Commodities 2022: Oil market tightness could resurrect crude investment in coming years

Renewed market tightness in the latter half of 2022, rather than repeated warnings over a looming oil investment shortfall, could give fresh support to oil prices and add impetus to an eerily cautious investment climate.

It would appear to be simultaneously the best and worst era to invest in the politically sensitive fossil fuel. Fears over stranded assets and greater push to meet greener investor goals sit side by side with capital discipline and potentially sustained higher prices should supply remain limited.

Key producers Saudi Arabia and the UAE and top investment banks like Goldman Sachs and JP Morgan warn of a potential mismatch between the ongoing energy needs and the jitters of Big Oil reluctant to spend on replenishing their lifeblood that could lead to triple digit oil prices.

While S&P Global Platts Analytics notes that most projects are viable at the $50/b mark, the majority of projects this year have been those deferred from 2020 and there will need to be a sharp pick up in final investment decisions to avoid a steep decline. Confidence that prices will stay higher for longer may well be needed.

"The uncertainty on future oil prices, as we have had many price cycles in the past 50 years, is producing caution among oil operators, particularly in the US where capital discipline has become a religion ... those days of growth in oil production for the sake of growth appear to be finally gone," said Rene Santos, an oil analyst with Platts Analytics.

"We're heading toward a phase that could be dangerous if there's not enough spending on energy," Saudi oil minister Abdulaziz bin Salman said in December, as he highlighted the risk of an "energy crisis" this decade.

Joe McMonigle, the secretary general of the International Energy Forum, also said recently that two straight years of massive capex cuts are leading to a supply shortage that could destabilize the global economy. "We can't let the climate crisis turn into an energy crisis," he said.

The International Energy Agency may see the solution long-term in sustainable energy sources with its landmark net-zero scenario -- requiring oil demand to plummet to 25 million b/d by 2050 from close to 100 million b/d currently -- but the practical realities for hydrocarbons are hitting hard. "We are not investing enough to meet for future energy needs, and the uncertainties are setting the stage for a volatile period ahead," IEA Executive Director Fatih Birol warned earlier this year.

Economic sense

But with Platts' Dated Brent oil prices already higher than recent historical averages for much of 2021 and potentially likely to stay elevated especially in the latter half of 2022, the economics of investing in oil is starting to appeal. There are striking similarities that could see oil prices in the next few years mirror the high oil price era that kicked off the previous decade.

"Global upstream investment is set to continue to increase in the mid-term as Brent is expected to stay above $65/b," Platts Analytics said in a research note, highlighting the close correlation between spending on exploration and production and oil prices. Investment may have fallen 24% last year, but is set to post a respectable 8% rise this year and similar growth in the next couple of years, according to Platts Analytics.

Before the pandemic hit US crude production had hit 13 million b/d and shale's ability as the marginal producer to bring on barrels quickly had eased concerns over the drop-off in longer-cycle investment. But with Big Oil reluctant to spend on the shale patch given the growing importance of sustainable investment targets, output has not returned in the same way.

"US operators are now paying down debt and increasing returns to operators while moderately increasing investments/production," Santos pointed out.

US rig counts have been creeping higher for around 18 months led by private and independent operators and while Platts Analytics sees US production returning and exceeding its record peak, it may take a couple of years before that happens.

Even typically costlier investment areas like Canadian oil sands and the North Sea make a lot of economic sense at current oil prices, let alone in the big powerhouses of US shale, Russia and Saudi Arabia.

However, JP Morgan warns that $80/b may be needed to close what it estimates to be a $750 billion capital expenditure gap through to 2030 and to deliver a balanced market in the years ahead.

Market tightness

Both JP Morgan and Platts Analytics estimate sustainable spare capacity at around 2 million b/d -- mostly in the hands of Saudi Arabia and UAE -- going into next year, which is around its long-term average and can cover a strong demand recovery but leaves the market exposed to supply risks.

Indeed, there is plenty of supply optimism for 2022 given the growth stories in Canada, Brazil, Kazakhstan, Norway and Guyana, but questions over the US supply recovery and the risks around ever-volatile Libya and Iraq persist. Meanwhile, Iran could add 1.4 million b/d of extra crude if sanctions are lifted. Still a rather big if.

If oil prices remain elevated, even if they don't reach the $100/b oil heights many market participants like to draw attention to, the incentive to invest in crude will be too much to resist.

"Oil majors that went green in the last two years will show their true colors in 2022," independent oil consultant Anas Al-Hajji commented, noting that oil prices will be higher next year than in 2021 given the lack of inventory build and robust demand.

So, while there is a strong market expectation that supply will outpace demand, this could come at a time when stocks need to be replenished including strategic inventories, OPEC+ spare capacity is at a low ebb and US shale growth is stymied by capital discipline.

This could leave oil prices at a level that will resurrect investment from its moribund state even from the most environmentally conscious of energy companies. It may well be just in time given the investment in sustainable energy solutions is set to fall well short in meeting those immediate needs.