Increased uncertainty to colour upstream sector's decision-making in 2020
The level of uncertainty and anxiety among upstream producers and supply chain has rarely been higher.
In 2020, decision-making will be more heavily influenced by sentiment surrounding the energy transition, political upheaval and trade disputes than in previous years.
This adds to the ever-present risks of unexpected supply-demand imbalance, niche cost inflation or a global economic downturn.
What are the biggest trends to watch in the upstream oil and gas business in 2020? Fraser McKay, head of upstream analysis at Wood Mackenzie, sees five key themes:
• Upstream capex spend will remain flat;
• Sanctioned volumes will be huge, and gas weighted;
• Excess supply chain capacity keeps costs lower for longer;
• Tight oil will slow down, but once again be resilient;
• Exploration will be under real pressure but will create value.
He said: “Despite funding concerns and pressure from investors and stakeholders regarding capital discipline and the energy transition, upstream development spend will remain flat for the second year in a row, totalling about US$450 billion, excluding non-integrated LNG plant spend.”
Change in emphasis
Flat year-on-year spend belies a near-term shift in resource theme emphasis. McKay said: “Digging into our new Lens platform, we find spend on conventional projects still dominates, accounting for 50% of global upstream capex.
“But an avalanche of future spend on liquefied natural gas (LNG) supply is being triggered by project sanctions in 2019 and in 2020. Spend on upstream LNG supply will be up 50% year-on-year to over US$30 billion in 2020.”
US unconventional oil and gas is the loser in gross spend terms in the near-term. The pursuit of free cash flow will force even greater capital restraint among the pure-play tight oil and shale gas producers. Spend on shale will fall by more than 10% in 2020.
While annual capex will remain flat, some of the projects likely to be sanctioned this year are huge.
McKay said: “A staggering 34 billion barrels of oil equivalent of resource and US$220 billion of total future development spend is held within the 40 projects we consider most likely to be sanctioned in 2020.
Making the transition
“For the second year in a row, two-thirds of the total resource comprises gas. This demonstrates industry belief in gas as a transition fuel that still has decades of running room.”
We expected a record year for LNG project sanctions in 2019. Operators didn’t disappoint, with 63 million tonnes per annum of new capacity given the green light, half of which was in the US.
Capacity additions in 2020 are harder to call, with sanction decisions for gas projects of this scale increasingly tough to make.
Capital efficiency will continue to be a focus this year. McKay said: “The window for upstream producers to lock-in low development costs for new projects will extend into 2020 and beyond in most sectors.
“For the supply chain, that means business will continue to be hard-fought and margins will remain under pressure; the nadir has longer to run.”
Apart from isolated hot spots, the service sector will need to adjust and consolidate in 2020 as finances are stretched still further. Capacity will gradually reduce, either via consolidation or equipment retirements.
He added: “We also expect more supply chain companies to pivot away from pure upstream services, towards other parts of the oil and gas value chain or renewables. Only the most cost competitive or innovative will find a way to adapt.”
Tricky times for tight oil?
The US tight oil sector will once again be a topic of much debate this year. Independent tight oil producers have their backs against the wall.
The to-do list in 2020 is arduous: deliver cash flow to repay debt and solve parent/child well interference.
McKay said: “It all adds up to a slowdown in activity and healthy dose of scepticism from onlookers and investors. So, is 2020 the year tight oil finally falters?”
Maybe not. Production won’t surge like it has in past years, but the Independents could surprise one final time.
How? We will be watching operators’ spacing patterns in Lens Lease Evaluator and completion designs in Lens Well Evaluator for signs of outperformance.
The shift to drilling exclusively extended reach lateral (XRL) wells could prove meaningful. Producers can grow volumes 15% more efficiently with XRLs. Increased well spacing and further high-grading to exclusively core inventory would compound the effect.
This could mean a surprise to the upside for production and cash flow in 2020. But it also means depleting core inventory significantly faster. And an even harder landing if the same pressures are exerted on producers in 2021.
We expect the exploration sector to create value again in 2020, despite facing a growing battle for support as companies and investors question the need for new resources.
The industry will definitely not spend more than 2019, and spend could fall further, as cost efficiencies continue and a few more explorers drift away from the sector.
McKay said: “The Majors are likely to remain prominent in high-impact exploration plays, though one or more might announce a strategic move away from wildcatting in favour of brownfield growth or new energy businesses.
“By contrast, national oil companies have been slowly increasing their exploration market share and this trend looks likely to continue in 2020.”
“Smaller players face the double whammy of waning investor appetite and, even when they are successful, fewer industry buyers for their pre-FID discoveries.
“The exploration-only business model faces extinction. But the concentration of exploration in the hands of the most capable and focused companies bodes well for overall sector results.”
Source: Wood Mackenzie