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Oil majors rethink upstream spending amid face-off for cheapest barrels


Recent investments at odds with energy transition scenarios

European majors lead transition, but US shale provides flexibility

Fate of weakest upstream assets still unclear

  • Author
  • Robert Perkins
  • Editor
  • Alisdair Bowles
  • Commodity
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London — Global oil majors are being forced to reevaluate the resilience and cost of new oil and gas projects to accommodate weaker demand outlooks and lower long-term prices in the wake of the COVID-19 pandemic.

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The West's top nine oil majors alone are sitting on more than 28 billion barrels of oil equivalent of undeveloped resources, according to company filings, and low prices in 2020 have already sidelined about a third of global oil and gas investments, raising concerns on the potential for future "stranded assets".

Resources held by Western energy majors could be the tip of the iceberg. According to the International Energy Agency, some 250 billion fewer barrels of oil and 30 Tcm less gas will need to be developed by 2040 for the world to hit its Sustainable Development Scenario (SDS), an outlook compliant with the Paris Agreement to hold the rise in global temperatures to below 2 degrees.

But despite mounting concerns over climate change, most companies are counting on prices that are inconsistent with global warming targets, according to climate think-tank Carbon Tracker.

Last year alone, 15 projects sanctioned by IOCs with a combined $60 billion in investment risk become stranded assets under the IEA's SDS demand scenario, according to a recent Carbon Tracker study. These include ExxonMobil's $10 billion Golden Pass US LNG project, Chevron's $6.3 billion deepwater Anchor US oil project, and Shell's $3.9 billion deepwater Mero Sepetiba project in Brazil.

In Europe, BP and Eni have already laid out plans to shrink their upstream portfolio, largely by shedding higher-cost resources to focus on their lowest-cost barrels.

Last month, Shell acknowledged for the first time that its oil production has likely already peaked, as the pursuit of "value over volume" accelerates for its upstream assets. Like many of its oil major peers, Shell has prioritized lower-cost upstream assets in recent years, selling off parts of its legacy portfolio and investing in large-scale gas assets and higher-margin deepwater and US tight oil acreage.

Often referred to as portfolio "high-grading", the sale of more costly, carbon-intensive assets by the oil majors will likely ramp up in the coming years as players prioritize developing of resources most resilient to lower future oil prices.

On the flip side, spending on low-carbon projects by European majors is starting from a low base but is set to rise sharply. In the case of Shell, upstream capex will shrink to around 35%-40% of the total by 2025, down from 50% currently, with about a quarter of spending going on a "growth portfolio" of marketing, power, biofuels and hydrogen.

Cheap barrels rule

Despite a flurry of new green spending pledges this year and ambitious low-carbon investment targets, oil and gas absorb the biggest share of oil majors spending by some distance.

Europe's three biggest oil majors, for example, plan to spend on average about 8% of their total capex on renewables and low-carbon investments this year. The US majors, which lag their European peers on green investments, have yet to even quantify their spending on renewables and low-carbon projects.

Collectively, oil majors are poised to spend just over $18 billion on wind and solar projects until 2025, according to Norway's Rystad Energy. The total, however, pales in comparison to the $166 billion they are forecast to spend on greenfield oil and gas projects during the same period.

Portfolio exposure is highly linked to demand outcomes and future prices under different scenarios. Under a faster shift to low-carbon energy, projects with the lowest production costs will be most competitive while high-cost projects run a greater risk of becoming stranded assets.

"The majors are focusing on the advantaged resources – high margin, low cost, low carbon risk," said Luke Parker, the vice president of energy consultants Wood Mackenzie, noting this also means "getting rid of the barrels and molecules that don't work -- the resource that will be stranded in a 2-degree future."

European/US divide

The threat to reserves and stranded capital varies widely by company and country. European energy majors are prioritizing lower-carbon gas resources and this means their upstream spending is least at risk from weaker demand under the IEA's "Beyond 2 Degrees Scenario" (B2DS). The picture changes, however, under the less stringent SDS, with US majors benefitting from the high degree of price sensitivity for shale assets, according to Carbon Tracker.

Eni and BP are amongst the best-prepared companies under the B2DS scenario, although up 60% of their respective portfolios are still uncompetitive, the report finds. By contrast, a higher exposure to short-cycle US shale plays sees Exxon and Chevron rank much better overall in the SDS outlook.

"I think if you start a shale well now you know it's going to be off your books much sooner than if you do an offshore platform," said Dan Klein the head of scenario planning at Platts Analytics. "Shale is the paragon of short-cycle oil supply and can step in if there is a shortage of supply, so it is a reasonable risk-reward at this point."

Meanwhile, big-ticket, multi-decade offshore oil developments are most at risk as there's a limited number of companies that have the resources and expertise to make them work efficiently.

Company outlooks on oil demand will also be informed by the prevailing policy climate, factoring in the likelihood of curbs such as the carbon-intensity of specific oil projects and gas flaring.

"In an efficient market there has to be sufficient return to bring on new supply and probably the divergence between European and American majors is the fact that American majors think that demand might be a bit stronger in the near term at least," Klein said.

Stranded or transferred?

It remains unclear, however, whether the energy transition will force Big Oil to leave billions of barrels that were previously assumed to be recoverable left in the ground.

Unwanted reserves held by oil majors could be sold and developed by smaller producers or privately-held companies less encumbered by shareholder ESG concerns.

Typically majors produce reserves on their books over a 20-30 year horizon. With average production decline rates from existing fields of about 8% per year, the risk to them of large-scale stranded assets could be relatively small given that oil and gas is expected to remain a key part of the global energy mix for decades.

Upstream resources that are written off as impairments as companies lower their future oil price assumptions are also being rapidly revalued by the market, feeding expectations of a surge in industry consolidation through mergers and acquisitions.

European oil and gas companies alone have shed more than $400 billion in market value this year as investors turn away from fossil fuel producers amid weaker oil price expectations.

With that in mind, perhaps the bigger threat to the sector in the near term is the potential for stranded value rather than stranded upstream assets.