Upstream KPIs turn positive
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We've had the best year for the oil and gas industry for some time: KPIs have turned positive.
Brent looks set to end 2017 over US$60/bbl, up 40% from the summer lows. Financially, oil and gas companies have turned a corner, some already generating free cash flow and accelerating returns of capital to shareholders. Even in a challenged global gas market, Asian demand is booming and LNG prices have bounced.
Many of us can look forward to a happier holiday season after enduring three torrid years of this downturn. But have things really turned for the better this soon?
There’s a false sense of security – like when calm descends half way through a horror movie.
We don’t think there’s a gory finale waiting to jump out and scare the living daylights out of the oil sector in 2018. But there are very good reasons not to be complacent.
First, the oil price won’t hold above US$60/bbl.
OPEC cuts have tightened the supply and demand balance and the market has again become sensitive to disruption (like the current Forties system outage) as well as geopolitical unrest. The current tightness though is temporary; the underlying market is over supplied for some time.
Global supply growth will outstrip demand growth in 2018 even with OPEC cuts in place all year, and will do so again in 2019 if cuts end. US tight oil is rampant (growing 1.2 million b/d in 2018) and will capture over 90% of contestable global demand through 2024.
This leaves little room for OPEC to increase market share on our forecasts for years or to regain a measure of control. Indeed, Brent over US$60/bbl will only spur new non-OPEC investment and leave OPEC out in the cold for longer.
Second, costs still need to be driven down further.
‘Low cost’ has rightly become the industry mantra and has to remain so. Ashley Sherman, Senior Upstream Analyst, and his colleagues reckon in our latest global survey that upstream costs will fall by 30% in the four years to end 2018.
But most of the drop has been borne by the service sector, now on its knees. There is scepticism as to how much progress has been made on structural cost reduction that will stick with any upturn in activity.
Outside the US Lower 48, operators are only part way through the transformation needed to provide a healthy opportunity set for investment.
Some greenfield projects in some geographies have made great strides to commerciality – NPV,15 breakevens for Norway’s big Johan Castberg project have been reduced from US$85/bbl in 2015 to US$55/bbl at FID earlier this month. Many others still don’t meet the demanding hurdle rates being applied.
What’s needed? More of the Johan Castberg model – re-scoping and re-engineering; better project execution; and broader technology-based structural change across the upstream value chain. Digitalisation isn’t yet embedded in upstream, but will be more prominent in 2018 and become a catalyst for improved productivity.
Third, the industry isn’t investing enough to sustain itself.
The Majors are spending much more on dividends and buybacks than organic investment. The investment rate for the Majors in 2017 is US$14/bbl – down 50% from 2014. This is spend on exploration and development per barrel produced – a proxy for the capital needed to sustain volumes.
At the same time, dividends have been maintained through the downturn (with the exception of Eni) at a rate of US$19/bbl. Shell and BP’s buyback plans announced in Q3 actually increase the proportion of cash to be returned to shareholders.
The industry as a whole can’t sustain low levels of investment for too long without shrinking.
The Majors’ production profiles are robust into the early 2020s and they don’t have an immediate need to invest. But other IOCs and NOCs do.
The rally in oil prices brings a welcome boost to end-of-year margins. But the industry can’t be distracted even momentarily from its quest to position for an uncertain future. The big challenges of over supply and the energy transition have not disappeared.