The Fuse

Spending Declines, Low Discoveries Prompt Worries About Long-Term Oil Supply Outlook

by Nick Cunningham | January 17, 2018

Total capital and exploration spending on global oil and gas will likely bottom out in 2018, and investment may not recover to the levels seen before the market downturn in 2014 until the mid-2020s.

Underspending has already translated into the lowest volume of oil discovered in decades. With expenditures continuing to lag previous years, global oil markets are likely in danger of being short of supply at some point in the 2020s. Ironically, increased drilling in the U.S. could leave the oil market struggling with excess supply in the near term, possibly exacerbating overall spending shortfalls.

Too little spending, too few discoveries

The volume of new oil and gas discovered has been in decline since 2012, according to a recent report from Oslo-based Rystad Energy. In 2016, total discoveries hit a record low at eight billion barrels of oil equivalent (boe), a figure that declined once again last year to about seven billion boe. As recently as 2012, it was not uncommon for the industry to discover several billion barrels of oil equivalent per month.

The volume of new oil and gas discovered has been in decline since 2012.

Other statistics illustrate the depth of the problem. Rystad said the reserve replacement ratio—the volume of new oil discovered relative to what was extracted in a given year—reached only 11 percent last year. That compares to a ratio of over 50 percent in 2012.

Moreover, the size of each discovery was also lower last year. The average 2017 discovery held about 100 million boe, or about a third smaller than the 150 million boe average in 2012. Lower reserves per field lead to fields ultimately being undeveloped. “Low resources per discovered field can influence its commerciality. Under our current base case price scenario, we estimate that over 1 billion boe discovered during 2017 might never be developed,” Sonia Mlada Passos, senior analyst at Rystad, said in the December report.

Rystad estimates that over 1 billion boe discovered during 2017 might never be developed.

The dearth of new discoveries is the direct result of a significant contraction in spending across the globe, which led to projects cancelled, rigs sidelined, and several hundred thousand workers laid off. Total spending on capital and exploration peaked in 2014 at $900 billion, according to Rystad. Upstream spending has fallen since then, contracting by 24 percent in 2015 and an additional 25 percent in 2016. Rystad predicts that spending will bottom out in 2018 at $510 billion before recovering in the years ahead—but total upstream spending might not hit 2014 levels until 2025.

Shale takes over

North America was hit the hardest by the contraction, with spending dropping by more than 30 percent per year in 2015 and 2016. Because of their short time horizons, shale projects were quickly scaled back.

But with shale also able to ramp up rapidly, Rystad predicts that as global spending increases, North America will attract most of that additional investment through the mid-2020s, averaging a compound annual growth rate of 8 percent through 2025. In fact, shale is already growing quickly, with the number of North American oil wells drilled jumping by 40 percent in 2017. That has contributed to total U.S. oil output rising close to the 10 mbd level. The EIA predicts that U.S. production will average 10.3 mbd this year, and 10.8 mbd in 2019.

North America will attract most additional investment through the mid-2020s, averaging a compound annual growth rate of 8 percent through 2025.

The increase in shale could take the market in two different directions. U.S. shale continues to attract rigs and investment, while the rest of the world struggles to rebound to pre-2014 spending levels. These two trends tend to result in a feedback loop—if increased U.S. shale output keeps oil prices suppressed, marginal projects around the world will remain sidelined, setting the stage for a possible price spike in coming years.

Supply problems for 2020s

Total investment is an imprecise metric when forecasting future production growth. Cost deflation has helped lower the amount needed to produce a barrel of oil, and rig counts can also be a misleading indicator. U.S. oil production surged in the second half of 2017, adding roughly 700,000 b/d when there was a negligible increase in the rig count. Increased efficiency is a caveat that needs to be taken into account regarding any supply forecast.

Shale “cannot increase indefinitely and, when it slows, new projects will need to be ready to keep the market from tightening abruptly.”

Nevertheless, low spending threatens long-term supply. U.S. shale output still only represents slightly more than six percent of global oil production. Sharp growth is set to contribute to a well-supplied market and counter OPEC cuts for now—but the ability of the Permian, the Eagle Ford, and the Bakken to satisfy the growth in worldwide oil demand going forward is questionable. Moreover, shale’s possible bearish impact on oil markets in 2018 and perhaps even 2019 “could also keep prices at a level that inhibits the development of projects with longer lead times elsewhere,” the International Energy Agency wrote in its 2017 World Energy Outlook.

And precisely because of those long lead times, the impact of “near-record lows of new conventional oil projects receiving approval in recent years has yet to be fully seen,” the IEA wrote. Shale will continue to grow in the short run, but it “cannot increase indefinitely and, when it slows, new projects will need to be ready to keep the market from tightening abruptly.”

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