Heading into 2021, Massive Minerals Management announces six predictions that energy sector participants as well as mineral and royalty owners in particular, should consider as they prepare for potential outcomes and ramifications of the Covid-19 pandemic extending well into 2021. In sum, we will likely see artificially depressed energy demand, stagnating prices, depressed drilling activity, less production and cash flow leading to diminishing returns to investors, ultimately leading to the acceleration of capital flight and consolidation among industry participants.
“To be certain, Covid-19 has not single-handedly destroyed oil and gas prices. For a number of reasons, commodity prices were facing headwinds throughout 2019 and into 2020. The emergence of the coronavirus and its knock-on effects, however, converted these headwinds into a collective hurricane,” says attorney, Ben Holliday, founder of Massive Minerals Management.
Six predictions for energy industry participants – particularly mineral and royalty owners – to consider if the pandemic extends through 2021 and economic recovery materializes later than expected:
- Demand remains artificially depressed. While the coronavirus has not materially impacted the supply side or curtailed our ability to produce oil and gas, we have witnessed a catastrophic demand destruction; simply put, we are not using anywhere close to the number of hydrocarbons that we were one year ago. People have refrained from travel and moving about all together due to short-term government restrictions and/or health driven choices in direct relation to the virus. While the temporary alteration of consumer patterns may accelerate some portions of renewable energy, the underlying demand fundamentals for hydrocarbons are there, they are just artificially depressed/constrained.
- Depressed demand leads to a stagnating price. Until the world returns to pre-Covid consumption patterns and people are back on airplanes, in offices, and returning to stadiums, etc. oil prices should remain correspondingly depressed.
- A stagnated price will lead to more depressed drilling activity. 2021 is presently trending heavily towards operators moving into what has been referred to as ‘maintenance mode,’ meaning that capex is geared primarily towards generating free cash flow from existing assets. A prolonged pandemic through 2021 and into 2022 should deepen this commitment to maintaining the status quo over production growth.
- Less wells = less production = less cash flow. The ability to immediately reduce drilling provides operators short-term relief in terms of cost-savings; less money is going out the door. However, due to the short-cycle nature of unconventional oil and gas development, where the vast majority of production occurs in the first 6-18 months, a dramatic drop in drilling and well completions will in short order lead to a correspondingly dramatic drop in production and therefore cash flow. This then exacerbates a separate headwind to additional drilling – the market’s demand for returns. Should the pandemic depress demand and thus price through 2021, the corresponding decline in production will lead to a commensurate decline in cash flow available to operators, both to service debt and return to investors.
- Decrease in cash flow destroys returns to investors, which leads to the acceleration of capital flight and eventually consolidation. As oil and gas companies find themselves increasingly cut-off from traditional sources of funding, the status quo has dramatically changed. The industry as a whole has shifted from growth-focus to survival, and here survival depends on the financial means to weather the downturn. H2 2020 has seen well, or at least relatively well, capitalized majors begin the acquisition cycle in earnest, with major acquisitions by Chevron (acquiring Noble Energy), Pioneer (acquiring Parsley Energy), and Conoco (acquiring Concho Resources). Should the pandemic continue on through 2021, resulting in a continued low-price environment which leads to correspondingly low returns, the number of vulnerable companies faced with insolvency or acquisition will increase exponentially. Consolidation will occur en masse in all facets of the upstream oil and gas industry, including service providers.
- What is the most likely outcome? Consolidation and Concentration. Should the pandemic continue relatively unabated through 2021, the most likely outcome for the domestic oil and gas industry is Consolidation and Concentration. Simply put, there will be fewer companies in all areas of the industry – E&P, services, mid-stream – focused on a smaller, tighter geographic footprint in select areas: the Permian Basin, as well as the Bakken, Eagle Ford, and Haynesville Shales.
Additionally, if these predictions ensue, the potential beneficiaries will be those companies well positioned to acquire low-cost operators and core acreage positions. Ideally, these are stock deals for less than 10% premiums. For mineral and royalty owners, now is the perfect time to prepare for an upswing. A good start would be to focus on the three most common issues that could be missed or glossed over during periods of highly active oil and gas development: the operator’s ability to hold acreage, confirming payment in full on all production from their minerals, and ensuring that any concerns about surface operations are properly addressed.
In a time of exponential change in both the global economy and the oil and gas industry, it is imperative that mineral owners have a complete understanding of their mineral asset portfolio and its full value profile both today and tomorrow. Therefore, for this audience specifically, Massive Minerals Management wrote an insider’s guide entitled “Top 12 questions mineral owners should ask” which can be found online here.
“If the Covid-19 pandemic continues through 2021, the oil industry and mineral owners should note that: drilling may slow, operator turnover will be high, royalty cash flow may decrease, and mineral acquisition offers may increase,” adds Holliday. “It’s paramount that mineral owners remain vigilant in these times and continue to monitor and compare production volumes, production payments, and lease compliance to ensure that any discrepancies are timely caught and addressed.”