Principal Analyst Angus Rodger discusses the impact of upstream cost deflation in the current oil price environment
By year-end we may be able to count the number of major upstream projects that reached a Final Investment Decision (FID) during 2015 on one hand. The dramatic fall in oil prices in 2014 and subsequent dismantling of 2015 company budgets has, by mid-year, already resulted in over 45 major project FID deferrals.
As a result, we estimate 20 billion boe of reserves has been pushed back from a diverse range of onshore, shallow-water and deepwater projects. Together, this creates a US$200 billion hole in the industry’s investment pipeline.
Why these projects, and why now?
Projects that are technically challenging, have significant upfront costs and/or low returns have proved vulnerable – over 50% of the 20 billion boe is located in deepwater projects, and nearly 30% in the Canadian oil sands.
From a corporate perspective, there are two main drivers for deferring projects:
• Releasing capital in response to the fall in oil prices
• Giving more time to develop enhanced designs, cost optimisation and other measures to improve overall economics. In essence, rebuilding projects for a lower price environment.
Trying to breakeven
Inflationary pressures have pushed many projects into economically marginal territory and operators are now reworking costs and development solutions to achieve their hurdle rates. But it won’t be easy. We estimate that half of the new greenfield developments still produce sub-15% development IRRs, which is below most companies’ economic hurdle rate.
For most operators, hoping a 10% reduction in capex is sufficient to reach FID won’t be enough, as only a handful have an NPV10 breakeven below US$50/bbl. Given where we are in the corporate capex cycle, only those assets with the most robust economics can expect to make the grade.
We estimate the majority of these projects are now targeting start-up between 2019 and 2023. However, if the major IOCs continue to focus on cutting future capital commitments – to the detriment of future production growth – then these dates will be pushed back further.
For some, aggressive re-phasing of capital spend and savings from cost deflation will enable them to have another run at FID over the next six to 12 months. But in a world of greater financial discipline and lower oil prices, others will require more radical changes to make them attractive investments.
Pre-FID project deferrals: 20 billion boe and counting [Subscription required]
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