By Irina Slav
Investment in new oil and gas projects last year sank to the lowest in 15 years at $350 billion. As the world continues its battle against Covid-19 and as the energy industry increasingly looks towards diversification outside its core business, it is doubtful how soon—if ever—investments in new upstream projects will recover to pre-pandemic levels.
This is not to say there is no sign of recovery in investments. Wood Mackenzie reports there are a total of 26 new projects in conventional oil and gas that could get their final investment decision this year. These projects, the Wood Mac analysts said, would require some $110 billion investments to unlock about 27 billion barrels of oil equivalent in reserves.
One interesting thing about these projects, which shows the changes that the energy industry is undergoing, is that more than 50 percent of the reserves to be tapped with these projects are natural gas reserves. Many of the largest projects slated for greenlighting this year are in liquefied natural gas, notably Qatar Petroleum’s expansion of production at the North Field. A tenth of the projects awaiting FID this year are deepwater production, and the rest are a mix of offshore and onshore projects.
According to Wood Mac, however, there is no guarantee that all these projects will indeed receive a final investment decision. This is due to a variety of reasons, chief among them the expected rate of return, carbon intensity, and the political context.
Returns—and the period they will take to make an appearance—have become of the utmost importance for oil and gas investors, and they have also become a top priority for the companies themselves. While before it was usual to pour millions in projects that might not return the investment for decades, the focus is now on shorter return periods, which means short-cycle projects have the best chance for approval.
LNG projects are not short-cycle ones. LNG facilities require massive upfront investments and take years to generate first returns. There are six large-scale ones due their FID this year, according to Wood Mac. The payback periods for these six projects vary between 10 and 15 years, which casts a shadow over their FIDs.
For one thing, as carbon intensity begins to garner more headline space, investors are increasingly paying attention to emissions—and so are buyers. While not standard practice yet, there are signs that carbon-neutral LNG may well be the standard LNG of the future, which means additional investments in carbon capture systems or other ways of reducing the emissions footprint of LNG extraction and production. It remains to be seen whether all planned LNG projects will be greenlit in this context.
The carbon issue has become an important one for oil investments, too. The demand outlook has brightened considerably as lockdowns end, and people start traveling again, not to mention the marked preference for personal transportation in the post-lockdown times, which is driving fuel demand higher. Yet so has attention to emissions from oil production.
A recent article by Argus on the future of oil investments in the U.S. part of the Gulf of Mexico noted that any plans would need to take into account not just costs but also carbon intensity. Virtually every large energy company now has a low-carbon transition plan of some sort to appease investors, and while they would need money from selling oil to implement these plans, they would also need to be careful about the emissions footprint of this oil’s production.
It is certainly a complex situation for an industry that has become the target of growing criticism and increasingly close scrutiny, both from regulators and from shareholders. Under this twin pressure, many projects—not just this year—could lose their viability because emission reduction could, and often is, a costly undertaking.
Yet the world will still need oil—and gas—decades from now, and it will need millions of barrels of it daily. This means companies, backed by their shareholders, will continue investing in oil and gas exploration and production. If anything, the energy transition drive would lead to tighter supply for the abovementioned reasons. This tight supply, in turn, will push the prices of these energy commodities higher. And this will drive more investments in oil and gas, emissions and all.
One interesting news story from this week by Bloomberg notes that the rally in oil prices has boosted oil and gas ETFs but also, ironically, ESG funds. That’s due to how ESG funds are constructed, the story explained, but the end result is that people investing in ESG funds are investing part of their money in Big Oil. And when Big Oil does well, so do ESG investors. This might make for some interesting food for thought about ESG investing and oil and gas, and, on a related note, about emission reduction and energy demand and supply.
These are the basics that would ultimately prevail, whatever the political context. There is demand for oil and gas, so there needs to be supply, as at least two Big Oil CEOs, of Shell and BP, have recently noted. Until the world needs oil and gas, we will produce oil and gas, they said on separate occasions. And while some of the priorities in making a final investment decision on a new project may have changed, the top priority has remained: will it make money? As long as there’s demand, many projects will make money.