The Root Of Strained Ties In The Energy Sector


The media’s focus on the tense relations between Saudi Arabia and the US obscures the real conflict: the oil business is struggling to find the proper price to promote project spending without stifling its own expansion.

The correlation 

In terms of broken relationships, one sticks out for the oil industry: the correlation between investment and prices.

The last time oil prices broke into triple digits back in 2013 and 2014, some 33 and 17 oil projects were sanctioned, respectively, compared to a projected 16 in 2022, according to S&P Global Commodity Insights analysis based on non-OPEC investments. In fact, this year’s estimate compares more to the number of projects sanctioned in years when Dated Brent was closer to $60/b rather than nearer $90/b.

This could lead to a potentially stark mismatch between supply and demand in the years ahead.

It’s not only a message that has been said loudly by key OPEC members such as Saudi Arabia and the UAE, but one many top analysts have been warning about, with Goldman Sachs’ head of commodity research predicting a new commodity supercycle.

Christyan Malek, JP Morgan’s Global Head of Energy Strategy, told S&P Global in a recent interview that while oil prices have moved structurally higher in the past year, there has been very little change in upstream growth ambitions, with nearly all companies that provide medium-term spending outlooks sticking rigidly to the ranges laid out over the past few years. This could leave a chasm in supply and demand by 2030.

“Oil Capex is up, but not enough,” said Malek.

So, while JP Morgan’s commodities team estimates upstream spending growing 13% this year, the highest growth rate in a decade, Malek said this comes from a very low starting point, and investment remains more than 45% below the 2014 peak.

Walking a tightrope

But a shortfall is by no means a foregone conclusion.

S&P Global analysis suggests recent new investments will help plug any potential hole in the next three to five years. “However, if oil prices were to collapse as a result of a potential upcoming recession, operators will reduce Capex significantly and will only fund a few new projects until there is a recovery in demand and oil prices,” said S&P Global Commodity Insights analyst Rene Santos.

This suggests the key is getting the balance between high and stable-enough oil prices for investment to thrive to create a steady stream of new projects, but not too high that it destroys demand or creates a sharp boom and bust.

Where that point often depends on whether you are a producer or a consumer, with Saudi Arabia and the US involved in a war of words over the use of production quotas and strategic reserves.

But in reality, the challenge is finding the sweet spot, often seen around the $60-$70/b mark. However, given the disconnect in prices and investment, that sweet spot may no longer exist, given the perceived need to entice investment at higher prices at the same time as a cost of living crisis that could damage energy use at those prices.

Doing more, spending less

Since 2014, lower oil prices have also created greater efficiencies and lower breakevens, so operators do more projects with less Capex, including fewer redundancies, a smaller footprint of processing facilities, faster drilling, and more.

According to S&P Global, CAPEX next year will probably only see a modest increase of around 10% due to oil prices averaging a little less than that seen in 2022 and also less cost inflation. This year a good portion of the CAPEX increase was due to inflation of around 12% globally, but that should come under control in 2023 as the effects of tighter monetary policy and weaker economic growth weigh.

The International Energy Agency has also cast doubts on the investment outlook, noting “while previous large spikes in oil prices have spurred a strong investment response leading to greater supply from non-OPEC producers, this time may be different.”

The IEA points to the weaker response to higher prices from US shale producers, traditionally the most responsive to changing market conditions, and which has been key to balancing supply with demand.

Indeed, US shale looks have struggled to quickly surpass its 13 million b/d peaks hit in 2020, remaining 1 million b/d shies so far, with S&P Global analysis noting “US oil production will grow in 2023 but significantly less than in 2018 when oil prices were much lower.”

Saying that there is still a lot of oil either lying dormant or looking to be unlocked or expanded: Key OPEC members like Saudi Arabia and UAE are building out capacity; sanctioned oil producers Iran and Venezuela have the ability to return several million barrels a day of oil if political issues are resolved; there is still 500,000 b/d in the SaudiKuwait Neutral Zone that could be freed up; and the US, Brazil, Canada, Norway and Guyana will add additional barrels.

Security of energy supply in the near term is one thing, security of long-term oil is another. Getting the price and policies right for investment have never been more important.


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Source: S&P Global




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