Deloitte: Debt, Shareholder Payouts May Take Priority Over CAPEX Spending
The global oil and gas industry will need a minimum investment of nearly $3 trillion between 2016 and 2020, or about $600 billion each year, to maintain production needed for existing demand. But a recovery in oil prices and cash flow might not guarantee a ramp-up in capital expenditures (CAPEX) on exploration and production (E&P) as operators face debt payment and shareholder payout obligations.
Spending cutbacks due to low oil prices mean that companies are spending below the minimum required levels needed to maintain existing production, according to a recent Deloitte Center for Energy Solutions report, Short of Capital? Risk of underinvestment in oil and gas is amplified by competing cash priorities. The global oil and gas industry must maintain production to meet annual demand of approximately 33.5 billion barrels for oil and 120.5 trillion cubic feet for natural gas. It must also meet annual demand growth of one to two percent while overcoming annual field declines of seven to nine percent.
Replenishing these resources consumes about 80 percent of E&P CAPEX, Deloitte said, adding that it takes a lot for the industry just to stay flat. Underinvestment in existing wells “points towards a looming problem of sustaining current production levels and adding new capacity, which will likely be apparent three to five years from now,” Deloitte noted in the report.
However, Deloitte notes that listed entities worldwide have $590 billion in maturing debt and approximately $600 billion in already reduced payouts to pay over the next five years. As a result, oil and gas companies are facing total cash outflows for debt and payouts of $4 trillion for the 2016 to 2020 time period. As a result, Deloitte estimates industry faces a $2 trillion funding gap over the five-year period, based on an average oil price of $55/barrel.
In the $100/barrel oil world – a growth period when all opportunities were good – the upstream oil and gas sector as a whole outspent cash flow by significant amounts just to grow their opportunities and reserve base, Andrew Slaughter, executive director, Deloitte Center for Energy Solutions, told Rigzone. But lower oil prices has led companies to accumulate significant debt levels and leverage levels across the sector.
“There’s a notion that any price recovery could be translated fairly quickly into an upturn in activity and drilling and completion, particularly for short cycle opportunities,” Slaughter commented. But Slaughter believes the recovery from the downturn – significant longer and more severe than previous downturns – will take longer as companies on debt repayment and maintaining shareholder payouts. Even dividends, which are notionally discretionary, are part of the shareholder value proposition. Confidence levels in company boardrooms, and financial institutions’ perspective of the oil and gas sector, also mean the recovery will take several years to play out.
As a result, oil and gas companies are likely to divert their CAPEX focus away from capital-intensive, front-end loaded projects such as deepwater and frontier. These types of projects are at the back of the queue for new capital, Slaughter said. Instead, companies will focus on less risky opportunities such as the Permian Basin and other U.S. onshore plays.
“The mix of opportunities is changing and it could be storing up vulnerabilities for the future,” Slaughter said.
Smarter uses of technology have helped companies achieve cost reductions over the past 12 to 18 months. Innovations in technology – such as equipment standardization, digitization and mass deployment of sensors that bring predictability to a company’s portfolio – will always help. But in the bigger picture, the industry tends to be calibrated with the oil price. Even if a steady recovery in oil prices occurs, service, equipment and engineering costs will start to rise again because of the supply chain tightening. These costs will outweigh any benefits of technology.
In the recent downturn, a lot of capacity has been taken out of service, including human capital and equipment. If an E&P operator wanted to ramp up activity quickly, they might find that capacity is stressed, Slaughter noted.
The minimum investment of $3 trillion would include about $1.4 trillion for oil and $1.6 trillion for gas. While companies will still be able to exploit proved oil reserves, they will likely need to maintain development spending over the next five years. The industry will need to replenish its natural gas reserves life, which is at a 25-year low, but it could go slower on the development, Deloitte stated.
Slaughter said he was surprised to see the amount of capital investment that will be needed to sustain gas reserves. The United States is lucky in that it has large, low-cost gas resources such as the Marcellus shale. But global gas demand is likely to increase year-on-year, at a faster pace than oil, because it’s used as a substitute for coal or as a complement to renewable energy. While a lot of investment in integrated gas and liquefied natural gas projects has taken place, there’s likely to be an underinvestment in gas.
According to Deloitte, low oil prices have created a cash crunch among E&P companies, forcing them to significantly reduce capital expenditures. The oil pricing environment has created tough times for the industry; so far, more than 77 E&P companies have already filed for Chapter 7 or 11 bankruptcy, and several are on the edge of debt default. After cutting CAPEX by approximately 25 percent last year, the global upstream industry, excluding the Middle East and North Africa, has announced further CAPEX cuts of 27 percent by 2016.
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