Oil and gas portfolio positioning with the Deloitte Upstream Diversification Index
Seeking balance in the new normal
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. Almost every oil and gas resource is struggling to provide the desired balance to E&P companies. The critical question is what portfolio of resources, concentrated or diversified, will deliver the best results?
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Deloitte's Upstream Diversification Index
Deloitte’s Upstream Diversification Index (UDI), a five-factor analytical tool covering the top 150 listed upstream companies worldwide, reveals that the oil and gas industry has followed different paths in the quest to find which portfolio management strategy can deliver the best results in this new lower-for-longer and volatile price environment.
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 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 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
The report 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.
About Deloitte's Upstream Diversification Index
Deloitte’s UDI could help oil and gas 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 index, which analyzes net-entitlement production of top 150 listed E&Ps and upstream portfolio of integrated oil firms worldwide using five factors (fuel mix, resource type, region, basin, and investment cycle), groups companies into four diversification sets—concentrated, less diversified, moderately diversified, and diversified—and then evaluates the performance of each diversification set using total shareholder returns, sustainable growth, profitability, and asset efficiency metrics.