Rocketing production costs, proliferating write-downs, stranded assets pave the way for renewable renaissance
An onlooker takes a photo of a fallen gas station canopy hit by Hurricane Irene, at the Atlantic Food Mart in Surf City August, 27, 2011. Photograph: Randall Hill/Reuters
The latest data from the International Energy Agency (IEA) and other sources proves that the oil and gas majors are in deep trouble.
Over the last decade, rising oil prices have been driven primarily by rising production costs. After the release of the IEA’s World Energy Outlook last November, Deutsche Bank’s former head of energy research Mark Lewis noted that massive levels of investment have corresponded to an ever declining rate of oil supply increase:
“Over the past decade, the oil and gas industry’s upstream investments have registered an astronomical increase, but these ever higher levels of capital expenditure have yielded ever smaller increases in the global oil supply. Even these have only been made possible by record high oil prices. This should be a reality check for those now hyping a new age of global oil abundance.”
Since 2000, the oil industry’s investments have risen by 180% – a threefold increase – but this has translated into a global oil supply increase of just 14%. Two-thirds of this increase has been made-up by unconventional oil and gas. In other words, the primary driver of the cost explosion is the shift to expensive and difficult-to-extract unconventionals due to the peak and plateau in conventional oil production since 2005.
The increasingly dislocated economics of oil production
According to Lewis, who now heads up energy transition and climate change research at leading investment firm Kepler Cheuvreux:
“The most straightforward interpretation of this data is that the economics of oil have become completely dislocated from historic norms since 2000 (and especially since 2005), with the industry investing at exponentially higher rates for increasingly small incremental yields of energy.”
The IEA’s new World Energy Investment Outlook published last week revised the agency’s estimates of future oil industry capital expenditures out to 2035 even higher, from $9.4 trillion to $11.3 trillion – an increase of 20%.
Oil prices could in turn increase by $15 per barrel in 2025 if investment does not pick up. Most of the investment increase required would be devoted not to new sources of production, but “to replace lost production from depleting fields,” said Lewis.
In the IEA’s own words:
“More than 80% of this spending [of between $700 and $850 billion annually by the 2030s] is required just to keep production at today’s levels, that is, to compensate for the effects of decline at existing fields. The figure is higher in the case of oil (at close to 90% of total capital expenditure).”
But as Lewis pointed out, the “risk of insufficient investment” is not a hypothetical matter that might occur a decade from now, but is “already today a clear and present danger” as most of the oil and gas majors have revised down their plans for capital expenditure in recent months.
Stranded by post-peak oil price hikes
There is therefore “a medium to longer-term threat” to the oil industry’s “business model from high and rising oil prices.” We just don’t get the same quality of energy from shale oil and gas as cheap crude – and what we do get comes at a higher cost.
Although oil prices are at record-high levels, production costs are rising so dramatically that they are fatally undermining oil company profits, forcing them to announce cut backs in expenditures this year.
ExxonMobil, Chevron and Royal Dutch Shell “are now signalling that they expect their capital expenditure (capex) to level off in the next few years,” reported the Financial Times. “And they are likely to come under continued pressure to bring it down.”
Mark Lewis thus concludes that “the upstream oil industry is already struggling to make the returns that shareholders require for the kind of upstream risks that are now being taken.” Profits are being squeezed, and they’ll only get slimmer with time.
Other factors likely to push oil prices higher over coming decades include the increasing reliance on shale gas “to fill the supply gap… in the face of stalling crude-oil production since 2005,” which has “significantly lower energy density than crude oil”; “declining exports of crude oil globally since 2005 as OPEC consumes more and more of its own production”; and “the ever-present but recently heightened geopolitical risks in key oil-producing regions.”
Lewis’ verdict for the future of the global oil industry is devastating. In Kepler Cheuvreux’s April report ‘Stranded Assets, Fossilized Revenues’, Lewis argued that a pending global climate treaty would seriously endanger the profitability of fossil fuel majors due to emissions restrictions enforcing ‘stranded assets’ (unexploited fossil fuel reserves that, having become obsolete, are recorded as a loss of profit).
Far from simply facing this risk due to a potential climate treaty, Lewis said, this risk arises even due to rising oil prices alone – prices driven primarily by the end of the age of easy crude.