The country’s oil and gas sector is witnessing challenging times due to the impact of Covid-19. While the pandemic has affected all segments of the oil and gas value chain, the effects have been different across segments. In the upstream segment, low crude oil prices have deeply impacted revenues of exploration and production (E&P) companies. Meanwhile, imposition of the lockdown has led to widespread demand destruction. Going forward, the sector will need adequate government support to bounce back from the ongoing crisis. Indian Infrastructure presents views of leading experts on the impact of Covid-19 on the sector’s performance…
What has been the impact of Covid-19 on the oil and gas sector?
The Covid-19 pandemic is a black swan event that has caused disruptions in almost all sectors of the Indian as well as global economy. The economic fallout of precautionary restrictions enforced by various governments has been quite severe, and the E&P segment is no exception. During the initial months of the pandemic (March-June 2020), the declining demand for hydrocarbons resulted in a steep fall in prices. This, coupled with disruptions in operational activities due to the lockdown, impacted the Indian E&P sector as well, with apprehensions surfacing with regard to the economic feasibility of huge investments already committed towards exploration activities. However, with mobility restrictions being eased in recent months in the “unlock” phase, the E&P segment has seen a revival in demand and prices, and on-ground activities in several exploration blocks are resuming in a staggered manner. The Hydrocarbon Exploration and Licensing Policy (HELP) was approved in 2016 to enhance domestic oil and gas production. Under the HELP regime, revenue sharing contracts (RSCs) have been signed for 94 exploration blocks. Prior to the onset of the Covid-19 pandemic, these blocks were at various stages of progress. However, almost all activities were disrupted in April-May, when the lockdown was the most severe. Besides, domestic and international restrictions on mobility of personnel and equipment also posed difficulties. Scarcity of labour was another issue faced by certain operators post the lifting of the lockdown. In addition, the process for grant of clearances was hampered as many state government offices were either closed or engaged in activities related to the containment of Covid-19.
The oil and gas sector is among the worst hit sectors, the others being aviation, supply chain, manufacturing and tourism.
On the downstream side, the 10 week general lockdown followed by a series of local lockdowns saw petroleum and natural gas consumption hitting the lowest level in a decade. Although gradual unlocking led to an increase in demand for petroleum products in June by 11 per cent, demand fell again in the subsequent month by 3.5 per cent. The reason for these monthly demand fluctuations can be attributed to the fact that despite the central government’s relaxations on resumption of industrial operations, localised lockdowns persist in places, thereby hampering economic activities and leading to low consumption of fuels, especially diesel. Further, several petroleum products such as aviation turbine fuel (ATF), motor spirit (MS), diesel, bitumen and pet coke witnessed a sudden drop in consumption owing to several restrictions on manufacturing and transportation activities. Domestic market demand for petrochemicals was also subdued given lower spending patterns across consumer goods and automobiles.
On the refining side, as a consequence of the demand drop, the supply of petroleum products led to significant adjustment (50-60 per cent) in refinery utilisation.
Further, in the upstream sector, the major challenges that were faced by Indian oil and gas producers due to the Covid-19 crisis include immediate liquidity concerns, delays in monetisation of oil discoveries owing to viability concerns and limited adoption of digital technologies for field operations.
In the upstream segement, E&P companies are facing severe stress due to a sharp fall in crude oil prices. While prices have recovered to $45 per barrel (Brent) as compared to lows of $16-$17 per barrel in early April 2020, they are still not in a comfortable zone.
In the refining and marketing segments, there has been huge demand destruction. In India, fuel demand reduced by at least 60-70 per cent as compared to peak levels, especially in the early lockdown period. This affected the capacity utilisation of refineries with many operating at the minimum technical level. Further, refining margins have been hit globally due to the plunge in crack spreads caused by weak fuel demand.
Similar trends were also observed for gas utilities with a shortfall in offtake from the transport, commercial and industrial segments. While there has been some recovery with the relaxation of the lockdown and resumption of economic activities, gas demand continues to be in a negative territory. Besides, as spot liquefied natural gas (LNG) prices are much lower, marketers of term LNG are struggling to sell and have been compelled to renegotiate their contracts.
Based on the issues that have been faced, what has been the industry’s response to the pandemic?
With easing of the lockdown restrictions, operations have resumed in several blocks in a staggered manner. Many office-based exploration activities such as seismic data processing and interpretation have resumed. However, due to the onset of the monsoons, field activities that were supposed to be completed in the April-May period will now be possible only from October or November depending on the region-by-region situation. This cascading effect of the lockdown and monsoons, along with supply chain issues, could lead to an overall shifting of timelines by over six months to a year. The RSCs under the HELP regime provide for invocation of force majeure in cases of unforeseeable events such as the Covid-19 pandemic. Accordingly, operators have applied for the grant of force majeure relaxations.
The Covid-19 pandemic has had a strong impact on key end-user segments such as transportation and manufacturing while also resulting in a significant reduction in demand for fuel products in India. In order to adapt to the distressing scenario, Indian refiners were quick to realign their operating models and supply chain cycles to ensure business continuity. Several refineries reduced their operating capacities while a few others suspended operations to outlast the crisis. The fall in US crude oil prices below the zero-dollar mark presented an opportunity for India to fill its strategic reserves to full capacity. As per the Ministry of Petroleum and Natural Gas (MoPNG), 5.33 million tonnes (mt) of emergency storage was built in underground rock caverns in Karnataka and Andhra Pradesh. Besides, state-owned oil firms were also asked to import oil when global rates fell to a two-decade low. Viewing Covid-19 as an opportunity, oil marketing companies such as Indian Oil Corporation Limited, Bharat Petroleum Corporation Limited and Hindustan Petroleum Corporation Limited have initiated steps towards digitalisation of payments for liquefied petroleum gas with the aim of having a fully digital payment regime by March 2021.
In the upstream segment, E&P companies have scaled down their capex plans as many projects will not be viable at the current level of crude oil and gas prices. Even on the opex side, costs are being reduced.
Meanwhile, refining and marketing companies have been able to take advantage of the situation by buying crude oil at distressed prices, especially in April and May. The government also aggressively purchased crude oil to fill its strategic reserves. In the gas sector, several consumers including gas aggregators and LNG regasification terminals have invoked the force majeure clause.
What is the outlook for the sector based on the current situation?
Considering that huge investments to the tune of over $2.3 billion have already been committed for exploration activities under the HELP regime, it is reasonable to say that the E&P segment is expected to see only delays in the timelines, but no major disruption in the longer term. In fact, even during the ongoing pandemic, 100 per cent bids were received for the recently concluded fifth round under the Open Acreage Licensing Policy, wherein 11 exploration blocks were put up for bidding. Further, bids were received from both public and private sector players. Such participation hints at a positive outlook for the E&P segment. Additionally, the government has also been taking proactive measures to make the ecosystem more conducive for operators. The recent notification for early monetisation of discoveries in the exploration period itself is expected to further incentivise exploration activities.
Going forward, the new normal for the oil and gas sector will likely be demand recovery in a layered fashion with some segments improving sooner, owing to easing in lockdown restrictions for businesses and the public alike. Petroleum products such as MS and diesel are expected to recover quickly due to easing of transportation and manufacturing restrictions. However, the demand for ATF is likely to witness a slow pick-up due to international travel restrictions and the work-from-home norm. The demand for bitumen is also expected to recover slowly owing to the slowdown in infrastructure projects, particularly because of some critical prevailing challenges including labour shortages and disruption of supply chains. Natural gas consumption will witness steady growth especially in the city gas distribution (CGD) segment. Additionally, Indian oil and gas players are likely to operate with tight gross refinery margins, witnessing a substantial reduction in revenues for the 2020-21 fiscal year.
The near-term outlook for the sector is certainly challenging. In the upstream space, while crude oil prices have recovered, they are still not in the comfort zone for E&P companies.
Further, in the downstream segment, the first quarter of the current year has been tough due to demand destruction. With the renewal of lockdown in several states, fuel demand is likely to be affected in the second quarter too. Besides, the refining margins are likely to be impacted as crack spreads continue to be in a weak territory globally. However, reduced fuel costs due to relatively lower oil prices are expected to be the saving grace. Moreover, the CGD segment is also likely to face stress due to the slow offtake. Even though partial recovery is expected in the second half of the year, there will still be some negative growth in demand.
Thus, the entire value chain is expected to face weaker profitability in the current financial year as compared to last year. The negative impact on earnings could be 20-30 per cent for different companies.
What will be the key priority areas in the post-Covid world?
With the resumption of economic activities, fuel demand has started picking up. Further, there has also been a revival in crude prices, with the Indian basket price currently hovering at around $44 per barrel after falling to below $20 per barrel in April 2020. While the situation is encouraging, the sector is expected to focus on deployment of innovative cost saving measures. Digitalisation of the oilfield business, automation and analytics could be some of the key priority areas to reduce costs. As a start, the MoPNG has already put together a draft vision document – Digitalisation Roadmap for Indian Exploration and Production Industry. On a concluding note, the sector must draw inspiration from the oil price crash of 2015-16, wherein many US shale oil companies sailed through the low prices by drastically reducing operational costs through improved technological efficiencies.
In the post-Covid world, it will be imperative to build resilience in revenue models and optimise production costs to ensure sustainable growth. The key priority will be to stabilise the sector through efficient management of operational and capital expenditure by adopting a robust investment monitoring framework. Besides, the sector will focus on recovery by effectively managing working capital and restructuring the product portfolio, and enhancing value and building resilience through mergers and acquisitions, organisational restructuring and leveraging technology for value engineering. The focus will be on taking advantage of soft natural gas/LNG prices and moving towards a cleaner economy by using natural gas as a fuel in sectors such as transport and power.
Besides building resilience, the sector is in dire need of creating and aligning digital transformation strategies across activities to drive cost and production efficiency. For instance, in order to achieve cost optimisation, refiners can embrace upcoming technologies for artificial intelligence-enabled remote operations, data-driven equipment strategies, analytics driven costing mechanisms, and IT integration for production enhancement, among others.
The oil and gas industry, especially the upstream segment, requires government support to cope with the impact of Covid-19. Fiscal levies such as cess and royalties need to be reduced. Further, the gas pricing regime needs to be rationalised to provide a certain level of floor prices to make production viable.
Also, as the government aims to increase the share of natural gas in the energy mix, reforms such as inclusion of gas under the goods and services tax and pipeline tariff reforms will be required. Besides, disinvestment is another area which is expected to witness a lot of action. The Covid-19 outbreak has accelerated the pace of digitalisation. The adoption of remote monitoring and videoconferencing tools is helping the industry in handling current challenges.
(*Contributed by Ranajit Banerjee and the HELP Department, Directorate General of Hydrocarbons)
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