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New wave of oil and natural gas mega-projects set to test capital discipline: Wood Mackenzie

Highlights

Pressure growing to deliver bigger projects

Project IRR's have slumped to 12%

Risk of return to large cost overruns

London — A new wave of oil and natural gas mega-projects lined up for approval by producers over the next 18 months will test industry hopes that cost overruns and delays on large-scale, complex upstream projects are a thing of the past, according to a report by Wood Mackenzie.

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An uptick in major project sanctions began towards the end of last year, suggesting confidence is returning to the upstream sector and project approvals are set to shift again in 2019, Wood Mac believes.

Most of the new planned projects are giant, capital-intensive LNG plants with multi-billion boe developments such as Mozambique LNG, LNG Canada. LNG expansions in Qatar and Papua New Guinea are also eyeing final investment decisions. FIDs for deepwater oil off Brazil, Guyana, Nigeria, and the US Gulf of Mexico are also on the cards.

But with free cash flow generation building as oil prices hold over $70/b, pressure is growing on producers to stick with their mantras of capital discipline amid a growing risk of over-confidence in launching large-scale projects, according to Wood Mac's research director Angus Rodger.

"There is a looming wave of big pre-FID LNG developments building on the horizon, all aiming for sanction between 2018 and 2020," Rodger said. "After a fallow period in new LNG project sanctions, and megaprojects in general, the next 18 months will likely see a step change. This will be the real test of whether the industry has addressed the issue of poor delivery."

FINANCIAL PAYLOAD

Keeping a lid on project costs will be key, particularly as oil major's switch of focus to smaller, quick-return projects during the downturn is "not sustainable longer-term an industry underpinned by large, cash-generative assets," according to Wood Mac.

The oil and gas industry has struggled to deliver big projects in recent years with poor capital discipline meaning many projects were delivered late and over budget.

Oil prices of $100/b encouraged the industry to take on complex developments, with big footprints designed to maximize reserve recovery and NPV, according to Wood Mac. The research group calculates that the top 15 cost blowouts were a cumulative $80 billion over budget, or an average of 53% over budget versus the initial forecast at FID.

The impact of the downturn on the economics of large projects has also been dramatic.

The weighted average internal rate of return, or IRR, for fields sanctioned through the period of 2008-2014 was 19% when sanctioned, Wood Mac estimates. Today, these same projects average 12% and just over a third have an IRR of below 8%, including most of the top 20 biggest projects by capex.

This year, Wood Mac expects at least 30 major project FIDs are expected in 2018, compared to total of 32 FIDs in 2017.

LNG PROJECT RISK

Wood Mac notes that a number of mid- to large upstream projects have been delivered on target over the past 12 months, many in areas notorious for cost blowouts, such as the Arctic and Caspian. Examples include Novatek's Yamal LNG plant and BP's Shah Deniz Phase 2 off Azerbaijan.

But there are still reasons to be concerned, according to Rodger. Two of the key factors that led to all seven of the recent Australian LNG ventures coming in over budget and delayed were remote locations and the strains of simultaneous development.

"We see the same characteristics again in many of the pre-FID LNG projects, which will be competing for the same manpower and service companies if sanctioned at the same time," Rodger said.

--Robert Perkins, robert.perkins@spglobal.com

--Edited by Maurice Geller, maurice.geller@spglobal.com