Four Key Trends Within the Oil and Gas Industry

Four Key Trends Within the Oil and Gas Industry

December 16, 2022

While the oil and gas market continues to experience relative instability as a result of pandemic-related factors, the industry as a whole is in a much better position than at the start of COVID-19. At that point, many large oil and gas companies were highly leveraged, and any generated cash flows were reinvested in the business. Initially, demand for oil plummeted at the beginning of the pandemic — catching overleveraged businesses off-guard — but as travel increased and industries reopened, commodity prices rose as a high demand was offset by a lack in supply, leading to greater profits for oil and gas companies.

Now, while companies are increasing their supply of oil and gas, they are constrained by caution, as they are hesitant to invest large sums of capital in longer-term projects only to find that they are not able to achieve a reasonable return.

Oil and Gas Companies Examine Their ESG Strategies

Oil and gas companies are experiencing pressure on the ESG (environmental, social, and governance) front. Institutions, investors, and countries are pressuring oil and gas companies to reduce their carbon footprints, especially in Europe. As a result, oil and gas companies are encountering challenges in raising large sums of capital since the market is unwilling to give them a fundamental value for their business due to regulatory concerns around oil and gas and other economic risks.

At the same time, oil and gas companies are balancing investing in future renewable resources with meeting the current need for oil and gas. Some energy companies are selling their non-core oil and gas assets to demonstrate to the market and investors that they are divesting of certain assets and investing in renewables. However, there is still a demand for oil and gas because of the relatively small size of the energy market that renewables make up, so companies are continuing to invest in fossil fuels, though at a slower and more prudent pace than five to ten years ago.

The renewable market is still very heavily dependent on government incentives such as tax credits, and oil and gas executives still need to provide a fair rate of return to investors. As a result, companies that moving to renewable projects experience uncertainty over whether large investments in renewable energy can justify a rate of return if the regulatory benefits on that energy changes.

Oil and Gas Companies Deal With Broader Economic Trends

With the high prices of commodities, oil and gas companies drilling and refining are generating good revenues, boosted by the high prices and the high demand from industries restarting as the pandemic waned, though there is concern of a looming recession due to high inflation and a cooling stock market. In the past, oil and gas companies would reinvest those profits, but now there is an increased desire from investors for dividends to be paid to stockholders and to move some money into renewable energy assets. In general, the valuations of these oil and gas companies have increased significantly, and while the overall stock market in 2022 is down, energy companies are somewhat positive.

The War in Ukraine Boosts Interest in Renewables

The war in Ukraine initially increased the pricing of oil and gas as concerns grew surrounding the curtailment of Russia’s energy supply as well as Western sanctions on Russian oil and gas companies that prevent that supply from reaching the global community. This is a challenge most significantly for European countries that were so dependent on Russian gas, and European concerns exist especially around the need for oil and gas in the coming winter. These countries are working with others as they search for a more stable, reliant supply of oil and gas, and the events have boosted European interest in renewable energy. The higher investment in renewable energy projects becomes more palatable when the alternative is to buy energy from Russia or pay expensive transportation costs when purchasing from other countries.

Oil and Gas Companies Deal With Impacts on Valuation

During the pandemic, there was a significant amount of distress in the oil and gas industry, as many companies were filing for bankruptcy and restructuring to improve their balance sheets, reduce their debt, and sell off non-core assets. However, with recent upticks in the oil and gas market, these companies are more profitable, distributing dividends and working to make use of this capital through consolidations and the purchase of assets.

There remains a bid ask spread as buyers weigh the uncertainty of future energy pricing and the current price of commodities, leading to caution in M&A transactions, but there is still a renewed interest in growth among companies (rather than simply trying to survive in a distressed situation).

Because of the aforementioned trends, the public markets are not giving a pure fundamental valuation to oil and gas companies. Multiples are reduced because of the risks associated with energy companies and the uncertainty around commodity prices. Overall, the oil and gas market are doing well, though stakeholders on all side are exercising caution, and transaction activity is not as robust as it would be in a typical economic environment.