Oil and gas on a knife-edge – remuneration might have to break the mould to retain talent throughout this current crisis
The market price of oil balances the scales between success and failure for companies operating in the sector. Boards keep a close watch on the break-even price.
The average break-even price in the US was estimated recently to be between $48 and $54 per barrel (with the caveat that a sustained price of less than $40 per barrel would have a devastating effect on the US industry). On the other hand, Saudi Arabia can make money at $20 per barrel but operators in Russia need $40. In the North Sea, where production costs are high, close observers of the industry have commented that at $60 to $70 per barrel life is comfortable but at $40 to $50 projects are at risk.
At the time of writing, the market price of a barrel of Brent crude is about $36 and the West Texas Intermediate price per barrel is about $34. A recent survey published by the Oil & Gas Council indicates that nearly 90% of respondents think that, over the next 12 months, the market price of oil will be in the range $20 to $50 per barrel. If that is right, the industry, globally, faces a prolonged period of belt-tightening.
Africa, where there have been a number of discoveries, is seen as a source of opportunities. Companies looking to reposition their business models through energy transition and diversification can see opportunities to acquire gas assets on the continent. But Africa has been hit hard by COVID-19 and there are other challenges. It was reported recently, that all drilling activity in Angola, the continent’s second-largest oil producer, has been halted. Our clients operating in Africa have first-hand experience of difficulties arising from:
• inconsistent regulatory environments and inadequate infrastructure
• renegotiation of financial terms
• delays to licence applications and renewals.
Closer to home, in the North Sea, decarbonisation (which involves developing robust ESG policies and practices), automation and increased investment in digitalisation are key focuses for the future. For our North Sea clients, decommissioning costs are a major challenge. There is also some concern about a dearth of private equity exit strategies. Private equity has made significant investments in North Sea and UKCS E&P companies. PE firms, particularly infrastructure funds, have also invested in mid-stream companies, some of which have been divested by bigger operators as part of their A & D policies. Their lower risk profile and cash flows make them attractive to long-term investors.
The current state of the oil and gas industry points to a strategy of cost cutting, consolidation and collaboration. Conserving cash resources is the priority – for all firms but particularly for the small and mid-size players, whose balance sheets are not so strong as those of the large firms.
Those companies, which eventually emerge successfully from this latest crisis to affect the industry, will need to have retained their executive talent. They will also need to ensure that remuneration policy and practice can and does recognise executives’ contribution to that success in a way which can be justified in terms of the outcome for shareholders and other stakeholders and the economics of the business. We are seeing more examples of companies breaking the mould by amending their remuneration policies and practices to deliver a greater proportion of remuneration in shares or share options, for executives and non-executives – and, in some cases abandoning annual cash bonuses.
In the meantime, if the number of acquisitions and divestments in the oil and gas sector increases, as forecast, companies operating long-term incentive plans and plan participants, will want to be certain of their position under the plan rules in the event of termination of employment or a change in control of the company. And, the deal on exit for executives managing private-equity-backed companies, agreed at the time the PE firm makes its investment, will be a key consideration for those executives. It may be difficult (and may be impossible, in practice) to renegotiate at a later date.
MM&K advises extensively on directors’ and executives’ remuneration policy and practice in the oil and gas sector internationally and is a leading independent adviser on remuneration to PE firms and their portfolio companies. In addition, MM&K is authorised and regulated by the Financial Conduct Authority for the provision of corporate finance advice.