Underinvestment In Oil And Gas May Cause Major Problems

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By Tsvetana Paraskova

Following an unpredictable and shocking 2020, stability and sustainability are set to be the two major themes in the oil and gas industry this year.

Companies in the sector will continue prioritizing financial resilience to boosting upstream investments, as global oil demand, although higher than in 2020, will still be below the pre-crisis levels.

In addition, more and more oil and gas firms will include sustainability, the energy transition, and Environmental, Social, and Corporate Governance (ESG) considerations in their strategic and investment plans, Wood Mackenzie said in its first look into the biggest themes in oil and gas this year.

“New businesses, and new business models, are emerging from the wreckage of 2020. Companies will focus their investment on building a foundation which will be sustainable across a range of scenarios,” says Wood Mackenzie’s Senior Vice President of Corporate Research, Tom Ellacott.

Diversification into green energy, including renewable electricity generation, hydrogen, and carbon capture, is set to accelerate, as a growing number of oil and gas firms will start talking about decarbonization and net-zero emissions targets.

Sure, the upstream will continue to be a core business for the major oil corporations at least for a few more years, as it will continue to be their “cash engine,” as BP has recently said, although it plans to have its oil and gas production drop by 40 percent within a decade.

The reshaping of the portfolios and the careful capital allocation after the third major shock to the industry in just over a decade will see continued underinvestment in oil and gas, analysts say.

The declining upstream investment, if not reversed in the next few years, could lead to a crude oil supply gap later this decade, regardless of when peak oil demand will occur. The world will need large amounts of oil even when global oil consumption stops growing.

Upstream Investment Not Picking Up

Following the shock in 2020, most oil and gas companies will be very careful with capital spending this year, and upstream investment is set to remain flat over 2020, although oil prices are expected higher than last year.

The industry will invest around US$300 billion in upstream oil and gas this year, flat compared to 2020, and close to a 15-year low, according to WoodMac.

“Falling prices would mean rapid cuts, whereas at higher prices, contingency and resilience will outweigh enthusiasm to take advantage of a nadir in service sector costs,” said Fraser McKay, Head of Upstream Analysis at Wood Mackenzie.

Around 20 large-scale oil and gas projects are expected to be sanctioned in 2021, up from only 10 in 2020, but half of the final investment decisions (FIDs) that were being taken each year before the pandemic.

Moreover, projects will be increasingly judged by their ESG credentials, WoodMac says.

For many companies, reducing debt will take precedence over boosting investment, while many others will optimize their upstream portfolios to turn in faster cash generation.

“We expect to see short-cycle opportunities move even further up the capital allocation pecking order, with exploration and marginal long-life projects losing out in the competition for capital,” WoodMac’s Ellacott said in the 2021 outlook.

Renewables Investment Rising

Last year, the crash in oil prices and the look into what reduced oil demand could mean for the industry prompted many European oil majors to unveil strategies for net-zero emissions within three decades.

Rather than stalling, the pandemic accelerated the efforts toward a lower-carbon energy mix, also supported by growing pressure from shareholders, society, and many governments vowing to ‘build back better’ with a focus on clean energy.

The oil and gas industry will be raising investments in green energy this year, according to new research by DNV GL, a technical advisor to the sector.

A record two-thirds, or 66 percent, of senior oil and gas professionals said their organization was actively adapting to a less carbon-intensive energy mix in 2021, up from 44 percent in 2018. Around 57 percent plan to increase investment in renewables, up from 44 percent in 2020, the global survey of over 1,000 senior industry professionals and executives showed this week.

To compare, a fifth of respondents, or 21 percent, reported their organization would boost investments in oil projects this year.

“Decarbonization has moved from something on the horizon to an immediate priority, and there are signs that our sector may invest to transform rather than cut its way out of the present crisis,” said Remi Eriksen, Group President and CEO of DNV GL.

“Sleepwalking Into A Supply Crunch”

The growing industry focus on low-carbon energy solutions could leave the oil market exposed to a supply deficit in just a few years.

OPEC+ currently has a lot of spare capacity that could come on stream when demand recovers. But sustained investments in oil and gas will be needed to meet global consumption of oil, which the world will continue to need, peak demand or not.

“The world may be sleepwalking into a supply crunch, albeit beyond 2021. A recovery in oil demand back to over 100 million b/d by late 2022 increases risk of a material supply gap later this decade, triggering an upward spike in price,” says Simon Flowers, Chairman and Chief Analyst at WoodMac.

Crude Oil

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