The world is awash in oil at the moment, but with chronic underinvestment in exploration coupled with global energy demand steadily rising, the stage may be set for an oil price spike in the years to come, according to some analysts. Others, on the other hand, predict that improved production methods and project efficiency will go a long way toward meeting supply demands with existing reserves.
“There is certainly unconventional exploration onshore because companies are looking at where they should go next” to invest their capital, Julie Wilson, research director of global exploration for research and consultancy firm Wood Mackenzie in Houston. “You’re looking at very tight source rocks that you haven’t previously considered to be productive. That’s still considered exploration because there’s high uncertainty. You have to do a lot of geochemical and geomechanical work to find the sweet spot – the most productive part of the play.”
“The division between conventional and unconventional has pretty much gone away for most companies now. They see the geology and opportunities as a spectrum,” she said.
To date, unconventionals haven’t matched the total of proved-plus-probable oil and gas reserves with conventionals, “but we’re getting close,” said Bob Fryklund, chief upstream strategist for IHS Markit in Houston. One consequence is that the industry has stopped talking about reserves and started talking about resources, he noted.
“The game is converting those resources over time and at the best price,” Fryklund said. “In the past we had all these resources that were sitting in the bank, so to speak. We had discovered them but we hadn’t converted them.”
When companies seek to carve out an exploration niche and become pure-play operators – by focusing on unconventional resources, for instance – they face a type of eggs-in-one-basket risk. That’s become most apparent in the Permian basin, where dwindling available pipeline capacity has led to production constraints. Niche-oriented concentration risk could affect exploration and production in future years.
Not to mention, there’s also an 800-pound gorilla in the room, a potential monkey wrench in the works challenging future exploration. For the oil and gas industry, climate change can look like an 800-pound gorilla with a huge monkey wrench, threatening to cause havoc at any moment.
“We’re in the middle of an energy transition. I think people can see that and the world is looking at decarbonizing. That’s a long-term trend and over time that reduces demand for oil as a transportation fuel, but I see demand continuing to grow,” said John England, a partner specializing in oil, gas and chemicals for consulting firm Deloitte LLP in Houston.
“If the future is going to be decarbonized, like most people think, there’s a place for some companies to be energy companies” as opposed to strictly fossil-fuel companies, Fryklund observed.
“There are people caught in the middle, and those tend to be national oil companies,” he said. “What’s happening with national oil companies is, they’ve been charged by their stakeholders with producing more domestically.”
Andrew Slaughter, executive director of Deloitte’s Center for Energy Solutions in Houston, sees potential for decarbonizing some sectors but believes others will be harder to modify.
“There are markets for oil which are more resistant to decarbonization on the supply side. You need to decarbonize those in a different way, maybe through energy efficiency. It’s a very long haul,” he said.
For now, the climate change issue represents more of an unknown for the industry than an actual brake on activities. Planners projecting future oil and gas production sometimes include a scenario for more rapid action to meet carbon goals like those in the Paris Agreement on climate change. BP did that in its 2018 Energy Outlook, released earlier this year, adding an “Even Faster Transition” forecast for accelerated decarbonization.
BP’s Outlook considers forces that will shape the world’s energy supply and consumption to the year 2040. It called its basic assumptions, or reference case, an “Evolving Transition” scenario that leads to a highly diversified global mix of energy sources two decades from now. World oil demand will be somewhere between 85 million barrels per day, under the fastest decarbonization scenario, and 110 million barrels per day, BP projected.
‘Plateau, Not Peak’
At the heart of the BP Outlook are assumptions about future growth in global gross domestic product and energy demand. It predicted world GDP will more than double by 2040, reflecting more prosperity in quickly growing emerging economies and the lifting of more than 2.5 billion people from poverty. That economic growth is generally in line with past GDP increases, it noted. As GDP grows, global energy demand will increase by about one-third over the coming 25 years, BP forecast.
“Nobody expects oil demand to grow very rapidly in the next 25 years, nobody expects it to decline very rapidly over the next 25 years,” said Spencer Dale, BP’s group chief economist. BP projected demand growth will slow in later years of its Outlook, but in terms of a demand peak, Dale advised, “Think plateau, not peak.”
That’s partly because Dale does not foresee substantial downward pressure on future transportation-fuel consumption because of hybrid and all-electric vehicle sales – he dismissed the possibility of “carmageddon.” BP estimated that by 2040, the number of electric vehicles on the road will reach 300 million, out of about 2 billion cars, and around 30 percent of passenger car miles will be powered by electricity. However, BP’s Outlook does take into account slowing growth in vehicle-fuel demand, and even includes a scenario for a ban on internal combustion engines.
Dale posited a future course for the industry with all new investment in oil exploration and production eliminated, where world production would decline about 3 percent annually. In that scenario, global oil production would fall to about 45 million barrels per day by 2040.
“Under almost any scenario that I’ve seen and even though it’s entirely consistent with (holding climate change) to 2 degrees C, entirely consistent with electric cars taking on far, far greater proportions than almost anybody else is predicting, the world will still consume enormous amounts of oil in 2040. And importantly, the world will need huge investments in oil over the next 20 to 30 years if we’re going to make sure that we can provide as little as 80 million barrels a day in 2040,” Dale commented.
“Remember, if we don’t carry on investing, that will go down to as little as 40 (million barrels a day) or so. And that, under almost any scenario, is far, far less than the world will need,” he said. “And so, the message from here is the world needs significant amounts of new investment in oil for many decades to come.”
Natural Gas Demand and Production
The future appears even stronger for natural gas production and consumption in the BP Outlook. World demand for gas will likely grow faster than for either oil or coal, increasing at 1.6 percent per year, “with its share in primary energy overtaking coal and converging on oil by the end of the Outlook,” BP noted.
“From a growth perspective, natural gas actually has a more favorable picture going forward. We need to keep exploring for and finding gas – natural gas is a pretty robust part of the future we see,” said Deloitte’s Slaughter.
Future natural gas demand benefits from a projected increase in gas used for power plants, offsetting declines in hydroelectric and nuclear power in overall share of energy sourcing, and from a preference for gas over coal in decarbonization. In the BP Outlook’s base case, global LNG supplies more than double to 2040, with about 40 percent of the expansion coming over the next five years.
“People have often referred to natural gas as a bridge fuel, but I think it’s part of the ultimate plan. So it’s a destination fuel, not just a bridge fuel,” England said.
The future for natural gas production looks promising, according to Rystad Energy, a Norwegian energy research and business intelligence company.
“Shale gas production in North America is estimated to continue its growth into the future, driving overall increase in gas volumes in the country amid forecasted declines in conventional onshore and offshore output,” Rystad Energy noted in its Exploration & Production Newsletter in August.
North America is now the largest gas producer in the world with output of 98 billion cubic feet a day expected this year, the company reported. About 70 percent of the total is contributed by shale gas production, with the Marcellus Shale constituting the largest share of total shale volumes. Russia is currently the second largest gas producer in the world with production of nearly 67 billion cubic feet a day forecast for 2018, it noted.
Both Russia and the Middle East, the world’s third largest natural gas producer, were estimated to have potential for further growth in the future. Although Russia holds impressive gas resources, many of its large discoveries are located in remote areas, posing problems for commercial development, Rystad Energy wrote. Therefore, it sees few Russian discoveries starting production before 2025.
The Middle East was projected to produce 62 billion cubic feet of gas this year. “The region has promising potential for production increase in the long term, which comes from sanctioned and unsanctioned fields expected to be developed. If these projects start to produce as estimated, then Middle East could surpass Russia as the second largest gas producer by 2022,” Rystad Energy predicted.
“Total global gas production is forecasted to reach 415 billion cubic feet per day by 2025 with North America contributing the largest share,” it wrote. “The global gas market is expected to see significant supply growth going forward, driven primarily by unconventional gas from North America. With the largest estimated remaining recoverable gas resources, North America is set to shape the gas supply outlook in the medium and long term.”
Squeeze on Capex
Economics are a critical factor influencing crude oil and natural gas exploration. That includes both product prices and the industry’s continuing decisions about capital expenditures, or capex. Oil companies evaluate exploration economics and make decisions about how to deploy capital. Many companies have been shifting their spending to stock buybacks, dividends and other forms of investor return.
Fatih Birol, executive director of the IEA, has warned that world oil supplies will tighten if the industry doesn’t restore investment in new production following the dramatic cuts made during the downturn.
“Upstream investment shows little sign of recovering from its plunge in 2015-16, which raises concerns about whether adequate supply will be available to offset natural field declines and meet robust demand growth after 2020,” Birol was quoted as saying at an industry gathering earlier this year.
“Broadly speaking, if you add exploration capex with development capex, it’s clear there has been a squeeze on capex since 2015, which is just beginning to open up,” Slaughter observed. “Investor sentiment has said, ‘We want to see more return.’ It’s more return driven, now.”
“There was a lot of debt taken on in the years leading up to the downturn and many companies today are trying to repair their balance sheets. That’s one of the reasons capex hasn’t spun back up like you might expect with today’s oil prices,” England said, adding that exploration funding extends beyond internally generated cashflow and bank loans – private equity is actively investing in oil and gas projects, he said.
Even OPEC has cautioned that global exploration expenditures have fallen below necessity. The industry needs at least $10 trillion in new investment by 2040 if future oil and gas supply is going to meet the world’s growing demand, said UAE Energy Minister Suhail bin Mohammed al-Mazroui, the current president of OPEC.
“This year is going to be an interesting year, where we are expecting to achieve the balance in the market between supply and demand, and most important, to see some significant investments come into the sector,” al-Mazroui said at the International Petroleum Week conference in London earlier this year. “We are talking about 22 years, and we know it takes about five years from deciding to invest to finalize the project. So I think we as OPEC are keen to see this restoration in the market and to work with everyone,” he said.
In the near term, upstream spending, including exploration, looks set to rise modestly as the industry returns to financial health, largely because of the climb in oil prices that began last year. Financial services provider Barclays reported overall upstream spending will increase 8 percent this year, based on its 2018 midyear survey of more than 200 companies. Barclays revised its projected North American upstream budget view to a 15 percent increase in 2018, adjusting for capital spending hikes from several U.S. companies. Higher oil prices, increased efficiency and rising steel costs due to tariffs were all cited as reasons for the increased spending.
International upstream budgets were predicted to rise 5 percent. Barclays estimated that national oil companies, which account for the bulk of international spending, will increase spending by 9 percent. But European international oil companies plan no increase in spending this year, and U.S. internationals will reduce upstream budgets by 6 percent, Barclays projected.
Risk of Recession
In regard to future crude oil production, the contribution from unconventionals, the size of industry exploration budgets and the degree of exploration success are all wild cards. What worries economists is the potential for oil supply to lag behind growing global demand, leading to another price spike and suppressing economies around the world. Mark Zandi, chief economist for Moody’s Analytics, has been widely quoted as noting, “Quickly rising oil prices have been a contributing factor to every recession since World War II.”
“I think $150 oil in a short period would suck the wind out of the expansion,” Zandi said. “Recession risks would be very high.” Oil prices rose sharply before the 1990 economic downturn, climbing to $40 after Iraq invaded Kuwait. The 2008-9 recession was preceded by an increase in the price of crude, with Brent nearing $140 a barrel. Today, the re-imposition of sanctions on Iran is expected to push oil prices up.
“No one yet knows how much supply the world will lose because of Iran, but the last time sanctions were imposed in 2012 it was 1.2 million barrels,” said Bjørnar Tonhaugen, senior vice president of oil markets for Rystad Energy.
For the longer term, if exploration falters, the price ceiling for crude could be very high.
In its “Annual Energy Outlook 2018,” the U.S. Energy Information Agency included a High Oil Price scenario in which Brent crude would reach $229 a barrel by 2050, adjusted to 2017 dollars. “The High Oil Price case reflects the impact of higher world demand for petroleum products, lower (OPEC) upstream investment, and higher non-OPEC exploration and development costs,” the EIA noted.
Projections of future U.S. oil production in the EIA Outlook’s Reference case are less rosy than some other forecasts, as exploration only offsets field declines.
“Despite rising oil prices, Reference case U.S. crude oil production levels off between 11 million and 12 million barrels per day as tight oil development moves into less productive areas and as well productivity declines,” the EIA forecast.
“Previously announced deepwater discoveries in the Gulf of Mexico lead to increases in Lower 48 states offshore production through 2021. In the Reference case, offshore production then declines through 2035 and remains flat through 2050 as new discoveries offset declines in legacy fields,” it reported.
The EIA also rejected the idea of future vehicle-fuel prices declining because of a demand peak. “Retail prices of motor gasoline and diesel fuel are projected to increase from 2018 to 2050 in the Reference case, largely because of expected increases in crude oil prices,” the EIA noted. “Although the spread between diesel fuel and motor gasoline retail prices has tightened on a volume basis in recent years, this trend reverses through 2041 because of strong growth in global diesel demand for use in transportation and industry.”
Reasons for Optimism
Slaughter called 2018 a landmark year, with the world reaching 100 million barrels per day of crude oil and liquids production for the first time. Because of natural field declines, the industry will need to replace at least 3 million to 4 million barrels per day of production for decades to come, he said.
Only a handful of companies, not many more than a dozen, have been leading worldwide oil exploration, Fryklund observed. “The big dilemma everybody is wrestling with is, ‘What’s the future of new venture exploration?’” he said. “The top 10 explorers in the world, over the last 10 years, have been more or less the same companies,” with a few companies dropping off the list or coming back onto it at various times.
“We see the overall U.S. production hitting a plateau in the mid-2020s. At that time you’re at 15 million barrels a day,” Fryklund said. “With decline, 7 million barrels/day will have to be replaced.” He said new oil could come from Alaska, the Gulf of Mexico (both the U.S. and Mexican sides), the San Joaquin Basin in California or the East Coast. “Given what we know about analogs and the conjugate margins, there’s probably significant oil resources on the U.S. East Coast,” Fryklund said.
As one positive sign, the oil industry opened a total of 19 new basins or producing areas around the world in recent years, Fryklund noted. “The issue is, because those are what I call mini-basins, you have to be there first. And if you’re a big guy, you have to take a big position,” he said.
This might be the most positive sign for future exploration: Despite going through a severe downturn, the industry seems to have returned to optimism. For some good reasons.
Since commencing a major exploration effort offshore Guyana in 2008, Exxon Mobil and its venture partners have made nine discoveries there. In an August news release, the company reported “plans for rapid exploration and appraisal drilling. A second exploration vessel, the Noble Tom Madden, is due to arrive in Guyana in October to accelerate exploration of high-potential opportunities and will commence drilling at the Pluma prospect approximately 17 miles (27 kilometers) from Turbot.”
Phase 1 of Exxon’s Guyana project is projected to begin producing up to 120,000 barrels of oil per day oil by early 2020. Phase 2, targeted for sanctioning by the end of this year, is designed to produce up to 220,000 barrels per day in 2022, Exxon reported. A third development, Payara, will target sanctioning in 2019 and produce approximately 180,000 barrels per day as early as 2023.
In recent exploration results, the Dorado oil discovery on the North West Shelf off Western Australia is the largest field found in that area in the last 30 years, according to operator Quadrant Energy Ltd. Shell reported a sixth oil discovery in the deepwater Norphlet play in the U.S. Gulf of Mexico. Extending the industry’s success in the Western Desert of Egypt, Eni made an oil discovery with its first well exploring deep sequences of the Faghur basin.
“I think there’s renewed optimism. After a number of years where returns were below 10 percent, we think they were above 10 percent in 2017. That means they’re in the black,” Wilson noted. She explained that at a 10 percent discounted rate, value creation below 10 percent is negative. Companies are now able “to deliver more value overall than the cost of exploration,” she said.
“In 2018 we’ve seen more Alaskan success, which is onshore. It’s Arctic, but it’s enormous. It’s not unconventional in that it’s not ultra-low permeability – it’s more about finding the sweet spot of that trend,” she observed. “They’ll probably bring unconventional technology to that play.”
Efficiency remains the key concept for the oil and gas industry today, both upstream and downstream. Economic discipline and production maximization rule in the upstream sector. And for exploration, the buzzword might be “cooperation,” as operators hope closer ties with suppliers and service companies enable better deployment of resources and hold costs in check. Fryklund noted that operators are already reshaping themselves around new models of operation. “We see the future really being defined around the business models of the companies,” he said.
Whether or not the industry will invest sufficient capital in exploration remains to be seen.
Most companies emerged from the downturn bloodied and bruised, and are still cautious about risk commitment. Still, there’s hope that exploration budgets will be rebuilt and the industry will go back to the business of finding oil and gas.
“I don’t buy that this is a crisis for exploration,” Slaughter said. “I see it as an opportunity.”