IEA sees upstream spend up, costs further down in 2017

Upstream oil and gas investment is on track to increase by 6pc in 2017 after falling sharply in the previous two years. A slide in oil prices could derail this recovery, according to the IEA.

But most of the fall in investment seen in 2015 and 2016 is due to lower unit costs rather than lower activity levels, the OECD enery watchdog says. It expects upstream unit costs to fall for a third consecutive year this year. That said, the fall in activity is enough to cause concerns about future capacity.

Investment fell by 26pc last year, to $434bn, after falling by 25pc in 2015, the IEA said in its World Energy Investment report. Over the two years, investment fell by a total of $345bn.

"Most of the decline can be explained by lower unit costs, but a significant share of the contraction is due to reduced drilling activity," the IEA said.

Based on current company plans, the Paris-based energy watchdog expects upstream oil and gas investment to increase to just under $460bn this year.

"The vast majority of the companies that have released their investment plans for 2017 anticipate an increase in their budgets, indicating that spending may have bottomed out," the report says. "However, with oil prices falling below $45/bl per barrel in mid-June 2017, there is a real possibility that companies may not be willing to fully implement these investment plans."

In the US shale industry, where firms "have benefited from a reduction in breakeven prices as a result of a combination of improvement in costs and efficiency gains", investment is likely to increase by 53pc this year compared with 2016.

"In Mexico, upstream investment will get a boost from its first offshore licensing round, which successfully attracted bids from several international operators," the IEA said. "Chinese NOCs have all announced a significant rise in their investment after two years of sharply reduced spending, while the anticipated rise in Russia's upstream spending is subject to downside risks."

But the IEA also said that "a drop in upstream oil and gas activity and the recent slowdown in the sanctioning of conventional oil fields to its lowest level in more than 70 years may lead to tighter supply in the near future".

"Given depletion of existing fields, the pace of investment in conventional fields will need to rise to avoid a supply squeeze, even on optimistic assumptions about technology and the impact of climate policies on oil demand," the report said.

The watchdog expects exploration spending to fall by a further 7pc this year, after already halving to about $60bn last year compared with 2014.

"The share of exploration in total upstream spending is set to reach around 12pc in 2017 — the lowest level for more than a decade," the IEA said. "While the recent fall in nominal investment numbers is largely due to cost deflation, the contraction in activity has already translated into a sizeable decline of resources discovered."

The agency's Upstream Investment Cost Index shows that average upstream costs globally "have fallen over the last two years by about 30pc to levels of more than a decade ago". The decline amounted to 17pc last year.

"We estimate that about 50-55pc of the cost reductions since 2014 can be characterised primarily as structural, with the remaining being more cyclical in nature and expected to evolve more in line with the trend in activities and evolution of markets," the IEA said. "For the US shale industry, the structural component of cost deflation appears to be smaller at around 40-45pc, as the nature of operations is more heavily influenced by short-term market factors."

The report said that the US shale industry focused its activities on "sweet spots" in 2015-16 amid lower oil prices.

"As those resources will be progressively depleted, activity will inevitably shift to less prolific areas of each basin. As a result, the US shale industry might experience inflation pressure if it is to maintain its production levels," the IEA said.

It expects upstream exploration and development unit costs to fall globally by a further 3pc this year, with "offshore activities seen as the key contributor to continuing cost decline".

"The offshore sector is less likely to rebound in the near future, given the steep plunge in activity and the cost reductions negotiated during the last year, despite a probable small recovery in activity in 2017," the IEA said.

But US shale costs are already rebounding, according to the watchdog.

"There are already signs that the sector is experiencing some renewed cost inflation — a trend that might accelerate in the second half of 2017, should oil prices remain at current levels — around $50/bl — or rise. We estimate that average costs for US shale activities will increase on average by 16pc in 2017," the IEA said.

The energy watchdog said that total investment in oil and gas fell by 26pc to $650bn in 2016, with the sector losing "its position as the largest recipient of investment to the electricity sector".