Spending on worldwide oil and gas developments needs to increase by about 20% to meet future demand growth and ensure companies sustain production over the next decade, according to recent research from Wood Mackenzie.
“Companies will need to start investing again to sustain their business. But decision-making will be fraught with uncertainties, the oil price and energy transition not least among them,” said Malcolm Dickson, director, upstream oil and gas.
WoodMac’s research shows that recovery will be much slower and shallower than in previous cycles. Development spending will increase 5% this year, after a 2% rise in 2017. Investment rises from a low of $460 billion in 2016 to just over $500 billion in the early 2020s—far below the $750-billion peak in 2014.
Tom Ellacott, senior vice-president, corporate research, said, “Four years of deep capital rationing have had a severe impact on resource renewal, especially in the conventional sector. Companies are rightly cherry-picking the best conventional projects in their portfolios for greenfield development. But not enough new high-quality projects are entering the funnel to replace those that have left.”
As a result, conventional growth inventories have shrunk during the downturn. Global pre-financial investment decision conventional reserves now only cover 2 years of global oil and gas production. While there is a new wave of big LNG projects coming, investment in conventional, deepwater, US shale gas, and oil sands will be well below pre-downturn levels. Only US tight oil is set for consistent investment growth over the next few years, driven by activity in the Permian basin.
The result is a corporate sector divided in two: the US tight oil “haves” with a strong outlook for investment and growth; and the “have nots,” the majority of which face a looming production challenge next decade.
A new investment cycle
According to WoodMac’s calculations, annual development spending will have to increase to about $600 billion to meet future demand for oil and gas through the next decade.
But Ellacott does not expect a rush to reinvest. “Many companies will justifiably be concerned about committing substantial capital to long-term projects with peak oil demand and energy transition risks within the investment horizon,” he said. “There’s also a prevailing mindset of austerity designed to appease shareholders—investment is lower in the pecking order for surplus cash flow than dividends and buy-backs.”
WoodMac expects strict capital discipline to continue to frame investment decisions, at least in the near term. This will favor short-cycle, higher-return opportunities.
The performance of US tight oil will be critical. US tight oil spending peaks in 2023 at a level 20% higher than 2014 in a base case. Outperformance in the Permian could drive the upside to this figure. But there are also downside risks that will need to be carefully managed to ensure tight oil does not fall short of expectations.
Bigger and better conventional projects will ultimately be required. Around half of the reserves in WoodMac’s pre-FID project dataset need oil prices above $60/bbl to achieve a 15% return. In this disciplined world, many companies are screening new projects on long-term oil prices well below spot. Further progress in project rescoping, digitalization, and better fiscal terms will all need to play their part in getting these projects over the line.
Exploration success will also be crucial to replenishing depleted conventional inventories. Yet-to-find volumes offer great potential. But exploration budgets were slashed 60% during the downturn and have yet to recover. Spending will have to increase to deliver the required volumes to drive higher investment.