Spare production capacity to erode in absence of fresh investments, warns IEA

London — The world's oil production capacity is expected to slow in the medium-term as the market digests the full impact of COVID-19 and the pivot toward cleaner energy, the International Energy Agency said on March 17.

The Paris-based agency warned in its Oil 2021 report that the industry's spare capacity supply cushion will slowly erode in the absence of fresh upstream investments.

"By 2026, global effective spare production capacity (excluding Iran) could fall to 2.4 million b/d, its lowest level since 2016," the report said.

Global oil supply growth is set to slow down from 2021 to 2026 due to spending cuts, project delays, and demand uncertainty, caused by the oil price crash and the pandemic.

Only a marginal rise in global upstream investment is expected this year after they fell by a record 30% in 2020 compared to the previous year, the IEA noted.

Many in the industry have recently warned that oil and gas investment will need to see a huge boost to prevent a supply crunch that could send prices skyrocketing and tip the global economy back into crisis.

Impact on upstream

2020 was a cataclysmic year for the oil industry, as capital expenditure and upstream spending fell dramatically.

The deferral of upstream projects has wiped out over 2 million b/d of potential supplies by 2026, according to the IEA. But spending is likely to stay around 15% below 2019 levels in the medium term.

"While spending looks set to remain constrained this year, a modest return to growth has been flagged further ahead," the report said.

The report said that to meet the growth in oil demand to 2026, supply needs to rise by 10 million b/d by 2026.

The IEA has forecast global oil demand to rise to 104.1 million b/d from 2020, when it averaged 91 million b/d.

By 2026, total oil production will rise by 10.2 million b/d from a six-year low of 94 million b/d in 2020, the report said.

Investment dilemma

The heightened supply and demand uncertainties amid the energy transition are creating a dilemma for governments and oil companies reluctant to leave resources in the ground or build new capacity that may sit idle.

"But if this leads to a shortfall in investment, it could also have geopolitical implications and heighten the risk of supply shortages later on," the report said. "Investment decisions made today could either bring on too much capacity that is left unused or too little oil to meet demand."

The IEA however said the cost-cutting by the industry meant that the balance sheets now reflect the lowest portfolio break-evens in two decades, making it more "resilient to future commodity price shocks."

The historic collapse in demand resulted in a record 9 million b/d spare capacity cushion, most of which is in the Middle East, which will keep world markets comfortably well supplied for the next several years.

The Middle East, led by Saudi Arabia, will lead the supply growth, though most of it will be from existing shut-in capacity.

This marks a dramatic change from the past few years, when the US dominated world supply growth.

US oil production tumbled last year as the oil price crash and pandemic triggered company bankruptcies and production shut-ins.

"Although costs of production in the shale patch have fallen, the availability of cheap capital is not as plentiful as it was in the boom years," the report added. "The industry is consolidating and is taking a more conservative approach to investment than was the case when smaller independent companies were the dominant players."

Navigating the transition

The contrast between national oil companies and energy majors in their approach to this transition is likely to widen further.

"No oil and gas company will be unaffected by clean energy transitions, so every part of the industry needs to consider how to respond as momentum builds behind the world's drive for net-zero emissions," said IEA executive director Fatih Birol.

Major oil companies are scaling back conventional, more expensive oil projects and pivot to a lower-carbon environment and favor more climate-friendly investments.

Meanwhile, National Oil Companies, or NOCs, especially in the Middle East will continue to focus on traditional strategies that feature capacity building. But the steep loss in oil revenues in the past year has forced many to curb investments and delay projects.

Based on current government policies and industry plans, the energy transition initiatives will only have a marginal impact on oil demand from 2021 to 2026, according to the report.

The IEA said that only 12 out of the 127 countries that had pledged to reach net zero by 2050 or 2060, had proposed or enacted legislation for these targets.