Sector Foresight - Oil update
The Oil Industry (specifically the offshore ‘upstream’ sector) is currently facing one its biggest challenges, due to the tragic explosion on the Macondo well in the Gulf of Mexico (“GoM”) on 19 April 2010.
- Despite the recent court ruling over the original 6 month moratorium restricting any off-shore drilling in the GoM, the U.S. government plans to reintroduce the moratorium in another version in the next few days, emphasising why the moratorium is necessary. It is also expected that a new moratorium could be extended to last 12 to 18 months; and that the impact of the moratorium is likely to be felt globally as other governments react.
- It is expected that oil and gas producers will spend $1.6 billion less on exploration and production in the United States than they had expected because of the moratorium, which will impact companies across the globe.
Who is impacted?
- Companies primarily operating in the ‘upstream’ oil sector.
- Offshore drillers are expected to take the biggest hit followed by subsea equipment manufacturers, especially small and mid cap companies with significant exposure to the GoM.
- As a result of increased costs associated with operating in the GoM, service companies are also expected to be impacted, with many looking at their cost base as well as how they can operate more efficiently.
- All companies that operate within the oil and gas sector, are likely to be impacted by increased regulations, as a result of the recent environmental impact that the oil spill has had.
- If the current moratorium is further extended, and oil rigs are moved out of the area, this will have a significant impact on any company reliant on the GoM both on a short and long term basis.
- Local companies to the GoM, such as those in the fishing or tourism industry have and will continue to be affected for a long period of time.
- The above will have an impact on companies globally, not just those that directly operate in the GoM.
The cash impact on the oil & gas companies of the current crisis will likely be felt in a number of areas:
- Companies in the upstream sector have a high fixed cost base. A significant portion of these cash costs will have to be serviced from existing cash reserves. Oil companies will likely seek to extend supplier terms, creating a liquidity squeeze that will ripple down the supply chain. The negative impact will hit cash first, significantly before it impacts on reported profits. The liquidity of key suppliers, customers and other third parties will have an effect on oil companies and other companies in the supply chain.
- Increased and immediate operating expenses such as inspection, maintenance, additional safeguards required due to more stringent regulation and insurance.
- Potential delays in the ability to obtain drilling permits as it is likely that no new contracts will be awarded until the moratorium is lifted. Delays in start-up and ramp-up of many projects are also expected.
- Uncertainty over the ability to cancel or reduce certain costly commitments, rig and service contracts.
- Increased and potentially significant CAPEX expenditure on ‘old’ rigs in order to improve safety standards due to the expected escalation in regulation.
To manage through these challenges, companies will need to have:
- Clear visibility over short and medium term cash flows and working capital;
- Good understanding of where cash (free and trapped) is held;
- Full understanding of the key cash drivers in the business;
- Develop action points to help reverse some of the anticipated cash outflows; and
- Tight controls in relation to the management of cash.
Our experience suggests that many companies continue to focus on profit and are often ill-equipped to deal with a sudden "Cash Crisis". In addition, they are unlikely to have the level of visibility and control to react quickly to these circumstances; and they will be unaware of how quickly their cash reserves could be depleted.
As such, without large cash reserves, companies in the upstream oil sector may face liquidity issues and without quick intervention may struggle to survive.
We therefore recommend that you stay close to your Oil & Gas clients and any companies providing support services, and understand what cash and other actions they are taking. KPMG has a wealth of practical experience of helping companies and their lenders navigate through exactly these kinds of situations including in this particular sector (please see attached credentials).
If you have any general questions or wish to discuss a specific matter confidentially then please don’t hesitate to get in touch with myself, Paul Kirkbright or your local KPMG Restructuring contact.
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