Top risks facing the oil and gas industry in 2022 - and what you can do about it

The oil and gas industry perpetually seems rife with uncertainty and a potential volatility. Between rising and diminishing consumer demand, price fluctuations, and of course, geopolitical issues where one global supplier or another threatens to cut off supplies, every day holds surprises and risks. But 2022 seems to be upping the stakes in terms of risk and uncertainty. The Russian invasion of Ukraine is a reminder of how quickly changes in the geopolitical landscape can impact energy prices. Negotiations over a new nuclear deal with Iran add another complication to the energy outlook.

At the same time, the lingering impact of COVID-19 is still being felt. While cases seem to be moderating in many parts of the world, the supply chain and vaccine mandate issues are ongoing, and China’s “zero-COVID” health policies pose a major risk for energy demand growth. Add to this mix the increasing measures across the globe promoting decarbonization efforts and growing activist pressure over climate change.

The potential oversupply scenario happens if OPEC makes good on its commitment to continue unwinding the supply cuts it made in 2020, and U.S. unconventional production grows as much as some analysts are forecasting. If these events occur, organizations may end up with an oversupply of oil, with as much as an extra 6.4 million barrels per day late this year. Add to that a potential new nuclear agreement with Iran and the volume of new oil coming onto the market this year will be even higher; some estimates have Iranian exports growing by up to a million barrels a day within a few months if a new pact is struck. (Of course, if a U.S.-Iran deal occurs, it might factor into OPEC’s decision to continue unwinding its cuts.)

On the flipside, of course, is Russia’s invasion of Ukraine, and the risks that it will lead to a further curtailment of Russian oil exports – including more drastic measures from Europe. Outrage over the invasion has led to some self-sanctioning by western buyers; the US has already initiated a ban on Russian oil, and the European Union (EU) is actively contemplating one. The IEA currently predicts as much as 3MM BPD of Russian exports could be taken off the market. On to the demand side, higher energy prices from the Ukraine crisis could have a knock-on effect on international economic growth.

Meanwhile, China appears to be sticking with its “zero COVID” policy, which includes severe lockdowns and other business-limiting measures. What’s more, President Xi's economic and environmental policies may slow down China’s economic expansion, and therefore decrease its demand for oil. This could have a ripple effect on the global economy, making forecasts of increased global oil demand of 3.3 million barrels per day illusory.

For the time being, we’re still experiencing a tight oil market although many are forecasting a growing oil surplus beginning in the second half of the year.¹

Russia’s invasion of Ukraine has prompted the U.S. and EU to impose severe economic sanctions on Russia.

This tense geopolitical issue is casting a long shadow over gas supplies and prices, especially in Europe.

Reductions in Russian spot sales of gas to Europe in late 2021 contributed to an energy crunch and record natural gas prices in the EU. The fear now is that fighting in Ukraine and the impact of sanctions will disrupt much larger volumes of gas, keeping prices high and undermining EU economic growth this year. If Moscow were to retaliate to U.S. and EU sanctions by cutting off all gas exports to Europe, the results would be even more onerous for European economies.

How this crisis plays out in the longer-term will have significant implications for the energy mix in Europe over the next 5-10 years. There is one school of thought that Europe will delay implementation of some of its key “green transition” energy policies to avoid short-term pain. On the other hand, many believe that this vulnerability will motivate EU countries to double down and accelerate the pace of their transition to renewables and clean energy in order to decouple from reliance on Russian gas. This will likely have a big geopolitical impact in terms of Russia's leverage over Europe, and also in terms of where Russia would sell its oil and gas supplies.

Is it politically feasible for EU governments to do this? Can the EU accept the potential short-term pain in terms of increased prices and limited gas supplies in order to gain a long-term advantage? And what steps will it take to ease burden on its citizens?

For example, Germany has said that, in light of the Ukraine invasion, it will not certify the Nord Stream 2 gas pipeline, which was designed to deliver more Russian gas to the EU.²  The bloc is also taking steps to displace some Russian gas with supply from the U.S. and Qatar until its transition efforts are further along and bear more fruit. These are all questions that many hope will be answered as the year moves forward.

When it comes to global energy transformation efforts, it seems like it is one step forward and two steps back. While global energy transformation efforts to reduce emissions are being baked into policies around the world, it’s not a one-size-fits-all approach and it’s happening at different speeds in different countries. And as events in Europe illustrate, politics have a major impact.

Fallout from the Ukraine crisis may accelerate the EU’s “Fit for 55” proposals, which aim to reduce greenhouse gas emissions by at least 55 percent by 2030. Meanwhile, China also appears to be willing to put up with higher cost and burdens as it forges ahead with its emission reductions. It turns out that in some parts of the world, energy transformation and energy security are seen as being synonymous rather than disruptive.

Ultimately, the tension between governments’ balancing of long-term energy goals and the short-term needs of their citizens will make the road to energy transition extremely bumpy. Governments will have their work cut out for them in trying to minimize the pain that will likely be caused by the transformation efforts while still making progress on its energy policies.

It is not just governments that oil and gas companies need to pay close attention to.. Environmental and social activists are putting increasing pressure on the industry, questioning its “social license” to operate. This is largely based on the pollution and climate change damage they believe the industry is responsible for.

The industry has dealt with this issue for decades but increasing attention on the threat of global warming has really increased.

Activist investors are speaking with their pocketbooks and shifting more of their investment dollars toward green energy. Another game changer has been the expansion of social media platforms and new technology that provides activists with the ability to get their message out more widely to the general public and also more directly to corporate executives and board members. In addition, climate activists are taking to the courts; although the results have been mixed, the potential liability and bad publicity it generates creates great uncertainty and risk for the industry.

As a result, oil and gas companies are feeling intense pressure to respond in terms of capital allocation decisions and strategy out of fear of damage to both their corporate reputation and bottom lines.

A somewhat surprising development that may come out of the private sector continuing to shift its investment focus toward green energy and away from oil and gas is that national oil companies (NOCs) may end up with even more power – at least in the short term. Regardless of what happens in the long term, worldwide energy needs are not decreasing. So while some oil and gas firms may gradually get squeezed out of the market, it may lead to even greater reliance on the NOCs for their production. And this may give them greater political leverage. But NOCs should act judiciously; if they push their advantage too hard, it may backfire and end up with a faster shift away from consumption of oil and gas in the longer term.

It’s impossible to predict the future. Who could have imagined the COVID 19 pandemic that’s upended the world and the global economy for two years? Or the military invasion of Ukraine by the Russian government that what will likely be a profound political and economic global fallout.

Much of what may happen is out of the control of the oil and gas industry. However, the following are some steps you may want to consider taking so that your organization will be as well positioned and prepared as possible regardless of what occurs in 2022.

• Have an ESG (environmental, social and governance) plan in place to proactively address activist investor and stakeholder concerns. Tackle the issues head-on rather than waiting to respond under pressure.
• Review your organizations’ crisis playbook. Does it include all potential scenarios, and is it updated regularly?
  
• Review your organization’s commodity risk management philosophy. Prepare for how short and long-term changes in the pricing environment could impact customer and shareholder sentiment, and also government involvement.
• Understand how proposed legislation and government actions could impact your company: Determine if your organization has the flexibility to shift gears quickly to take advantage of opportunities as political agendas change.
• Focus on relationship building: Continue or increase efforts to build relationships with all relevant stakeholders, including consumer groups, governments, regulators, and society at large. In the same way, consider industry and cross-industry cooperation efforts to proactively shape reasonable regulation with governments.
• Get your supply chains in order: Review your current setup and determine how you can reduce disruption and improve resilience.
  • For example, are your operations flexible and resilient enough to adapt and adjust in real-time to changes in trade flows, new regulations, continued COVID-19 disruption, climate change, trade tensions and other geopolitical movements?
  • Is your technology current so you can reduce operating costs, provide visibility, and seamlessly diversify the way customer needs are met?
• Review your organization’s cyber defense protection: The risk of a cyber breach is perhaps the most underestimated above-ground risk in the oil and gas sector. It cuts across political and geographical boundaries, and any company, regardless of size, is a potential target. No matter your location or where you operate, you are equally vulnerable to a cyber security breach.

As this article has highlighted, there hasn’t been a time where there’s been more uncertainty for oil and gas companies. What is certain, however, is that the world is not going to go back to where it was, and the oil and gas industry will need to change. There will likely be a continuing push for decarbonization and other climate control efforts, whether by governments or activist and consumer groups, and incremental tweaks to technology may not do the trick.

The speed and intensity of the transformation may be impacted by short-term supply and price issues and geopolitical events, but the future direction is clear. The oil and gas industry will need to change, and you should be taking steps now to prepare for the inevitable.  

The oil and gas industry has faced a talent shortage for years due to an aging workforce, limited new/young talent entering the industry, and growing competition for talent with the technology industry. This difficulty in getting and retaining talent, which may pose significant issues for the future of the industry, can be attributable to several factors:

The negative perception of the industry: The industry is often cast in a negative light by the media. As a result, many talented individuals tend to shun the industry – although this is by no means universal.

That’s why oil and gas companies continue to rely on the experienced crews who often come back after retirement as contractors.

What’s more, there may be a need to “import” foreign employees from India, China and Russia, for example, to help fill the breach. But that also may entail a host of political, immigration and security issues.