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Covid-19 and cap scrap put our industry under threat

Covid-19 and cap scrap put our industry under threat

A toxic cocktail of the Covid-19 outbreak and an act of self-sabotage by two of the world’s biggest oil nations has created unprecedented and overwhelming currents for the oil and gas industry to swim against.

The market was contending with oversupply even before the virus further crimped oil and gas demand, but the frankly stupid decision by Moscow and Riyadh to scrap international production caps only compounded matters.

The effect has been a rapid and deep decline in Brent crude prices since the start of this year and a stream of reports warning of impending bankruptcies and job losses.

There is talk about the symbiotic, collaborative relationship between operators and suppliers, but the two segments do face different sets of risks and hurdles.

Some exploration and production companies will be able to fall back on to the cushion of reserves built up over the last three years – a spell characterised by fairly stable prices and cost reductions.

Plenty of operators will have hedged at least a proportion of their oil and gas sales at higher prices for a period and, therefore, won’t be feeling the pinch just yet.

Oil and gas companies are no stranger to crises. In the not too distant past, they will have dealt with a lot of the threats they currently face. That’s in their favour.

Certain distressed businesses will struggle to meet their cost commitments, and may even go bust, leaving their venture partners scrambling to plug the gap.

We’ll no doubt see the premature termination of drilling contracts, and delays in construction contracts.

And decommissioning security agreements – which require the deposit of cash or another type of security, such as a letter of credit, into a trust – will come into sharp focus before long.

As for the oilfield service sector, just doing the day job will be a massive issue.

Most companies in the supply chain hadn’t fully emerged from the previous downturn and had wafer-thin margins.

Now they have to contend with restrictions on the movement of employees, goods and services that are more stringent and debilitating than anything imaginable in the run-up to Brexit.

Regrettably, the most vital survival mechanism is not necessarily in their control.
They need to get paid, preferably on time, by their clients, whether that means operators or larger service companies. There has been a lot of noise around the use of “force majeure” clauses that suspend the obligations of the contract parties, but great care must be taken with invoking such clauses as this may stop payment and the ability to submit a variation order.

As predicted by the likes of Wood Mackenzie and Rystad, businesses will fail, but there are critical steps that can be taken to draw some of the sting out of the current market rout.

It may sound obvious, but actually taking time to identify key risks and weigh up their potential impact on the balance sheet is a sensible and practical starting point. One example of this is the volatile currency markets, where FX specialist Global Reach Group noted the GBPUSD rate had recently dropped to a 35-year low and urged companies to hedge their foreign exchange exposure to mitigate risk.

Senior management teams and boards will have to respond quickly to the fast-changing landscape and assess whether they have sufficient resources to fulfil contracts.
These teams will also need to be steely enough to guide their businesses through a long recovery, but still able to step back from the day-to-day firefighting to plan ahead for the medium term.

There has also been a call to relax the current insolvency rules so that directors are not held personally liable for their actions during this time. The proposed reforms include a 90-day moratorium which would allow companies to hold off insolvency action from other creditors during that time.

This could give the directors time to reshape their business. They would also amend the existing wrongful trading rules so that directors would not be held personally liable if acting reasonably and they misjudge the potential negative impact of coronavirus.

Businesses will also need government to continue to weigh in and pull some financial levers, particularly given that many institutional investors have gone cold on the oil and gas industry. This support includes HMRC who are being asked to take a proactive role in assisting businesses at this difficult time.

The early signs are encouraging, with the UK Government pledging £330 billion worth of loans to struggling firms, and a historic wage support package covering 80% of pay. Business rates relief will be one of the most tangible, immediate benefits across the board in the UK.

Energy sector companies will certainly hope to lean on some of these crutches, but will of course be in a queue with other industries.

All energy firms will have to do business differently, and it’s perhaps this that gives our industry the best chance to develop and survive.

David McEwing, partner, Addleshaw Goddard

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