Oil producers struggle with investment balance amid energy transition

While the world walks, talks and turns toward a greener energy future, it still will need enough oil and natural gas to fuel power plants, cars, trucks and airplanes, heat homes, businesses and factories, and make plastics for decades to come.

It’s likely much less will be needed, but still more than today’s fields can produce. That’s the dilemma.

“Our products make the world run,” Chevron CEO Mike Wirth said at the World Petroleum Congress in Houston last week.

Supplying the oil and gas to make the world run until greener fuels and renewable energy take over will require trillions of dollars in investment. Much more than companies have invested in recent years.

The risk is that investments in new oil and gas production will come up short, leaving supply unable to meet demand and driving up prices. On the other side of the curve is the risk that billions invested in long-term projects may come up short on returns if the world transitions to greener energy faster than anticipated.

It’s not an easy choice.

“The investment environment for the oil and gas sector is becoming more challenging in the face of unprecedented uncertainty and risks, including record price volatility, evolving government regulations, (and) increasingly diverging long-term demand narratives,” the International Energy Forum said in a Dec. 7 report.

The forum was established 30 years ago, and boasts a membership of 71 producing and consuming nations. Its report is clear: Investors need to pour a lot more money into new production to prevent a supply shortage and unaffordable energy prices.

“Oil and gas upstream investment will need to increase and be sustained at near pre-COVID levels of $525 billion (per year) through 2030 to ensure market balance, despite slowing demand growth,” the report says.

“Upstream investment in the oil and gas sector in 2021 was depressed for a second consecutive year at $341 billion — nearly 25% below 2019 levels. Meanwhile, oil and gas demand is now near pre-pandemic highs and will continue to rise for the next several years, particularly in developing countries.”

But companies are hesitant to write such big checks — protective of their shareholders and responsive to their lenders — for projects that can take a long time to pay returns, especially with the constant risk that prices or demand could fall.

“The lower-price cycle of the past six years and long-term demand debates have driven up investment hurdles and the cost of capital for long-cycle oil projects,” the IEF report states. “This is fostering an environment of ‘pre-emptive underinvestment’ for oil and gas supply, where investments are lagging robust demand.”

Forecasts of peak oil demand by the early 2030s is a scary thought for hydrocarbon producers, just as shortage-induced $100-per-barrel oil is alarming for consumers.

“Publicly admitting that oil and gas will play an essential and significant role during the (energy) transition and beyond will be hard for some,” Saudi Aramco CEO Amin Nasser said at the conference in Houston. “But admitting this reality will be far easier than dealing with energy insecurity, rampant inflation and social unrest if prices become intolerably high.”

The International Energy Forum report says the next two years “are critical for sanctioning and allocating capital toward new projects to ensure adequate oil and gas supply comes online within the next five to six years.” Considering the long-term energy uncertainty, companies will “continue to favor projects with access to existing infrastructure as these require less capital, have shorter payback periods, and are more insulated from long-term demand risks.”

In addition, “investment decision-makers must also consider if demand will still be there over the lifetime of a specific project and the impact of government policy changes,” including the transition to green energy and a lower-carbon economy.

If upstream investment comes up short, the report says, market volatility will increase, and increased uncertainty of supply could add a premium to prices.

In addition to new projects, “a steady stream of investment is needed to offset declines in existing oil and gas fields,” according to the report.

Decline rates are inevitable, but how fast production falls depends on spending and whether companies focus on short-term production or larger, longer-life investments. “In the past two decades, as short-cycle production sources became a greater share of global production, global average annual decline rates have increased.”

Without a lot more money invested into drilling, the IEF estimates that non-OPEC production could decline by 20 million barrels per day (or 41%) by 2030.

Even the higher prices of recent months, in the range of $70 and $80 per barrel, hasn’t prompted the investments needed for future production, the report said.

“Unlike cycles past, the primary obstacle facing global supply in the next decade is not the lack of resource, but rather the increased above-ground risks that could stymie investment and result in an undersupplied market. This is a unique and unfamiliar challenge for an industry where the price has always ultimately justified the means.”

Lower oil prices in 2015 through 2020 cut into capital spending, setting up the world for oil and gas shortages if demand picked up. Jeff Miller, CEO of oil field services giant Halliburton, said at the Houston conference that the world’s underinvestment in oil and gas is leading global markets to an era of scarcity.

And it’s not just underinvestment, but a changing investment strategy.

“The list of sanctioned projects provides a picture of an industry shifting from expensive, large-scale, single-project investments to small- or medium-scale onshore and subsea tieback projects,” the energy forum report states.

“Remarkably, there are currently no new greenfield mega projects planned — a single, large-scale project with peak production of more than 500,000 barrels per day, with new infrastructure — in the next five years.”

Looking for less risk, “almost 250 small- to medium-scale projects are expected to begin by 2030, assuming investment materializes,” the report said. “These projects require less capital, have shorter payback periods, and are more insulated from long-term risks.”

The changing energy world means “what may be profitable in today’s environment may no longer be economic tomorrow.”

Larry Persily can be reached at [email protected].