First there was Peak Oil, the Malthusian fear that the world was running out of oil. This idea has been around for a long time but had its most recent renaissance in the mid-2000s with a host of books warning that global demand was going to overwhelm the industry’s ability to supply.
The expansion of unconventional oil and natural gas production quieted concerns about supply constraints. The world is not running out of hydrocarbons.
More recently industry insiders have introduced the concept of Peak Demand. As economies mature, they generally become less energy-intensive as economic activity shifts from manufacturing to services. Combined with policy drivers and economic incentives encouraging greater energy efficiency, developed economies are generally using less energy to generate each additional unit growth in economic output.
This isn’t true everywhere, with developing economies continuing to see strong demand growth. But in aggregate, as the world becomes wealthier, demand forecasts are flattening – it’s not a sharp peak, but rather a plateau.
That concerns industry executives. Because in a world awash in oil and natural gas combined with softening demand, the task of allocating capital to generate returns for your shareholders becomes tricky. And even attracting capital becomes challenging when the market sees little upside opportunity.
Growing Oil Demand Shock
And then arrives COVID-19 and a global pandemic, which “has created the largest oil and gas demand shock in history.”
Last December 2020, the Boston Consulting Group and the International Energy Forum issued a report titled “Oil and Gas Investment in the New Risk Environment,” warning that the dramatic decrease in upstream investments could set the stage for Peak Investment and a future oil supply shock.
This report is a collaborative effort by BCG, a global consultancy, and IEF, an international organization consisting of the energy ministers from 70 producing and consuming nations. IEF has more member countries than OPEC and the IEA combined, representing all corners of the globe.
As all of us know, the industry has been slashing costs in response to the downturn, cutting capital expenditures. But the report suggests that “these lower capex levels appear to be insufficient to deliver the volumes of oil and gas needed to maintain market stability.” The fear is that as the world economy recovers post-COVID, growing demand will generate supply constraints, increased market volatility, and end up undermining economic recovery and global energy security.
The reduction in capex in the previous downturn from 2014 to 2015 was 28 percent. Capex continued to fall in 2016 and then remained relatively stable until 2019. But as the impact of COVID-19 rippled across the world, the industry cut capex in 2020 an additional 34 percent. The result is that “every dollar of 2020-2021 capex that is cut will have twice the impact in reducing activity that cuts made after the 2014 price fall had.”
In fact, the IEF and BCG suggest that investment must increase 25 percent per year from 2020 levels for the next three years to avoid crisis, with far more investment by 2030 to assure stable energy markets.
Where Will Investment Come From?
As President Biden issued an executive order on his first day in office rescinding the permit for the Keystone XL pipeline, this need for investment was on my mind. It’s a decision that hurts Canada, the United States’ largest trading partner; it hurts U.S. workers, it hurts AAPG members – particularly in Canada, and it constricts the ability for vital energy resources to get to global markets.
Yes, many countries have set goals to reduce carbon emissions and promised to accelerate the adoption of lower-carbon energy technologies, but the availability of energy supplies when needed – energy security – is strategically important. It has to be a priority and it requires investment.
But where is this investment going to come from?
The report identified four factors affecting the industry’s ability to secure capital:
- Investor and regulatory requirements for oil and gas producers to reduce the carbon intensity of their operations is a growing constraint.
- Companies considering a shift from E&P to a broader, more integrated energy business are choosing to allocate capital away from upstream projects.
- Private equity and other sources of capital investing in oil and gas, particularly unconventional resources, are demanding a real return on their investments.
- All-time high debt levels are limiting the ability of companies to secure capital at competitive rates in order to make further investments.
This is a conundrum. On the one hand there is continued demand for oil and natural gas – no forecasts suggest otherwise – and even if demand levels don’t increase significantly, we still have to replace the volumes consumed each year. But the upstream investments needed to do so are dropping, and the capital for these investments is harder to secure.
I call it a conundrum, because there’s no simple answer, and the IEF and BCG don’t try to offer one. Their purpose is to call attention to the problem and its potential repercussions. But what if that old chestnut is true, and each problem is an opportunity in disguise?