Tough decisions ahead for energy companies

May 7, 2014
Opportunities abound, but challenges are numerous.

Opportunities abound, but challenges are numerous.

OIL & GAS FINANCIAL JOURNAL: Niloufar, can you tell our readers a little about your background and how you came to be vice chair, greater Houston market managing partner, and head of the US energy practice at PricewaterhouseCoopers?

MOLAVI: I have a bachelor's degree in accounting and a master's in professional accounting with a concentration in taxation from the University of Texas at Austin. After graduation in 1991, I joined the former Price Waterhouse (now PwC), at a time when the firm was growing its oil and gas tax practice.

It was an exciting time to start my career. Our practice was expanding globally to meet the growth of the energy industry as new opportunities were opening up in places like Russia, the former Soviet Union. Given that the US was the headquarters for our global energy practice, we started to transfer a lot of our talent overseas at that time to open new offices in Eastern Europe, Asia and Africa. It was a very good opportunity for me, as a young associate, to step up and take on new opportunities that I had never done before, and really watch the transformation that was happening from an industry perspective. I loved it. Growing up through our oil and gas tax practice, I had the chance to do a lot of international work, including some non-conventional tax projects and some research and development tax projects. Not only was I seeing firsthand all of the industry at play, but I was learning a lot about new technologies impacting the energy sector as part of that. I was fortunate enough to make partner in 10 years, and a few years later, I was asked to lead our US energy tax practice here in Houston.

Then I had an opportunity to do something very different and serve as the chief diversity officer for PwC. It was an incredible experience but a few years later there was an amazing opportunity for me to come back to the Houston market to lead the US energy practice and become the managing partner of what we refer to as the greater Houston market, which includes Houston, New Orleans, Tulsa, and Oklahoma City. That's how I got to be where I am today.

OGFJ: How many people do you employ in the Houston office?

MOLAVI: We have about 1,600 people.

OGFJ: Did you leave Houston when you were chief diversity officer?

MOLAVI: I commuted, so I did not move my family. I spent 90% of my time on the road, not only in New York, where our US headquarters are, but I traveled across the country to all our offices.

OGFJ: Can you provide an overview of what PwC does in the energy sector?

MOLAVI: We cover three different spectrums of work within energy. Most people know PwC for our audit and assurance practices for which we have served our US and global clients for many years. People also know us as a provider of tax consulting services domestically and worldwide. The area that people may not be as aware of is our consulting practice, which econsists of three areas: deals, forensic services, and management consulting.

Photos by Sylvester Garza

Obviously, the deal side includes M&A transactions, helping our clients with due diligence and even sell-side diligence, all the way though the transaction and integration in all areas, including financial, valuation, and so forth. Forensics includes areas such as third-party compliance, support for arbitration, litigation and dispute analysis, securities litigation and investigations, including FCPA compliance. Management consulting is across the spectrum from operations and operations effectiveness to security, technology, people and change, risk, innovation, and capital projects and infrastructure, to name a few. In early April, we completed our acquisition of Booz & Company, which has now enhanced our strategy consulting capabilities.

OGFJ: How would you describe the current state of the energy sector, particularly the oil and gas industry, relative to other industries in the US?

MOLAVI: When you look back at the 2008-2009 recession, it's clear that Houston and the energy sector in general fared better than the rest of the country. That doesn't mean that the market and sector were immune to the effects but the relative impact of the recession was not as significant here in Houston or elsewhere where energy is a key driver of the economy.

PwC does an annual CEO survey where we ask CEOs around the world in all economic sectors about the trends and issues they're seeing most affect their companies and industries. The survey also includes a cut focused on feedback from CEOs in the energy sector. According to this year's survey, 41% of the energy CEOs is confident about the continued growth of their own businesses, but only 15% of them are optimistic about the growth prospects within the energy industry. So there's a pretty big gap there, which I think is indicative of some of the challenges that the energy industry will continue to face, such as how to deploy capital, how to do more with less, and how do the investors see value.

There is a lot of growth expected in this industry, but it's not going to happen overnight. It's going to happen over the next 20 years or more. We saw significant increases in capital budgets in 2013 for most companies, but we're seeing some of that reduced already in 2014, in part because companies are trying to absorb everything that was acquired or investments that were made in the prior year. Also, investors today tend to want companies to be more focused on certain core competencies where they feel they can understand and get their arms around what the company actually does. There's no lack of opportunity in the industry, but with limited resources, now is the time to make some tough decisions.

OGFJ: Are low natural gas prices helping the manufacturing sector make a comeback?

MOLAVI: I think there are several growth factors, one of which is the low cost of energy. Global manufacturers, over the past few years, were facing higher labor costs in the foreign jurisdictions, increased regulation, and higher transportation costs. Compared to the US, with its lower energy costs, the US looked more inviting to many global companies. They were attracted to the abundant skilled labor, the lower cost of raw materials, and a more certain regulatory environment. All of this has had an impact, but you also can't discount the role that the low cost of natural gas has had on their decisions.

OGFJ: The US is on the verge of becoming a major exporter of natural gas in the form of LNG. Some in the manufacturing sector believe this will drive up prices domestically. In your view, is this a concern?

MOLAVI: You're right. Many of the manufacturers have been very outspoken about why we shouldn't be exporting LNG. However, producers are going to increase the level of production beyond what we have today with the export option. Increased production to meet both domestic use, as well as exports, will help stabilize prices. The supply is going to keep up with the demand.

Interview Niloufar Molavi of PricewaterhouseCoopers

OGFJ: US oil production has reached a level we haven't seen since the 1970s. The Permian Basin just surpassed the Eagle Ford and Bakken shale plays in oil production for the recent quarter. What does this upward curve in domestic oil production mean for the petroleum industry and for investors?

MOLAVI: This has been talked about a lot. The industry expects there will be more than $5 trillion in investments made in the oil and gas industry over the next 20 years. And it's going to be across the board, not only upstream producers but the infrastructure that needs to be built to support that with midstream companies and downstream companies – pipelines, processing plants, power plants, etc. Everybody is going to be involved. The need is there.

If you look at the megatrends, there is a tremendous rise in demand for energy in places like China, with the rise of the middle class there. Car ownership in China has risen exponentially in recent years, and increased car ownership means increased use of energy. I remember seeing one statistic that says we should expect to see a 50% rise in energy use globally, not only in China, but in places like Turkey, Indonesia, and Mexico. There is some decline in developed countries due to declining populations, but overall the outlook is for a sharp increase in energy usage because of the emerging economies. The increase far exceeds the decline. New technologies will help us meet the rising demand.

OGFJ: Midstream construction has been on the uptick mainly due to shale development. Considerable oil production is currently being shipped by rail due to lack of transportation infrastructure in some regions. How long will it take midstream build-out to catch up with shale development?

MOLAVI: Rail has always been a source of transportation in the petroleum sector, but in the past 18 to 20 months we've seen a spike in shipments due to significant increases in oil production. The midstream companies are spending a lot of capital and expanding their infrastructure. Delays in decision making around opportunities such as the Keystone XL pipeline have made an impact. While that debate will continue, companies are doing what they can in the meantime to focus on putting in infrastructure where it is needed to get those resources to the refineries, processing plants, and eventually to the LNG export facilities.

OGFJ: This a broad question, but what are some of the trends you're seeing in the oil and gas sector at this time?

MOLAVI: Our industry continues to look for ways to become more cost efficient in everything from operations to supply chain management. The shale plays present several challenges for companies: how to grow faster, cheaper; how to move more efficiently between multiple plays; and how to transform the oilfield into a manufacturing operation. When you're talking about managing costs in this industry, it's also importatnt to consider real-time quality data. Consequently, we spend quite a bit of time working with our clients on digital oilfield and their ability to process data and react to it in a timely manner.

Who are you talking to about issues like this? Is it an E&P company or a technology company?

MOLAVI: Actually, it's mainly the oilfield service and drilling companies, but the E&P company has to be on the same page with their service providers. The services companies are feeling pressure from their clients to manage costs, be more efficient, reduce drag time. Whether they're in the Gulf of Mexico or the Eagle Ford shale play, they all have the same motivations.

The aging workforce has also been a big issue in the energy industry. It tapered off during the recession, but now companies are dealing with it again. With many baby-boomers retiring, there is a big talent gap between their generation and the younger, less experienced industry workforce. The supply of talent is finally reaching acceptable levels as more students are entering engineering professions, but now the challenge for companies is determining how to take the new talent to the next level. This has actually presented PwC with an opportunity. We've been working with companies to help them learn how they can develop talent and resources, better manage knowledge transfer and leverage technology to bring less-experienced professionals up-to-speed.

OGFJ: Do you see continued foreign investment in North American oil and gas? Will it mainly be in the form of company acquisitions, joint venture agreements, supply agreements, or all of the above?

MOLAVI: Foreign investors are looking for different reasons to do business in the United States. A lot of the time, the foreign investor is looking to obtain access to technology, and that's typically done through a joint venture transaction. In those circumstances, the US company remains the operator because the foreign company doesn't yet have the expertise it needs. The US company benefits because it obtains the capital from the joint venture that it needs for further business development.

PwC publishes a quarterly report on M&A trends in the energy sector, and we analyze all the transactions. The first quarter of 2014 has been very strong. Our data shows a significant number of M&A transactions after a period when things were has stabilized toward the end of last year. We also saw the number of US transactions involving a foreign entity go up significantly in the first quarter.

OGFJ: Several independent E&P companies have told me they are capital constrained. They have more drilling opportunities than available capital. What impact does this have on drilling and development activity?

MOLAVI: Again, I think this is among the choices they have to make. When most companies came out with their capex budgets for 2014, we saw some decline. Part of it is that they're trying to optimize investments and expenditures from last year. We're seeing a lot of divestments that companies don't consider core assets. They have to choose which areas they want to focus on. But the fact is this is a capital intensive industry, and you're going to spend a lot before you get a lot out of it.

OGFJ: What is your outlook for the offshore industry, particularly in the Gulf of Mexico? It looks as if the GoM shelf is enjoying a comeback, but deepwater and ultra-deepwater drilling has slowed a bit.

MOLAVI: In general, what we are seeing is that companies are focused on the use of the latest technology that's available. Investments need to be made to upgrade to newer drillships that have the latest technology onboard. They may not be able to use it, but it can be used elsewhere. Some companies are divesting of assets to enable the investments in upgrades.

OGFJ: Do you see any significant regulatory events coming down the pike, such as increased state or federal regulation of hydraulic fracturing?

MOLAVI: This is an industry that has a long history of being regulated and will not be immune going forward. We've already seen quite a bit of new state legislation dealing with fracking. But will the industry continue to see further regulation? I think it would be hard to say at this time. It's just a matter of how much and to what extent? One of the top concerns in this year's CEO survey was uncertainty around regulation.

OGFJ: Final question: You have a strong background in taxation. Do you see any possibility for federal tax reform in the near term?

MOLAVI: Not in the near term, depending on how you define near term. It will be very difficult to see any kind of major tax reform anytime in 2014, mainly because of the midterm elections this year. Also, I think it would be difficult to see a bill advance far enough in Congress before the next presidential election in 2016. Everybody agrees on one thing – we need tax reform in this country. Where the disagreements come into play is how we're going to get there. That's the sticking point, and the two sides are very far apart in terms of the philosophies of what tax reform really means. It's going to be a long journey, but along the way we will see small bits of certain legislation passed because some of that will be necessary with the expiration of certain provisions. Major tax reform will likely come later than some would hope.

OGFJ: Thanks very much for your time, Niloufar.