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Outlook 2018
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Drillers holding fire

Unless oil prices surge, drilling activity will remain subdued next year. Any increase will breed cost inflation

The exploration and production sector begins 2018 after relative calm in 2017. The resolve of Opec has been matched by the resilience of American shale, leaving oil prices within a band of $40-60 a barrel. The lower end of this band is uncomfortable but survivable. The higher end isn't quite enough to stimulate a leap in capital investment.

American tight oil output increased in 2017, but investors are showing signs of fatigue—the industry continues to need external funding and average equity values have lagged the oil price by 20 percentage points since 2014. So in 2018, shale producers may at last start focussing on generating cash over growing production. There are signs that technology improvements are slowing and the low breakeven sweet spots are finite. Cost inflation and bottlenecks in the supply chain are visible, particularly in well completion. Production expectations for US shale may prove optimistic unless oil prices break through the $60/b ceiling.

In the medium term, the lack of major project sanctions since the 2014 price crash will start to affect supply. Provided demand rises as most forecasters predict, then the market could be undersupplied in the early 2020s and prices will rise in anticipation. Long term, demand uncertainty hangs over the industry, with a range of 35m barrels a day across various oil-demand forecasts in 2040.

Equity investors aren't yet convinced of a sustained upturn in oil and gas prices and continue to prefer the largest oil companies and their dividends over smaller E&Ps and their potential for growth.

Strategically, the majors will follow a similar path in 2018—they'll reposition portfolios for lowest-cost production, secure long-term gas options, invest in high-impact and near-field exploration and "green" their businesses through more investment in renewables.

In 2018, the focus of exploration drilling will shift towards South America

Operational efficiencies seem to have largely run their course. Westwood has seen net income breakeven oil prices for the mid-cap companies it follows fall by $24 per barrel of oil equivalent to ~$40/boe. Half of this drop came through balance-sheet capital write-offs reducing depreciation charges and half from lower operating costs. The latter stalled in 2017 and the supply chain is suffering. Increased activity will flow straight into higher costs.

The industry hasn't given up on exploration and performance improved in 2017, with the highest success rates and lowest finding costs in 10 years. Drillers have become more selective with their wells. The low level of drilling, down 60% on 2014, will continue into 2018.

Hot areas for the industry include Guyana, which continues to yield substantial oil discoveries and, with well over 2bn barrels discovered, has emerged as the largest new oil province of the past decade. With only 780,000 people, the bonanza could transform the country, but the fast pace of operations is putting a huge strain on the authorities. In 2018, we'll have a better idea of how big it will turn out to be and whether neighbor Suriname will share in the prize.

A major new deep-water gas province has emerged in Mauritania and Senegal, with 40 trillion cubic feet discovered and likely more to be found. Kosmos Energy drilled the first dry hole in the play in October 2017, but there's already more than enough to support a liquefied natural gas scheme. In early 2018 (or sooner), Kosmos's Lamantin well should tell us whether there's significant oil in the basin too.

Arctic exploration had mixed fortunes in 2017: success in Russia and Alaska but disappointment in the Norwegian Barents Sea. The opening of a new 1bn-barrel oil play in Alaska provides a fillip for its industry, and in the Laptev Sea Rosneft appears to have opened a major new oil play. Norway is counting on the Barents Sea to replenish reserves, but the geology is unforgiving. There was little to show for a high-impact nine-well programme in 2017. (One well remained as Outlook went to press).

In 2018, the focus of exploration drilling will shift towards South America, where more than 15 high-impact wells are planned, including in Guyana, Suriname and Brazil. The Eastern Mediterranean will see more wells in Cyprus and Egypt as the industry chases follow-ups to the giant Zohr gas discovery. Frontier drilling will continue in Africa, with wells in unproven basins offshore Morocco, Namibia and South Africa. Drilling will also continue in Mauritania/Senegal fol­lowing up the Tortue discovery where, in addi­tion to Lamantin, the Kosmos-BP joint venture will test its biggest prospect to date at Requin-Tigre. The Barents, despite 2017's disap­pointment, will have another busy summer in 2018—Statoil plans to drill at least five exploration wells seeking the elusive breakthrough discovery.

Keith Myers is President, Research, Westwood Global Energy Group

This article is part of Outlook 2018, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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