On the Spot

Jennifer Fox, Managing Director , AfricAsia Capital

February 2015

Q: What is the greatest challenge now facing Asia’s oil and gas industry in ensuring future growth and meeting the energy demands of the region?

A: Only a few months ago, the challenges for Asia’s oil and gas industry were centered on how to keep pace with burgeoning demand in the region, powering a growing population and sustaining GDP growth. Key issues at the time were how to find the talent needed to grow the business and controlling rapidly escalating project costs.

What a difference a few months has made to this outlook. The combination of weakening demand and growing supply from North America has seen the oil price plummet by more than 45% since mid June. For the industry globally, the talk is now of cost cutting and reduced capital spending and this will surely play out for the industry in Asia.  High cost projects will inevitably be deferred.  For players with strong balance sheets there will undoubtedly be opportunities as more highly geared companies look to sell down some of their portfolio.  In some cases, full-scale consolidation plays may develop.

The knock on effect will be passed down the line to the O&G industry suppliers and smaller players who will suffer the most, without alternative and more reliable streams of income. This will have repercussions throughout Asia, as a likely wave of consolidation in the services sector will occur, as we just saw with the Halliburton takeover of Baker Hughes.

If we look back on history, following the slump in crude prices in 1990, there was a flurry of M&A activity that changed the face of the industry, with The Seven Sisters reduced to five and many mid sized players losing their independence. If the oil price weakness prevails for any length of time, we can expect to see further industry consolidation again during 2015. Indeed the trend may have already started with the recently announced US$8.3 Billion takeover of Talisman by Repsol.

The challenge will be for those with good assets but weak balance sheets; to not sell out too soon as the current price volatility creates ambiguity in valuations. It is clearly a Buyers market.

Add this scenario to current financial instability in the markets, due not only to the Oil price, but problems in Russia, falling demand in China, possible rate rises in the US & fears of another debt bubble, and immediately the availability of capital for both Emerging markets and by default, the O&G sector almost dries up, as a fast flight to safety inevitably results.    

With Oil stocks continuing to take a beating, Investors are alarmed that the energy industry may be a fast-growing part of yet another high-yield debt bubble, the last of which came to a dramatic end in 2008 with the mortgage security bubble, when oil also dived from $147 to $32 in under 5 months. Add on further fears of falling cash flows threatening dividends, and investors are heading for the hills. 

While the short-term outlook is clearly challenging, in the long run the lower oil price is likely to stimulate demand again. This may be more noticeable is Asia, where import dependence is highest.  Paradoxically, short-term pain may well lead to long-term gain for the sector as a whole.

In conclusion: The current price drop is the greatest challenge for both capital availability and deployment and pure investor sentiment, which is shunning the energy sector at present and for the short-term future. 

The survivors and successors will be those with solid capital and cash flow – prerequisites to be able to navigate the current storm into calmer waters.

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