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Upstream spending slides, cost-cutting kicks in

The oil industry has tightened its belt several notches, getting better at extracting more oil for less money, says the IEA

Investment in the oil and gas sector fell by 26% to $0.65 trillion in 2016, partly thanks to less drilling as the low oil price hit investment—but also because upstream players have made big strides in cutting costs.

In its World Energy Investment 2017 report, the International Energy Agency (IEA) also forecasts that upstream spending will rebound slightly in 2017, by 3% in real terms—a rise largely driven by a 53% increase in US shale investment and resilient spending in the Middle East and Russia.

Evidence of an uptick in investment elsewhere is visible too. Wood Mackenzie reports that the number of upstream projects reaching final investment decision in 2017 could double to 25 compared with only 12 in 2016.

The IEA says that, while costs would be expected to fall when less drilling is going on during the oil-price downturn, improved efficiency have helped firms save cash. Global upstream oil and gas costs fell 17% in 2016 and, the US shale sector apart, are expected to decline for a third consecutive year in 2017, though more slowly. That could signify a sea change in the way the industry operates.

"Oil and gas companies have improved capital costs and operational efficiency to an extent that could herald a structural break with the past," the agency says in the report.

The industry has long been criticised—often from within—for failing to operate as efficiently as it could. Producers could get away with that when oil was $100 a barrel, but no longer. If the IEA is right, the leaner operating model might put drillers on a more sustainable financial footing.

They will need to be, as costs are also falling among rival energy sources, notably renewables. Solar photovoltaic unit capital costs fell by 20% in 2016, according to the IEA.

Nuclear and hydro hold back renewables

But while solar and wind power are making rapid gains, alternative energy overall is failing to raise their share of the new energy investment pie, because investment in nuclear and hydropower have declined.

Taken together, spending in wind, solar, hydropower and nuclear in terms of planned new generating capacity declined in 2016. The main loser here was hydropower, which failed to match a bumper year in 2015 driven by final investment decisions on big projects in China and Brazil. This failure to boost renewables across the board jeopardises the move towards clean energy at the expense of fossil fuels, the agency says.

"While the expected generation from newly sanctioned solar PV and wind capacity has grown by around three quarters over the past five years, that from final investment decisions for nuclear and hydropower declined by around 55% over the same time frame. As a result, the expected low-carbon generation from sanctioned new facilities is not keeping pace with demand growth, falling far short of what is needed for the low carbon transition," the agency says. 

Source: IEA

It also notes that in China, the growth in hydro and nuclear generation in 2016 each had a larger impact on Chinese emissions than solar PV by a factor of four, even though China was the world's largest investor in solar.

Meanwhile, although electric vehicle sales continued to grow, low oil prices spurred a 2.4% rise in gasoline demand, a higher rate than the previous five years. Transportation sector emissions-continued to rise as a result.

Overall, global energy-related CO2 emissions remained roughly flat in 2016 for the third consecutive year, a result of greater energy efficiency, coal-to-gas switching and the cumulative impact of low-carbon generation, the IEA reports.

Rising US shale gas production enabled more than 1% of global coal generation to be replaced by gas in 2016, while wind and solar PV capacity additions rose to a record 125 gigawatts. 

Investment flows

Oil companies have needed to be fleet on their feet to maintain access to investment when needed. This was a struggle for US independent oil firms, which work predominantly in the shale sector, in 2016, as they typically carry more debt than other oil companies and rely more heavily on bond markets for funding. A slide in the oil price sent bond prices soaring.

However, the IEA found that, on the whole, the lower oil price did not significantly affect funding mechanisms for oil and gas investments, even if much of the sector became more highly leveraged.

"For the majors, cash flow remained the main source of finance, though net debt increased by over $100bn between mid-2014 and early 2017. US independents, with a more leveraged business model, initially saw debt costs soar, but their financial health has improved thanks to efficiency gains and the lower cost of debt. They continue to rely heavily on asset sales and external equity financing," the agency reports.

But a slump in sanctioning of new conventional oil projects could lead to tighter oil supply in the near future.

"Given depletion of existing fields, the pace of investment in conventional fields will need to rise to avoid a supply squeeze, even on optimistic assumptions about technology and the impact of climate policies on oil demand. The energy transition has barely begun in the transportation and industrial sectors, which will rely heavily on oil, gas and coal for the foreseeable future," the IEA says.

Uncertainty over the longer-term trading environment and a desire to get oil to market as quickly as possible are among factors driving a move to shorter project cycles in the oil sector, along with the development of technology to make it possible to speed up the development process.

The debate brewing among oil company shareholders over whether investment in longer-term mega-projects could be wasted if oil demand slumps and strands the assets may also be informing this push towards projects with shorter-term returns.

Source: IEA
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