Over the last 12 months there has been an unprecedented level of cost cutting in the upstream energy sector. The price needed for companies to be cash flow neutral has fallen dramatically but production growth is faltering as a result of severe cuts to investment.
The trend of drastic capex cuts has demonstrated that the industry has a strong survival reflex. Fifty-six companies covered in Wood Mackenzie's corporate analysis will achieve cash flow neutrality at an average oil price of around US$50 a barrel Brent in 2016 and a growing list of companies will even be cash flow neutral below US$40 a barrel in 2016.
Cuts to exploration and production (E&P) investment have been the main lever. Spend in E&P has been reduced by 49% or US$230 billion, relative to 2014 levels. These cuts to capital investment have damaged growth prospects.
According to Wood Mackenzie's Corporate Benchmarking Tool, the aggregate five-year compound annual growth rate (CAGR) for production has fallen from 3.4% at peak in 2014 to only 1.4% in Q2 2016; the most affected peer group is the focused US Independents, where cutbacks have been the most severe.
Balance sheet management is front of mind across the industry -
cost containment and capital discipline are still the strident
messages emanating from all companies. But strategies will need
to shift away from survival mode and look to the future.
Tom Ellacott - Senior Vice President, Corporate Research
Only four companies are expected to grow at double-digit rates between 2015 and 2020. Lundin Petroleum, a Swedish independent E&P company with a stake in Norway's giant Johan Sverdrup oil development, ranks a clear first with 31%. At the other end of the spectrum, nearly 30 companies will be producing less in 2020 than in 2015.
Next generation growth projects are key to mitigating base-business declines. Production from legacy assets is in steep decline; the pace of recovery in North America onshore and a new wave of major growth project sanctions will be needed to maintain volumes next decade. The industry needs to take action if it is to move out of survival mode.
Many oil and gas companies are now starting to adapt to the new lower-for-longer price environment. Smarter capital allocation and efforts to rework projects to reduce costs are starting to pay off. But despite several high-profile recent project sanctions it may well be too early to call the start of the next investment cycle, as many of the next-generation projects still fall short of tougher economic hurdle rates, especially technically complex projects such as deepwater.
As the Q2 results season sparks to life we will be monitoring for signs of further cost reductions as companies re-engineer future developments.
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