Winning Strategies for Oil Price Volatility

The Covid-19 pandemic has been the most disruptive force to the world economy in recent history: external, unpredictable and well outside most of our experience. While prior economic disruptions could be explained by unsustainable economic growth, geopolitical problems, or new technology proliferation, the pandemic has come ‘out of nowhere’ and every one of us is affected by its impact.

Organizations across all sectors are working to understand what the shock of Covid-19 means for them and what actions they can take to ensure their business has the resilience to endure the pandemic. Questions around how to mobilize and empower a remote workforce to keep operations going, how the availability of products and services will affect their ability to do business and the scope and impact of government interventions are common to all.

For those in the international oil and gas industry, the situation is slightly different, because these factors are intensifying an existing environment of uncertainty including socioeconomic development, the transitioning energy mix, and geopolitical risk. Difficulties that have only been compounded by the Covid-19 crisis.

The unique predicament facing oil and gas

For example: the outbreak of Covid-19 has caused a dramatic drop in demand for oil products, affecting the entire oil and gas sector. Many governments have initiated “sheltering-in-place” orders, limiting the need to drive cars and trucks, drastically reducing air travel, and relaxing existing environmental or protectionist laws such as IMO 2020 or the Jones Act. This has come at the same time as industry-specific volatility in the form of a production conflict between Saudi Arabia and Russia, causing additional downward pressure on prices. OPEC+ has tried to resolve the oversupply situation, but it is not clear if these production cuts are significant enough to substantially raise prices. At the time of this writing, May WTI had fluctuated in the negatives days before expiry, and prices for June were well below $20.

This leaves the oil and gas industry in a more volatile and uncertain situation than other industries. Jet and gas demand and prices are plunging while diesel remains less affected, leading to huge variation in demand mix and gaping price differentials. VLCC rates’ volatility is skyrocketing due to Saudi demand and need for storage, doubling to $25.56/mt in March, compared with $10.92 in the previous week. In addition, forward curves are fluctuating rapidly due to the constant flow of new information regarding COVID-19 recovery.

The dangers of legacy planning

Thrust into a situation where no one really knows exactly what’s going to happen and new information about the impacts to the industry are being revealed on a daily, if not hourly basis, the oil and gas industry’s digital immaturity is being thrown into stark relief. Especially when it comes to planning and value chain management.

While most refineries do have automated economic planning tools, they are often rooted in legacy planning methods, which fail to really harness data to understand economic impact. Many lack the agility needed to support real-time decision making about vital issues such as the optimal crude grade to purchase and consume, or how to best plan production so as to utilize contracts and trading optionality and bring value back to the refinery.

Even trading and supply organizations – usually the most agile parts of any oil and gas business – still lack some crucial capabilities. Few have the ability to quickly see and test how decisions influence the end-to-end value chain – a valuable capability in a connected commodities environment. The result is often an approach that focuses on maximizing book value, which can often negatively influence or constrain enterprise objectives.

Pipeline companies may feel they have limited flexibility due to heavy regulatory oversight, but there are still ways for them to update their business model to reflect changing circumstances. For example, empowering departments to understand customers’ needs and quickly consider the most relevant contract structures, asset purposes, and/or services they can offer customers at the best prices, while relieving pipeline assets enough to generate new business elsewhere. Commercial and operational functions could also be integrated to ensure that schedules are feasible and take advantage of commercial flexibility for better management and optimization of pipeline nominations.

The oil and gas value chain may be complex, but it has had some historical advantages.  The portfolio of products are relatively small, new products are rarely introduced, demand patterns shift slowly and transportation is relatively fixed given the very high cost of building new assets. This has encouraged a static attitude to go with the industry’s static nature; oil and gas companies haven't significantly invested in making their operations more dynamic and responsive and have lagged behind other industries. Now is the time to rethink it.

Rethinking the oil and gas value chain

The dynamics of the current global situation are such that oil and gas companies need to entirely rethink the way they do business to have any chance of minimizing the impact of Covid-19. This new way of thinking starts with the value chain.

A creative approach to price volatility

For example, consider the relative price of the forward curve for RBOB & WTI futures:

It is well known that there is a large financial incentive to hold onto inventory for both crude and products while waiting for the price to appreciate over the upcoming months.  However, given the current sharp drop in energy demand combined with a slower response to production, storage capacity is at a premium.

What is the cost of such a strategy? Getting quotes for storage facilities is a relatively simple task, but storage prices are rapidly increasing due to a spike in demand – and everyone is holding their inventory. In these circumstances, companies must consider previously unexplored options. Companies must quickly value options like floating storage, tank service switches or unique leasing arrangements while simultaneously evaluating the cross-functional costs and feasibility.

Storage plays are merely one example of the multitude of options that are available. The specific nature of any winning strategy is dependent on the company’s operating position. But at its heart, a winning strategy combines the market outlook with comprehensive insight into the company’s capabilities – from manufacturing capacity and contract obligations to demand outlook, supply availability and commercial flexibility.

Building a digital value chain

In order to identify winning strategies, we need a complete view of all existing assets, people and circumstances – because only a fully understood value chain can be reimagined. This is where AI can help. We often think of AI as a replacement for human intelligence, but identifying opportunities and risks will always require the intervention of prudent analysts and commercial experts. These experts will need to evaluate costs, benefits, risks, feasibility and opportunity in the middle of such widespread, volatility while consuming huge volumes of information.

This is where AI-driven, decision-support tools can help rapidly determine which proposals are winners and which can be discarded. Models can be built to show the entire connected value chain and predict demand and disruptions, and to extrapolate scenarios. The ability to quickly test and receive the results of large cross-functional changes will allow commercial and planning personnel to explore more innovative proposals and make faster, more proactive decisions.

None of us were prepared for the change we are experiencing now – and we are faced with the prospect of a turbulent future. The only way forward is to prepare ourselves to be resilient and responsive to what comes next.