Capital expenditures (capex) of global integrated oil and gas companies are expected to fall a further 8% in 2017, according to a recent outlook by RBC Capital Markets. The continued decline is driven by a combination of reduced, and more phased, activity as well as cost deflation. Total capex for the majors is seen at $123 billion this year, which is about half the peak in 2013.
"Assuming our price assumption of $58/bbl Brent for 2017, we expect the sector to generate a total of $174 billion in operating cash flows, implying a capex/cash flow ratio of 71%, significantly below the full cycle average of 85-90%. We expect dividends to be roughly covered by operating cash flow through further divestments, mostly mid or downstream assets, for those majors who have higher free cash flow break-evens in the near term," the report said.
"Capex budgets for the majors in 2016 were particularly dynamic, with the lag in planning cycles meaning that original spending plan discussions for the year likely started when oil prices were higher than the lows seen in January and February. Interestingly, as we moved through the year, oil prices continued to rise while capex budgets kept on their downward trajectory."
According to RBC, for the sector as a whole, expectations for capex in 2017 have steadily edged lower and are now 30% below what they were at the start of last year. ExxonMobil Corp., Statoil ASA, and BP PLC stand out as cutting the most, while the increase in expectations for Repsol SA at the start of last year reflects the integration of the Talisman Energy Inc. acquisition.
Cost deflation continues
With the recent rally in oil prices, an important question for longer-term investors and one that has been of more focus in 2016 is: Will the "cost deflation" story continue?
"Although some areas may be more reactive to higher oil prices (e.g., rig rates), our analysis of the latest data points suggest most other parts of the cost spectrum should continue to see deflation, which is likely to continue to put downward pressure on spending over the next year. Overall, we see the majors well placed to capture the deflation in 2017, whilst benefiting from improved oil prices," the report said.
While rig rates have been particularly reactive to lower oil prices, both on the downside and more recently following the production cut announcements by the Organization of Petroleum Exporting Countries, contract-based services are less reactive, but deflation is ongoing: Multiple areas have taken longer to see a material reduction in costs, including engineering services, platform construction, and maintenance, although it appears costs in all of these areas are now being driven down. RBC believes this lag is driven by order backlogs, which sometimes can be as much as 2 years (e.g., South Korean construction yards).
New project sanctions
Following the multiple project deferrals in 2015, 2016 was a year of showcasing for the majors, highlighting that they could sanction projects at significant lower commodity prices, and still maintain economic returns, helped by continued cost deflation.
"Looking at the sector overall, we expect the total volumes sanctioned to increase from 2016 into 2017, and even more so from 2017 to 2018. In sum, we expect just over 1 million b/d of volumes to be sanctioned in 2017 (net to the majors) an increase from 900,000 b/d in 2016. The highest profile projects include Libra in Brazil (Total, Shell), as well as a number of Gulf of Mexico prospects including Vito, Kaikias, and Rydberg (all Shell-operated)."