Meanwhile, produced water is disposed of by drilling disposal wells, or by being treated and discharged in the sea. Al Hosani sees a link between the gas and water produced in the upstream sector, and connects them to form a new value chain leveraging the ideas behind the circular economy. “In my model, you produce the gas, you use it to power water treatment facilities, and then you ship the clean water—using the same tankers already transporting oil—to places in need,” she says. “I studied Cape Town as a recipient of water because they have a major hub for oil tankers. Our oil tankers go there anyway on their way to other places.”Next >