Upstream: short-term spend and long-term trend

Upstream capital requirements depend on expected demand and achievable capital efficiency

At 2021 levels, the upstream oil and gas industry is underinvesting. Demand for oil and gas has rebounded rapidly, but the global investment recovery has not kept pace. Capital discipline, greater emissions scrutiny from stakeholders, price volatility and governments’ energy transition plans remain constraints.

But the underinvestment is probably less than many think. Spending is on the rise, led by national oil companies (NOCs) with double-digit budget hikes. As we wrote in our recent report, How much does the oil and gas industry need to spend?, we believe the industry is in the second year of a three-year recovery in activity and capital expenditure. We expected at least high single-digit increases in spending in each of 2022 and 2023, which would be enough for supply to meet our near-term oil and gas demand forecasts. But increasingly high prices combined with recent budget announcements could accelerate the rebound. Longer-term, we see the need for continued upstream investment to meet our demand forecast. Under our base-case scenario, a cumulative US$12 trillion of investment is required out to 2050.

To find out more, fill in the form for an abridged version of our report and, in the meantime, read on for an outline of our analysis.

Cost efficiency is the key

The industry’s relentless focus on capital efficiency after the 2015-16 downturn did much to unwind the equally relentless excesses of the 2010s. Absolute spending levels halved. More importantly, however, was the shift to lower-cost assets, reductions in like-for-like unit costs and improvements in project execution and efficiency. Consequently, when the 2020 downturn occurred, though spending intensity dipped, there was far less room for further efficiency improvements.

The balance between continued improvements in technology and digitalisation and service-sector cost inflation will dictate the absolute levels of spending required. Rising unit costs are likely, but the intense operator focus on cost discipline makes a return to runaway budgetary inflation highly unlikely.

Longer-term, around US$400 billion is required annually in real terms

Once the temporary spending recovery to restore growth comes to an end, investment growth will inevitably wane as demand plateaus and enters into a slow decline in the mid-2030s.

The critical factors determining the level of investment required will be demand expectations and capital efficiency. Despite potential price upside, we do not expect operators to change course. Capital discipline is working, and the industry’s approach has changed forever.

Deepwater and liquified natural gas (LNG) will be key drivers of the recovery in spending. The US Lower 48 will remain important, but play a smaller role than previously expected, as investors and operators focus on returns. Cuts to unconventional gas spending were less dramatic than tight oil, with the US industry already in the doldrums prior to the events of 2020.

The global near-term split of oil versus gas spending shows no real change, with oil still attracting nearly two-thirds of sector spending, despite international oil companies’ increased focus on gas’ Scope 3 emissions advantage and resilience to the energy transition.

Geographically, Brazil and Guyana will continue to step up as their advantaged deepwater oil assets are developed. Elsewhere, Qatar is in a big LNG expansion phase, while China is boosting domestic supply.

Resource-holding NOC’s share of global spend is increasing

Resource-holding national oil companies (NOCs) and low-cost operators will become bigger market players. The big NOC names have growth ambitions and intend to expand production of oil and gas while reducing carbon emissions intensity. The Middle Eastern NOCs are on an expansion drive to increase oil and gas capacity.

The Majors and Large Caps, in contrast, have permanently reduced their investment intensity and these will never return to pre-pandemic levels. The Institutional Investors Group on Climate Change (IIGCC) net zero standard, Glasgow Financial Alliance for Net Zero and other stakeholder initiatives are calling for participating investors and companies to commit to decreasing oil and gas spending. This is a key risk to ensuring sufficient investment recovery to meet expected demand.

Oil and gas new project returns at current prices are far above typical industry investment thresholds, which will test industry resolve. The oil price is signalling more investment, but the stock market is rewarding investment discipline. What works to balance the market might not work for public companies. The strategies and spending decisions of the NOCs will have a bigger role to play in defining industry spending levels.

Energy transition risks are growing

Persistently buoyant investment levels are not assured. The oil and gas industry faces enormous challenges as the world transitions to a low-carbon future. Listed companies, in particular, are facing growing scrutiny and calls for radical strategic change. Investors are demanding better financial performance coupled with rapid progress on environmental, social and governance (ESG) metrics, including carbon emissions.

The tension between operators targeting ever more cost improvements and a supply-chain that is approaching breaking point casts doubts over the industry’s ability to maintain capital efficiency. Price volatility due to demand uncertainties could reinforce or break discipline, or recreate capital starvation, perpetuating the risk of under- or over-investment, particularly by the Majors, Independents and private companies. This would cede market share to NOCs that are committed to oil and gas, and increase the chances of oil and gas price volatility later in the decade.

Even if demand declines rapidly, however, trillions of dollars of investment will be needed to compensate for natural decline rates. Under our accelerated energy transition scenario to reach a 2 °C pathway (AET-2), we still see the need for US$7.5 trillion of upstream investment by 2050.

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