The implications of constrained investment capacity

Oil prices have come down significantly in the fourth quarter of 2018, primarily based on fear and speculation, and taking the risk premium out of the price. In 2019, we expect CAPEX to remain close to last year's levels (~$102 billion in onshore drilling and completion costs in 2018). While companies have pledged reductions in outlays, we believe that the elevated price will stimulate private sector participants and induce independents to loosen the reins just a bit. That should lead to somewhere around 1.3 million barrels a day of growth in our forecast. If companies had stick with their original guidance, then the growth should be more like 800-900 mb/d. What we see is plays like the Eagle Ford and the Bakken as funding development of Permian Basin assets. This is not, however, a linear progression. We'll have a pattern of "surge and consolidation" throughout the year, especially since we'll have a massive amount of volumes coming onstream in the fourth quarter as these above ground constraints out of the Permian basin get resolved.

This is indeed strong growth, but it is actually a deceleration from 2018's 1.9 mmb/d explosion. The cause of the slowdown is that the financial industry has changed their demands of the North American industry. The equity market understands the industry can grow and set new world records but is now skeptical that it can make money.

That's a big change in the competitive landscape and the potential way that the US plays in the market, bringing capital constraint to the forefront. There are two kinds of capital constraint: involuntary discipline, where prices and capital markets offer producers no option, and voluntary constraint, where companies choose to curb capital to return cash to shareholders or avoid returns erosion. In 2019, the US independents started with the former. Now that prices have recovered sharply, the question is whether they will engage in the latter.

Outside the US, meanwhile, investment activity has been quiet, which is bringing its own implications.

As far back as 2010, the world was drilling approximately 1800 newfield wildcats and discovering over 20 billion barrels every year. This has dropped down to approximately 600-700 wildcats for the past few years, so overall there has been a decrease investment in the conventional world, and therefore a decrease in results. The conventional world lost out to investment by the unconventional world, and it wasn't just exploration that took the hit. Field development and sanctioning activity were also sacrificed, and its impact will show up sooner than the exploration hole.

In our forecasts, we see the need for sanctioning activity of conventional projects to pick up strongly for the industry to hit its targets to meet global demand growth. If that money doesn't come, there could be consequences. Investment rebounded sharply from its nadir in 2016, but 2019 is another critical year for conventional project sanctioning in deepwater like Brazil and Guyana, and in the shallow waters of Mexico.

What the industry has forgotten is that 90% of oil and gas production is from conventional resources. You can do a lot with the unconventional and it's certainly the fastest growing, but you can't ignore conventional resources.

Peak demand is also something that affects both the conventional world and the unconventional, and it is driving companies to short-cycle opportunities. When you go after the shorter cycle opportunities in mature basins, you're essentially taking funding away from frontier exploration and emerging basin exploration. This results in finding less volumes, but the volumes being found are still profitable because they return money faster and tend to be smaller (tiebacks, etc.).

Investors in upstream need to have that confidence that demand is going to be there in the longer term, and at the moment, if there's uncertainty. This is adding to the reluctance to invest in very long-term projects.

Watch a panel of our experts for more information and detail on the implications of a constrained investment capacity.

Posted 8 May 2019

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.