Bricks and mortar

According to David McMillan, oil and gas companies are adjusting their corporate real estate strategies to respond to the new operational reality


According to David McMillan, oil and gas companies are adjusting their corporate real estate strategies to respond to the new operational reality

The 18 months between July 2014 and the beginning of this year have been challenging for the oil and gas industry. Oil prices have fallen by more than 70 per cent, putting significant pressure on companies’ profit margins. A recent uplift, albeit encouraging, does not yet guarantee a permanent revival. Supply remains high, and is forecast to marginally surpass global requirements over the next two years, while oil producing countries continue to negotiate a joint protective strategy. As oil and gas companies tend to have significant capital expenditures and comparatively high space per employee ratios, they are looking at how real estate strategies can help them withstand market pressures.

The effect the low oil price is having on real estate is multi-faceted. On the one hand, the overall impact on office real estate markets is quite limited. JLL continues to forecast increases in leasing and rental levels in 15 out of 24 key European markets in the next four years. Strong demand from other industries will maintain pressure on availability of space in prime locations, driving sustained rental growth and increasing office space costs for oil and gas companies in major European cities.

On the other hand, for oil producing regions and cities heavily exposed to the industry, notably Aberdeen, UK and Stavanger, Norway the impact has been more keenly felt. Falling demand for products and services from the resulting in reduced workforce requirements and slowing demand for real estate. Space requirements from smaller players and oil service companies are likely to drop further as many may lack the financial resources of the oil majors to weather the storm.

In Aberdeen in particular there is a significant oversupply of corporate space. Prime headline office rents have been stable with increased incentives, which is in itself an indicator of weakened real estate market. In this time of market uncertainty, occupiers are reluctant to enter into pre-let agreements and are increasingly concerned about flexibility, workforce requirements, and space optimisation. Many have realised that they need a proactive long-term real estate strategy to be able to future-proof their business.

An immediate response from the oil and gas sector has been to focus on cost cutting and postpone further spending. For many companies this lead to headcount reductions and asset divestments. In the most acute examples, market pressures are forcing businesses to file bankruptcies and default on loans. According to Standard and Poor’s data, the oil and gas sector contributed to over a quarter of the total global corporate defaults in 2015. A number of oil and gas companies, especially those with low debt to equity ratios, are expected to explore options for raising capital and increase borrowing.

Real estate tends to be put under scrutiny when financial pressures are high. According to JLL’s latest Global Corporate Real Estate (CRE) Survey, 77 per cent of CRE teams reported increased demands to reduce operating expenses. Furthermore, we observe that the expectation that real estate should deliver cost savings is now part of business as usual. Adverse market conditions put additional pressure on oil and gas companies, impacting real estate strategies and demanding a plan of action from real estate teams. Real estate can deliver significant savings to the organisation, which is why many oil and gas companies are turning to proactive real estate management.

Real estate strategies to support the cost-cutting agenda

Portfolio analysis and review
Many oil and gas companies are reviewing and analysing their real estate portfolios. Understanding the composition and usage patterns of their corporate space helps them estimate excess costs arising out of highly expensive and underutilised locations. Forensic review of assets can identify space inefficiencies, which, when addressed in a timely manner, can substantially reduce operating expenses. General right sizing and consolidation of space equally supports the cost cutting agenda and improves efficiency of the corporate real estate portfolio, ensuring that the core operational requirements are met.

Cost reduction
Oil and gas companies are actively reviewing high cost production locations and associated real estate requirements and identifying savings from expensive offices. Many are using lease break options, subletting, and releasing excess space where demand from space remains strong. This way oil and gas companies can substantially reduce their costs without compromising on key locations. Many companies are benefiting from lease restructuring for the core locations, improving efficiency of their contract arrangements.

Monetisation of assets
Similarly, there has been a greater focus on capital-raising and exit options from core and non-operational portfolios, as occupiers with owned real estate seek to take advantage of wellperforming real estate investment markets. Since for many oil and gas leaders growth is still a priority, capital raised through the sale of real estate can be reinvested back into the business to support operations and business expansion.

Increasing flexibility and agility of the portfolio
The results of JLL’s Global Corporate Real Estate Survey suggest that well over half (64 per cent) of CRE executives experienced increased demand for bringing more flexibility to the leasehold portfolio and on-demand space. This trend is particularly relevant to the oil and gas sector, which in the current climate, is exposed to volatilities in workforce requirements and increasing disruption of traditional operational models by transformative technologies.

Finally, as some larger and more financially robust companies are taking the opportunity to capitalise on the low oil price phenomenon and acquire assets and stakes at below-market value, the industry is likely to see some increase in targeted M&A activity in the near future. Those companies considering acquisitions should be preparing their real estate portfolios for the coming changes. M&A activity frequently becomes a catalyst for optimising space and taking a fresh look at how corporate real estate strategy can support wider strategic objectives.

Growing global concerns around talent attraction and retention are encouraging business leaders to evaluate their workplace environments. For oil and gas companies this is a great time to tackle pending talent shortfall as the current generation of senior executives begin to look towards retirement. Forward-looking companies are shaping their real estate strategies today around the talent needs of tomorrow. Whilst immediate market pressures force oil and gas companies to focus on cost reduction, there is still a strong argument for building a real estate strategy that can support the wider strategic objectives around growth, innovation, and talent.

JLL
David McMillan is Director & Energy Sector Lead, JLL. JLL is a professional services and investment management firm offering specialised real estate services to clients seeking increased value by owning, occupying and investing in real estate. On behalf of its clients, the firm provides management and real estate outsourcing services for a property portfolio of 4.0 billion square feet, or 372 million square metres, and completed $138 billion in sales, acquisitions and finance transactions in 2015.

For further information please visit: jll.com