The energy industry was in rough shape when 2020 started and the COVID-19 pandemic has only created more difficult terrain. In a Q&A with ABF Journal, Craig Jones, senior director of the energy practice at Alvarez & Marsal, shared his perspective from more than 20 years in the energy industry on the obstacles energy companies are currently facing and how turnaround professionals can address them.
The past 12 months have seen a dramatic increase in restructuring and turnaround activity in the energy space. The likes of Chesapeake Energy, Hornbeck Offshore, Diamond Offshore Drilling and many others have filed for Chapter 11 bankruptcy protection to address the challenges that were in place entering 2020 and the additional pressure brought on by the COVID-19 pandemic.
As this storm continued to grow, Craig Jones joined turnaround firm Alvarez & Marsal, as senior director of its energy practice in April. In a Q&A with ABF Journal, Jones outlined how a lack of discipline and uneven commodity prices had the industry on bad footing to start 2020 and how the COVID-19 pandemic caused further deterioration, leading to unique challenges for companies and turnaround professionals.
The energy sector has been hit particularly hard in 2020. What are some of the factors behind these struggles and how have they influenced the industry?
Jones: Broadly speaking, the energy sector was already facing major headwinds in 2019, particularly in oilfield services, and specifically within pressure pumping. Most of the issues were self-inflicted due to operators’ and service providers’ lack of capital discipline in prior years. As a result, there was excess capacity of horsepower, inventory, rental assets and new competitors in the market. This overcapacity, coupled with the operators’ sourcing strategy to commoditize products and services used in drilling, completions and production, resulted in substantial margin erosion across the oilfield services space. Additionally, these cost reductions may have given operators a false sense of sustainability for reduced level of effort (LOE) costs, alleviating the pressure to look internally with the same sense of urgency.
This has been a common theme through decades of the previous boom and bust cycles the industry has endured. However, this time it seems to be different as the onset of unconventional resources has introduced volatility to commodity prices, operations and, ultimately, returns for companies participating in this space. As a result, operators and services companies alike won’t be able to simply flex their headcount and supply chain to weather the storm. There will need to be consolidation and fundamental changes to cost structures and operating models for those companies to remain viable and provide attractive returns going forward.
You joined Alvarez & Marsal in April. How has the industry shifted in your first few months or so on the job as a senior director in the energy practice?
Jones: Since joining the firm in April, I would say I have seen a shift in the industry. The government COVID-19 lockdown had just occurred a month prior on March 13. Most of the industry, if not the entire country, was still in a state of shock. Many of my contacts were taking it day by day and worried about losing their jobs alongside learning how to work from home. At the same time, companies were dealing with the same issues at a more intensive level. Once companies got over the initial shock, they began kicking change into action at a rapid pace. I know several contacts that have been released as a result of reorganizations and transformations. Other former industry colleagues are working diligently on creating new organizations and attempting to develop new processes to do “more with less.”
How was the energy sector faring prior to COVID-19? Has the pandemic altered the course or pushed it forward?
Jones: The pandemic has dramatically accelerated the headwinds the industry had already been grappling with. When commodity prices plummeted and operators shut down operations and even shut in production, it sent shockwaves through the entire industry. Companies that were treading water to remain cash flow positive found themselves either seeking new capital in a very tight market, or they were forced into some form of restructuring. Currently, other companies with balance sheets that are strong enough to provide a buffer are looking inwardly at their entire organizations and operating models to establish how they will fundamentally change the way they operate moving forward. This may include exiting geographies, streamlining their product and services portfolios to leverage synergies, consolidating amongst competitors, and collapsing organizations to eliminate redundancy. The pace of change with which many of these initiatives are taking place is unprecedented and you can certainly attribute this step change to the COVID-19 impact.
Have certain subsectors of the industry fared better than others?
Jones: Given the current market situation onshore in North America, the scope and definition of subsectors has become more finite than ever before. At a macro level, oil and “wet” gas has fared better than dry gas production. Looking across basins, the areas with the highest break-even costs have been the hardest hit. The Utica and Marcellus in the Northeast; the Bakken, DJ and Powder River in the Rockies; and the Scoop/Stack in the MidCon have been the most dramatically impacted. At the same time, the Permian, Eagleford and, to a certain extent, the Haynesville shales have fallen to a slower pace. However, digging deeper, you need to look county by county within these basins to find the most productive acreage. Producers and service companies with operations in these areas are focusing resources accordingly to maximize utilization and generate as much cash flow as possible.
When do you expect there to be a leveling out in the energy sector, if any at all?
Jones: There will most certainly be a leveling out at some point. The long-term fundamentals for energy remain strong, although I do believe there will be a step change as a result of emerging communication and collaboration platforms like [Microsoft] Teams, Zoom, BOX and others. Major companies are starting to revisit the traditional model of coming into the office. There is no doubt that business travel will also be impacted, even in a post-COVID-19 world. Companies have learned that employees can be extremely productive while using these tools at a savings to their bottom line. This will result in fewer cars on the roads, planes in the air and overall energy demand. All these factors further support the fundamental changes the industry is currently taking on. However, there will be a remaining long-term demand for oil and gas. As a result, the companies that successfully emerge from this current cycle will be well positioned for long-term success.
In the best of times, what do turnaround professionals need to focus on when working with struggling energy companies?
Jones: Cash is king in a restructuring. As such, many times there is an urgent need to take out cost and create immediate value. The importance of this role cannot be understated. However, it is just as important for struggling companies to improve, or in many cases, implement systems and processes across key functions that will make these savings sustainable. For example, we can easily take on a request for proposal (RFP) project to reduce costs across several categories of spend for an organization. However, if the company doesn’t implement a proper sales [and] operations planning (S&OP) process, utilize material requirements planning (MRP), staff a professional sourcing and procurement organization, and develop key metrics and reports, these savings will be short lived. Furthermore, the company will most likely find itself in the same situation down the road.
How has that changed in the current environment? How will it affect the relationship into the near- and long-term future?
Jones: The only change I see is that many companies are attempting to make these changes internally as they consider consulting spend discretionary. The key for companies will be determining when that approach makes sense and when complexity, risk or urgency necessitates looking for a third-party partner to drive the results needed at the pace required.
Craig Jones is the senior director of the energy practice for Alvarez & Marsal.