Energy transition raises exploration uncertainty

Independents and the majors are increasingly focusing their exploration efforts on proven basins, writes Konstantin Rozhnov

Oil and gas exploration, especially in frontier areas, faces an uncertain long-term future as a range of players — from the majors to private equity (PE)-backed firms — manoeuvre between sustainability concerns, cost pressures and the need for hydrocarbon assets to continue generating cash in the coming years.

Publicly traded upstream independents such as Tullow Oil, Africa Oil and Kosmos Energy, which used to invest heavily in frontier exploration, have been squeezed by two oil price downturns since 2014. They have slashed spending and refocused on producing assets and infrastructure-led exploration in proven basins that deliver faster payback and more attractive returns, and require less capital.

PE-backed companies have fared better, thanks to their owners' deep pockets. Such companies have been among the first to acquire oil and gas assets no longer fitting into international firms' strategic visions. And such assets may be easier to acquire at discounted prices owing to less competition from cash-strapped listed independents. But PE investors from developed economies have started acknowleding environmental, social and governance (ESG) issues and how potential investors and buyers view the impact of climate change on their portfolio companies.

US private equity firm Carlyle, which says energy transition is a core part of its investment thesis, has unveiled a climate resilience case study for Neptune Energy, a North Sea-focused firm that it backs. Carlyle says Neptune produces mostly gas, which "has a vital role to play in the energy transition", while its emissions are a third of the industry average.

PE firms usually exit their investments after 5-7 years, prompting some PE-backed exploration companies to avoid big spending on drilling in the shorter term, buying time to look for other sources of funding. New money may come into the sector from less ESG-focused investors in developing economies, but even they will be wary if more countries and regions start planning to phase out fossil fuels.

Make the grade

The majors are also high-grading their exploration portfolios, as they cut budgets in response to last year's sharp oil price downturn and as European firms react to investor pressure. For them, it is a question of how quickly they can deplete their hydrocarbon reserves without eating into the cash needed for their energy transitions well into the 2030s. BP's energy transition strategy includes staying away from new exploration basins. Shell's plan envisages no new entries into frontier exploration after 2025. Total has made no exploration limitation pledges, but it is cutting its exploration spending anyway, focusing on "what we call the low-cost development projects", chief executive Patrick Pouyanne says.

The firm has been drilling in Suriname and Guyana, two of the most promising frontier basins, but this activity by some of the majors is still mostly about working through frontier elements of their existing portfolios, with a focus on near-field and scale opportunities while disposing of less advantaged ones.

Even state-run oil firms may avoid a big exploration push in the coming years, despite expectations that oil and gas will be in demand globally for decades and that their economies will remain dependent on those revenues. Middle East producers alone already hold sufficient proven reserves to maintain their 30mn b/d oil production for the rest of this century, according to BP's 2020 Statistical Review.

Expectations of higher oil prices in the next few years are set to attract investments in less costly, short-cycle, quicker payback and near-field exploration, despite the more uncertain longer-term outlook for exploration globally. But the question remains whether this will be enough to deliver the resources the world will still need until greener energy can really take over.