Oil: In need of investment

The worst-case scenario for oil in 2017 is that the Organization of the Petroleum Exporting Countries (Opec) doesn’t comply with the cut of 1.2m barrels a day announced on 30 November and that non-member countries do not meet their commitment of cutting 558 000 barrels a day. 

Opec knows this, which is why it described as “vital” the need to get global oil stock to normal levels. Richard Robinson, investment manager at Ashburton Investments, says that if the non-member cut does not materialise and compliance from Opec sits at 67% rather than the norm of 85%, then oil inventories would not normalise until near the end of 2018 and the markets could face sub-$50 per barrel oil prices for all of 2017. 

Oil fell from over $100 per barrel in mid-2014 to less than $30 per barrel early in 2016, leading producers to cut jobs and scale back on projects. This has in turn led to reports by the International Energy Agency (IEA) and Opec warning that investment in new oil fields is needed to prevent the sector from dipping back into an under-supply scenario.

They say that if new project approvals remain low in 2017, the sector will battle to meet global demand by 2020. 

Debt-laden oil industry

PwC’s Chris Bredenhann says there have been significant job cuts and capex reductions in the oil sector, both in Africa and the rest of the world. Nigeria and Angola have been hit especially hard. 

“The oil companies are taking on major losses; there are high levels of debt in the industry,” says Bredenhann. According to him 80% to 90% of the oil companies’ cash flow is going to servicing debt. 

Bredenhann says Shell is still paying out dividends to its shareholders, but it is borrowing money to do that: “It’s going to take a long time to work through.” 

One knock-on effect from low oil prices is that the current trend of declining investment in new oil projects will continue. Shell has, for example, pulled out of the Arctic because the resulting oil would have been too costly, while Total has halted investment in Canada’s oil sands for similar reasons. 

It takes between three and six years to get conventional oil fields producing.

Declining investment

Investment in the oil sector peaked in 2014 at $780bn, but fell to $580bn in 2015 and is expected to have fallen to $440bn in 2016. The IEA says approval for new crude oil projects is at its lowest level since the 1950s. 

The IEA believes that $700bn needs to be invested every year and the oil price needs to rise to $80 per barrel in order for supply and demand to be balanced by 2020. 

Opec said in its most recent annual report that it is “vital that the industry ensures that a lack of investments today does not lead to a shortage of supply in the future”.

In its statement after the 30 November meeting, Opec again mentioned the lack of investment in the sector. 

It said it had noted the drop-off in investment levels in 2015 and 2016 as well as the large number of job layoffs, and called for continued investment. 

“2017 is the last year where we will see a decent level of new oil hitting the market from large and mid-size offshore projects,” says Robinson. “From 2018 onwards, there will be a visible and significant drop in offshore supply. In fact, only 1.3bn barrels of new offshore oil volumes have been sanctioned in 2016, compared to a yearly average of around 10bn between 2010 and 2013.” 

The Trump factor

Another unknown factor that the oil sector is going to battle with is the changes in US policies under president-elect Donald Trump. During the US election campaign, Trump promised protectionist trade policies and a fossil fuel revival. He said he was in favour of removing oil sector regulations and opening federal land to drilling. 

Whether he delivers on these campaign promises will have their own complications for the oil sector. Some analysts have suggested that increased protectionist policies in the US would be bad for Asia’s dependence on trade with the US, which could have negative effects on economic growth and oil demand. 

This article originally appeared in the 29 December edition of finweek. Buy and download the magazine here.