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The Edge

Should IOCs invest more in upstream?

NOCs dominate spend on new oil and gas projects

4 minute read

The world needs more oil and gas to strengthen energy security – it’ll be a good few years before low-carbon supply eventually takes over. Banks and investors have acknowledged the shift in sentiment, many softening their hardline stance on financing fossil fuels. Does that open the door for a flood of E&P investment? Fraser McKay, Rob Clarke and Greg Roddick of our Upstream Research team are doubtful and shared their thoughts with me.

First, E&P investment is already in an upcycle, it’s just much more muted than in the past. Upstream budgets are up 10% for the year, and we forecast global investment will rise to around US$480 billion in 2023. That’s well above the cyclical low of US$380 billion in 2020 though barely half the 2014 peak.

Second, another healthy crop of conventional projects is poised for final investment decision (FID) in 2023, underpinning spend in the coming years. We count 40 projects, holding 25 billion boe of resource (two-thirds oil), which will require total investment of up to US$170 billion.

Regional hotspots account for the lion’s share. The Middle East captures most of the spend, mainly for giant projects in Qatar, Abu Dhabi and Saudi Arabia. North America is next with large-scale projects in Alaska, Canada and the Gulf of Mexico. The US Lower 48 is evergreen, contributing one-fifth of global spend, with drilling activity at three-year highs, and lifting tight oil production to record levels this year.

These 40 conventional projects are marginally cleaner than current fields in production, with an average full-life emission intensity of 19 kgCO2/boe (Scope 1 and 2). The economics, too, appear robust – the Class of 2023 achieves a 15% average IRR at a Brent price of US$50/bbl, similar to last year’s crop.

However, whether all make it to FID this year is another matter. Windfall taxes, cost inflation and financing costs threaten returns and undermine confidence in investment. We reckon only 30 conventional projects will be sanctioned, the second year in a row that FIDs underwhelm against expectations. US Lower 48 spend is also at risk from the same cost challenges.

Third, national oil companies will do much of the heavy lifting in conventional investment, continuing the gradual shift away from IOCs that’s been underway for a decade. NOCs operate all of the top five pre-FID projects ranked by reserves – ADNOC with three, Qatar Energy and Petrobras (deepwater Brazil) with one each. IOCs partner on some of these and operate other pre-FID projects (mostly deep water). The biggest of the latter are ExxonMobil’s Stabroek Phase 5 in Guyana and Eni’s Baleine Phase 2 in Cote D’Ivoire though both are the latest phases of bigger developments and not in the same league reserves-wise.

To get this close to sanction, any project has to be low cost, low carbon and have a short development cycle to deliver early production and cash flow. ExxonMobil and Eni are both shooting for a rapid 36 months. We expect companies to delay FID on projects where there is a risk to metrics, much as TotalEnergies has done on its huge greenfield Suriname oil development in the last few weeks.

Fourth, the big question is whether IOCs should be increasing investment beyond current plans and budgets. It’s one thing for NOCs to develop the indigenous resource that may be the primary engine of their economies. Moreover, low-cost reserves such as those in the Middle East will have an economic durability through almost any demand or price scenario that unfolds. For an IOC with a portfolio of pre-FID conventional projects, the risks are very different.

The Russia-Ukraine war has changed the immediate perspective on how quickly the world can move towards a net zero pathway. IOCs are starting to adapt – BP’s decision in February 2023 to row back from its aggressive plans to reduce production and emissions is a tacit recognition that oil and gas will be needed for longer.

Not all projects in an IOC’s hopper will be low cost and low carbon, or as swift to bring to production as the best-in-class. Many will have payback periods of 10 to 15 years and asset lives of 20 years or more. Cash flows and returns from these projects will be generated next decade which may be a whole different world. Any FID puts a project in the lap of the gods, but the risks today are that much higher.

Our view is that IOCs will invest more, but it will be incremental – that’s one way to limit or avoid cost inflation and keep investors on board. For the most part, IOCs will tap the same rich seam of the last several years – short-cycle, low-cost and low-carbon projects. The Class of 2023 shows that doesn’t have to mean exclusively more tight oil or shale gas. Some of the best opportunities will be giant deepwater projects – TotalEnergies’ and Shell’s huge discoveries in Namibia show there are more of these to come.  

We have not bought into the view that the industry is under investing in upstream supply, a theme we will expand on in a forthcoming Horizons insight. If FIDs do fall short in 2023, we’d see it as a good sign of corporate behaviour – that companies are sticking with capital discipline in the face of firm prices. The industry can’t afford to fall into the trap of the bad old days of the 2010s.