Portfolio optimization for upstream oil and gas companies
Deloitte Upstream Diversification Index two-part series
Balancing investments, production, and returns in today's lower-for-longer oil price environment is becoming a major challenge for exploration and production (E&P) companies. E&P companies are continuing to strive for the right balance of resource types and geographies. A critical question is what portfolio of resources can deliver the best results across a range of price scenarios?
- About the Upstream Diversification Index
- Part two of the series
- Part one of the series
- Get in touch
- Join the conversation
About the Deloitte Upstream Diversification Index
The Deloitte Upstream Diversification Index (UDI) analyzes net-entitlement production of 230 leading global upstream companies using five factors (1. fuel mix, 2. resource type, 3. region, 4. basin, and 5. investment cycle). The objective of this index is to measure the pace, direction, degree, and areas of changes in a company’s portfolio, facilitating consistent benchmarking and enabling decision making.
Deloitte’s UDI can help oil and gas (O&G) companies make better operational and financial decisions by offering a new, more consistent, and rigorous framework for internal portfolio management analysis, strategic discussions, and communications to management, investors, employees, and other stakeholders.
The portfolio predicament: How can upstream oil and gas companies build a fit-for-the-future portfolio?
The market hasn’t rewarded oil and gas companies, but why?
When the going got tough for upstream oil and gas (O&G) companies, most of them did whatever they could to weather the storm. In the lower-for-longer environment, most upstream companies reduced costs, some high-graded their portfolios, others concentrated their assets, and many were hard-pressed to adapt quickly enough. While crude oil prices have since improved, companies that took actions to protect their portfolios are not yet seeing recognition for their efforts—the market does not seem to have fully acknowledged their early moves to portfolio optimization. The stock prices of nearly 73 percent of the companies failed to grow in line with oil prices and the overall stock market since January 2017.
A deeper dive into the myriad narratives in the marketplace indicates that at the heart of the matter lies an important issue—the absence of an understanding of what constitutes a “good” portfolio and a common tool to judge its effectiveness. Put simply, the portfolios of many upstream oil and gas companies worldwide are undergoing profound changes, making it difficult to study and appraise them using standard portfolio evaluation metrics, especially when these are coupled with selective disclosures from companies.
According to our analysis of 230 leading global upstream companies, 62-80 percent of portfolios are still not fully ready to navigate the uncertain future over the next five years. There’s work to be done.
What makes a successful portfolio?
A fit-for-the-future portfolio shields itself from probable price downsides, best sustains performance in a lower-for-longer price environment, and scales up most quickly when prices move higher. Future-ready portfolios analyzed using a common lens like Deloitte’s Upstream Diversification Index display certain traits that seem to have helped them stand out from the crowd and in the eyes of investors. Read The portfolio predicament: How can upstream oil and gas companies build a fit-for-the-future portfolio? to learn more about five traits of successful portfolios.
Deloitte’s Upstream Diversification Index report part two
The portfolio predicament is part two in our series of reports on portfolio optimization for O&G companies. Read the report to explore future readiness of O&G portfolios across price scenarios and identify certain traits exhibited by companies with future-fit portfolios.Read “The Portfolio Predicament” on Deloitte Insights
Want more information on where your company falls within the UDI?
Seeking balance in the new normal
Diversification activity, according to Deloitte’s UDI, grew rapidly until 2011, driven by significant production coming from new resources like shales and liquefied natural gas (LNG). However, over the past few years, diversification activity has been flattening out and showing signs of divergence in companies’ portfolio management strategies. Many pure-play E&Ps have become less diversified as they have exited resources and regions to concentrate on fewer, while supermajors and integrated oil companies have extended their already diversified upstream portfolio across resources, fuels, investment cycle, and basins to spread risks.
Pathways to success: Portfolio positioning
Diverging portfolio pathways in the upstream oil and gas industry confirm that investment decision-making and portfolio management have never been as complicated as they are today. The report discusses relative risk and rewards of upstream oil and gas portfolio positioning strategies and provides new insights into successful strategies of companies that have outperformed across the cycles:
- Portfolio performance trends
An analysis of E&P companies’ financial performance and business strategies over the past 10 years using a combination of key financial parameters such as relative total shareholder returns, upstream profitability and stability, asset efficiency, and more, suggest that companies that remained either strategically concentrated or moved toward diversification outperformed those that frequently shuffled their portfolios or remained in the "middle" of the diversification spectrum.
Underperformance was largely reported by medium- to large-sized pure-play E&Ps (production of more than 250,000 barrels of oil equivalent per day) where there have been frequent changes in portfolio mix. Weak performance was attributed to one or more of the following aspects: inconsistent strategy, weak position in top markets and quality basins, a lower long-lived asset base, limited infrastructure advantages, moderating production growth rates, or limited financial and investment flexibility.
- Positioning portfolios for the future
Seeking balance in the new normal notes that the pressure to perform and the need to come out of this downturn successfully will likely push these E&Ps to either side of the spectrum and thus lead to greater exchange of assets, mergers, and reprioritization of capital in the industry. The case for concentration is strong due to the growing need to sell noncore operations to reduce the pressure on cash flows, but so is the need to focus on meaningful diversification given the competition and margin pressure in the US shale market.
Although consistent strategy, financial prudence, and operational capabilities will often be central to any company's success, how they gain competitive and operational advantages in the markets they operated in or monetize the available optionality from their asset base will likely differentiate good performers from underperformers on both ends of the curve. Likewise, the pathways of companies moving backward with overleveraged concentration and those moving forward with reduced optionality will likely be less successful.