Capex cuts: the road to rebalance or rebound? — Fuel for Thought

The supply response of US shale output to lower oil prices has garnered more than its fair share of news headlines over the last year.

Where the collapse of US drilling rates have been straightforward to track, the longer term consequences of more conventional, bigger-ticket spending cutbacks has been tougher to gauge. Outside shale, the much longer lead times and investment cycles of projects means the fallout of upstream cuts now — while no less real — is less tangible.

With low prices sapping investment dollars in new sources of supply, the scene is perhaps being set for a potential future price rebound rather than a sustained rebalancing of market fundamentals.

Oil producers have certainly been digging deep to cut their capital spending in a hectic bid to future-proof balance sheets from thinning cash flows projections. And the numbers have been stacking up.

Industry wide upstream spending is down 20% this year, according to the IEA and spending by the supermajors alone in 2015 is down by $22 billion, BP calculates.

But the headline capex cuts should not be mistaken for a proportional drop in activity levels — as part of the reduction is explained by falling costs. Since the oil price dive, the industry has become — understandably — fixated on capital efficiency and technology gains. Companies are doing more with less so the read across from outright spending to future production is not a straight line.

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The focus then, needs to be on the progress of actual projects rather than extrapolating the impact of cyclical spending plans, industry watchers note.

According energy investment bank Tudor Pickering Holt, some 150 oil and gas projects have been delayed or cancelled globally over the last 18 months, jeopardizing a combined 13 million b/d of future oil production. The bank believes the deferred projects — which exclude US shale — hold some 125 billion barrels of oil equivalent of resources, of which 60% are liquids and the rest gas.

Given average lead times and production lives of non-shale projects, the timing of the production impact would likely be felt from around 2020 for a period of 10 to 20 years, according to TPH’s Anish Kapadia.

Oil will still flow, but the question is: when?

But the deferrals don’t mean the reserves will stay in the ground. Many represent a re-phasing of investment, pushing fresh supply into future when price do recover.

“A bunch of projects will still go ahead, but some of the 13 million b/d will be pushed to the right in terms of timing,” Kapadia said. “A lot of these are price dependent — many struggled at $80-100/b, but costs and breakevens will come down and they could come back into play at a lower price.”

Kapadia sees ExxonMobil as most exposed to deferred projects in terms of reserves and production. Having deferred volumes equivalent to 60% of its proven reserves, ExxonMobil has effectively sidelined some 2.5 million boe/d of future production capacity from 25 projects, the bank calculates.

The IEA last month predicted that Russia, Brazil and Canada would bear the brunt of the medium-term supply hit, revising downwards it estimate of non-OPEC output in 2020 by 1.1 million b/d.

So how does all this stack up for oil market balances in the coming years and is the market facing an acute price rebound at the end of the decade?

Were it not for a slowdown in global economic growth, the expected demand boost from lower oil prices over the same period would certainly result in a sharply tighter market.

The IEA’s new long term energy outlook predicts a tipping point from 2020 when years of stellar non-OPEC oil supply growth is effectively thrown into reverse. Non-OPEC supply is expected to top out at 55 million b/d in 2020 before shrinking by 2.1 million b/d over the following decade.

Over the same period, world crude oil demand will grow by almost twice as much to 100 million b/d, the IEA believes, with the balance of supply thrown over to OPEC producers.

But the oil market downturn has accompanied more pedestrian assumptions of global economic growth. A year ago, the IEA saw both world oil demand and non-OPEC supplies above the current projections. The difference now is that upstream spending cuts today means OPEC will enjoy a bigger slice of the market in the future. For many, that switch of fortunes alone could stoke bullish sentiment over the oil price recovery. — Robert Perkins