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Majors open their wallets for upstream spending

Upstream capital expenditure (capex) among big international oil companies (IOCs) is gathering momentum on the back of high oil prices and growing demand. The question is whether the attractive returns on offer will outweigh the increasingly high cost of uncovering fresh reserves

The majors have unveiled plans for higher spending in recent weeks. ExxonMobil tops the list with a pledge to spend up to $37bn annually over "the next several years", when just a year ago it predicted a $25bn to $30bn range until 2014. Last year, the supermajor's capex totalled $32.2bn, of which $27.3bn was spent upstream – representing a 32% increase over exploration and production (E&P) spending in 2009.

ExxonMobil attributed the boost to a surge of investment in North American unconventional energy and liquefied natural gas (LNG) schemes in Australia and Papua New Guinea, among other projects. Unconventional oil and gas reserves now account for 40% of the company's resource base and these will grow more expensive for ExxonMobil and its rivals to exploit as the easiest-to-reach reserves are developed.

"All the majors are reloading their exploration portfolios – that has definitely become a much more important part of the growth strategy in the near term," says Tom Ellacott, an analyst at energy consultancy Wood Mackenzie. He says the big IOCs are making up for lost time, having failed to invest sufficiently over recent years in up-and-coming areas – such as west Africa's transform margin and Brazil's pre-salt offshore plays – at a time when reserves could more easily be replenished elsewhere. Now, as those reserves wane, investment is pouring into resources once considered peripheral to core business. In November, Wood Mackenzie estimated the oil industry's total capex for 2010 would be around $380bn – 5% higher than 2009, but still 10% less than 2008. The figure is expected to climb sharply again this year.

Innovations such as floating LNG production mean that once isolated and unviable pockets of offshore oil and gas can now be exploited – but at a price. Meanwhile, in recent weeks, both BP and Total have signed multi-billion dollar upstream deals with Russian companies covering projects in the Arctic, where technology requirements will not come cheap. They add to a fast growing pool of projects in the Russian and Norwegian Arctic plays, where costs will be exacerbated by the need to satisfy stringent environmental requirements.

Another feature of new spending patterns is that a lot of projects are heavily front-loaded in terms of investment. The wave of Australian LNG projects is a case in point. Costing tens of billions of dollars to build, once operational they will generate revenue over decades at a much lower cost.

And it is not just IOCs that are bumping up capex, national oil companies (NOCs) are also spending big. State-owned China National Offshore Oil Corporation plans to spend $8.8bn this year, compared with $5.6bn in 2010. Brazil's Petrobras is boosting spending at home and overseas, such as offshore Angola. Under its 2010-14 business plan, it will invest nearly $119bn on E&P, with $10.3bn of this earmarked for international projects.

Malaysia's Petronas, meanwhile, plans to invest more than $90bn over the next five years as it strives to slow the decline in the country's gas reserves. Most of the spending will likely be directed towards domestic projects, with hopes buoyed by the country's first big discoveries in four years – the NC3 and Spaoh-1 oil and gas discoveries, both off Sarawak, which hold a combined 100m barrels of oil and 2.8 trillion cubic feet.

As is the case with several NOCs facing declining reserves at home, Petronas will also boost overseas spending. "If we do not grow, we will become irrelevant," chief executive Shamsul Azhar said. Petronas is weighing up possible expansion into unconventional hydrocarbons exploration in Australia, China, Indonesia and Myanmar, but it would not take on high-risk projects based on "a herd mentality", Azhar added.

But doubts remain over how much value in terms of increased oil and gas reserves all this extra spending will generate. The evidence of recent years suggests lower returns are to be expected, even if the sizeable – and lucrative – reserves in Canada's oil sands, for example, indicate some projects may diverge from that trend.

Steven Kopits, managing director of energy research firm Douglas Westwood, noted in a February presentation to the US House of Representatives Energy subcommittee that while a global upstream capex of $2.4 trillion in 1995-2004 yielded a rise of 12.3m barrels a day (b/d) in world oil output, the $2.4 trillion spent in 2005-10 was accompanied by a 200,000 b/d fall in production – albeit against the background of slowing energy demand towards the end of the period.

Extra cash garnered from higher oil prices went largely into costly and increasingly sophisticated assets, together with increased staffing levels, Kopits told the subcommittee. Staffing is a growing part of firms' expenditure as they seek highly skilled – and paid – engineers and geologists for increasingly sophisticated operations. In the oilfield services sector, for example, the employee count among the seven leading firms increased by more than two-thirds, to 125,000, in the four years to 2008 and is on the rise again.

However, all this is unlikely to deter companies from ploughing more investment into E&P. "Faced with greater obstacles to resource access and given the confidence among the big companies that high oil prices are here to stay, exploration expenditure will keep rising in the near term," says Wood Mackenzie's Ellacott.

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