Why Big Oil Is Helpless To Prevent A Supply Crunch

Why Big Oil Is Helpless To Prevent A Supply Crunch


<p>While volatility fears partly explain the behavior, IOCs have also promised shareholders tight capital discipline, returning any surplus from higher prices back to investors through increased dividends and stock buybacks.</p> <p>Big Oil is atoning for past sins. During the last up-cycle before the 2014 crash, the group acted like $100-plus oil would be around forever. It squandered immense amounts of capital in mega-projects that suffered cost overruns and delays. The <a href="https://www.reuters.com/article/kazakhstan-kashagan-production/update-1-kashagan-oil-output-seen-back-to-normal-from-mid-april-after-maintenance-work-idUSL5N1RH437" target="_blank" data-ga-track="ExternalLink:https://www.reuters.com/article/kazakhstan-kashagan-production/update-1-kashagan-oil-output-seen-back-to-normal-from-mid-april-after-maintenance-work-idUSL5N1RH437" rel="nofollow">Kashagan project in Kazakhstan</a> became the poster child for this, with a group of majors shelling out&nbsp; $55 billion to launch the technically challenging project. Analysts now reckon it will take more than a decade for the companies to recover their sunk costs. The result: international oil companies generated a lower return on capital at $100 oil than in the early 2000s when prices hovered around $20 a barrel.</p> <p>It’s unsurprising investors now demand tight capital discipline, forcing the majors to put “hard ceilings” on expenditures. Shareholders now scrutinize any large project to make sure it’s profitable at low oil prices. But there are only so many such “good” projects out there in non-OPEC countries, which has stemmed the flow of new supply from potential offshore and oil sands.</p> <p>The oil industry has also pumped the brakes on exploration expenditures. Discoveries of conventional oil by the global oil industry <a href="https://www.iea.org/newsroom/news/2017/april/global-oil-discoveries-and-new-projects-fell-to-historic-lows-in-2016.html" target="_blank" data-ga-track="ExternalLink:https://www.iea.org/newsroom/news/2017/april/global-oil-discoveries-and-new-projects-fell-to-historic-lows-in-2016.html" rel="nofollow">fell to historic lows</a> in 2016 and 2017. Paal Kibsgaard, CEO of Schlumberger says the industry will face <a href="https://www.upi.com/Schlumberger-sees-growing-supply-challenges/2641524226970/" target="_blank" data-ga-track="ExternalLink:https://www.upi.com/Schlumberger-sees-growing-supply-challenges/2641524226970/" rel="nofollow">growing supply challenges</a> in coming years and that a “significant increase in global E&amp;P investment will be required to minimize the impending production deficit.”</p> <p>A significant increase in investment hasn’t materialized, however. Indeed, the IEA says the recovery from the historical drop off in investments – by 25% in both 2015 and 2016 – has “<a href="https://www.iea.org/oil2018/" target="_blank" data-ga-track="ExternalLink:https://www.iea.org/oil2018/" rel="nofollow">barely started</a>.” The investment rate was flat in 2017. Early data suggests only a modest rise in 2018, with outlays overwhelmingly focused on U.S. shale where there is greater clarity on growth.</p> <p>In recent months there has been an uptick in <a href="https://www.bloomberg.com/news/articles/2018-06-21/chevron-deep-water-tentacles-show-big-oil-rivaling-shale-in-gulf" target="_blank" data-ga-track="ExternalLink:https://www.bloomberg.com/news/articles/2018-06-21/chevron-deep-water-tentacles-show-big-oil-rivaling-shale-in-gulf" rel="nofollow">deep-water activity</a>, but the <a href="https://www.rystadenergy.com/newsevents/news/press-releases/oil-gas-projects-coming-off-backburner/" target="_blank" data-ga-track="ExternalLink:https://www.rystadenergy.com/newsevents/news/press-releases/oil-gas-projects-coming-off-backburner/" rel="nofollow">oil sands</a> – high-cost reserves requiring mammoth outlays – have seen little momentum. At best, it looks like a case of too little, too late for these sectors. Upstream investment, the IEA concludes, “may be inadequate to avoid a significant squeezing of the global spare capacity cushion by 2023, even as costs have fallen and project efficiency has improved.”</p> <p>Many thought shale oil would save the day, but while it continues to perform well the looming supply deficit may now be too big to overcome, particularly with President Trump determined to <a href="https://www.wsj.com/articles/u-s-signals-zero-tolerance-on-future-iran-oil-exports-1530028859" target="_blank" data-ga-track="ExternalLink:https://www.wsj.com/articles/u-s-signals-zero-tolerance-on-future-iran-oil-exports-1530028859" rel="nofollow">fully implement sanctions</a> on Iran, and the ongoing troubles in Venezuela and Libya.</p> <p>The U.S. Energy Information Administration (EIA) forecasts <a href="https://www.eia.gov/outlooks/steo/report/us_oil.php" target="_blank" data-ga-track="ExternalLink:https://www.eia.gov/outlooks/steo/report/us_oil.php" rel="nofollow">domestic oil production to average 10.8 million barrels a day</a> this year, up 1.4 million barrels a day from 2017. In 2019, oil output is forecast to increase rapidly again, averaging 11.8 million barrels a day, which would push the United States to the top of the producer list.</p> <p>Shale will ultimately run into severe infrastructure restraints without investment. Indeed, bottlenecks are already popping up. The situation is aggravated by <a href="https://www.forbes.com/sites/daneberhart/2018/04/19/president-trumps-tariff-threaten-to-blunt-americas-booming-energy-sector/#51f9d46457ff" target="_self">Trump’s trade policies</a>, as tariffs add to industry costs and threaten to close valuable markets. Shale is also facing capital discipline demands from its investors. John Hess, CEO of Hess Corp., said recently that <a href="https://www.reuters.com/article/us-oil-opec-hess/focus-on-returns-now-will-hurt-long-term-u-s-shale-oil-investment-hess-idUSKBN1JH1DB" target="_blank" data-ga-track="ExternalLink:https://www.reuters.com/article/us-oil-opec-hess/focus-on-returns-now-will-hurt-long-term-u-s-shale-oil-investment-hess-idUSKBN1JH1DB" rel="nofollow">investor sentiment had shifted</a> over the past year. “I’d say it’s gone from drill, baby, drill,’ to ‘show me the money,’ he said. Hess added that fiscal discipline would “act like a break on long-term investment.”</p> <p>The lack of investment threatens to curb future shale growth, putting even more pressure on other sources of non-OPEC supply. They look unlikely to deliver.</p>”>

With OPEC’s supply cut agreement effectively dead, and Saudi Arabia and Russia racing to hike production, the oil market has clarity on a critical component of global supply.

Under pressure from President Donald Trump, Saudi Arabia is preparing to max out production to near its capacity of 12.5 million barrels a day as Washington gets ready to apply harsh economic sanctions on Iran in November. Saudi Arabia’s Gulf OPEC allies, the UAE and Kuwait, are taking similar steps, while non-OPEC member Russia is eager to boost revenues to support its oil-dependent state budget.

But OPEC and Russia together account for only about 40% of the 100 million barrels a day oil market, leaving an incomplete picture of global supply as disruption fears continue to support rising prices.

Non-OPEC supply will be critical to determine whether the market can avoid another price spike to $100 or higher. On this front, the supply outlook – outside of America’s booming shale plays – is grim.

OPEC, the International Energy Agency (IEA) and several multinational energy companies warn that investments in large oil projects – multi-billion dollar schemes in plays like deep-water or oil sands — have not responded to the oil price recovery and still largely reflect the trends seen in the immediate aftermath of the prolonged oil price collapse of 2014, which saw oil prices drop as low as $30 a barrel in early 2016.

Knowing the importance of deep water, oil sands and other “megaprojects” to future global supply, OPEC, and the IEA have been for some time urging international oil companies (IOCs) to hike capital expenditures in exploration and development. But IOCs are ignoring these calls and are continuing to plan around oil prices closer to $50-$60 a barrel, never mind $75 or higher. They are still operating in “lower for longer” mode, having recently survived the worst oil price downturn in history.

While volatility fears partly explain the behavior, IOCs have also promised shareholders tight capital discipline, returning any surplus from higher prices back to investors through increased dividends and stock buybacks.

Big Oil is atoning for past sins. During the last up-cycle before the 2014 crash, the group acted like $100-plus oil would be around forever. It squandered immense amounts of capital in mega-projects that suffered cost overruns and delays. The Kashagan project in Kazakhstan became the poster child for this, with a group of majors shelling out  $55 billion to launch the technically challenging project. Analysts now reckon it will take more than a decade for the companies to recover their sunk costs. The result: international oil companies generated a lower return on capital at $100 oil than in the early 2000s when prices hovered around $20 a barrel.

It’s unsurprising investors now demand tight capital discipline, forcing the majors to put “hard ceilings” on expenditures. Shareholders now scrutinize any large project to make sure it’s profitable at low oil prices. But there are only so many such “good” projects out there in non-OPEC countries, which has stemmed the flow of new supply from potential offshore and oil sands.

The oil industry has also pumped the brakes on exploration expenditures. Discoveries of conventional oil by the global oil industry fell to historic lows in 2016 and 2017. Paal Kibsgaard, CEO of Schlumberger says the industry will face growing supply challenges in coming years and that a “significant increase in global E&P investment will be required to minimize the impending production deficit.”

A significant increase in investment hasn’t materialized, however. Indeed, the IEA says the recovery from the historical drop off in investments – by 25% in both 2015 and 2016 – has “barely started.” The investment rate was flat in 2017. Early data suggests only a modest rise in 2018, with outlays overwhelmingly focused on U.S. shale where there is greater clarity on growth.

In recent months there has been an uptick in deep-water activity, but the oil sands – high-cost reserves requiring mammoth outlays – have seen little momentum. At best, it looks like a case of too little, too late for these sectors. Upstream investment, the IEA concludes, “may be inadequate to avoid a significant squeezing of the global spare capacity cushion by 2023, even as costs have fallen and project efficiency has improved.”

Many thought shale oil would save the day, but while it continues to perform well the looming supply deficit may now be too big to overcome, particularly with President Trump determined to fully implement sanctions on Iran, and the ongoing troubles in Venezuela and Libya.

The U.S. Energy Information Administration (EIA) forecasts domestic oil production to average 10.8 million barrels a day this year, up 1.4 million barrels a day from 2017. In 2019, oil output is forecast to increase rapidly again, averaging 11.8 million barrels a day, which would push the United States to the top of the producer list.

Shale will ultimately run into severe infrastructure restraints without investment. Indeed, bottlenecks are already popping up. The situation is aggravated by Trump’s trade policies, as tariffs add to industry costs and threaten to close valuable markets. Shale is also facing capital discipline demands from its investors. John Hess, CEO of Hess Corp., said recently that investor sentiment had shifted over the past year. “I’d say it’s gone from drill, baby, drill,’ to ‘show me the money,’ he said. Hess added that fiscal discipline would “act like a break on long-term investment.”

The lack of investment threatens to curb future shale growth, putting even more pressure on other sources of non-OPEC supply. They look unlikely to deliver.



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