Upstream oil and gas investment decisions bolstered by lower breakeven costs

Photo: Royal Dutch Shell.

Wave of large projects post-2019 could signal new cost cycle underway

As previously forecasted by Wood Mackenzie, 2017 saw a significant recovery in upstream FIDs (Final Investment Decision), with the number of project sanctions more than doubled compared to 2016. Wood Mackenzie expects a similar total this year – around 30 major project FIDs – supported by continued lower oil and gas spending.

Cost reduction efforts by the industry have largely been successful.

The primary focus has been to reduce project footprints through fewer wells, smaller facilities, and the greater use of subsea tie-backs and existing infrastructure.

Lower costs, lower breakevens, higher prices, and improved corporate finances all contributed to an upgrade in industry sentiment and more projects getting sanctioned in 2017, according to Wood Mackenzie.

However the projects that did get the greenlight are notably smaller. The average capital expenditure to develop ‘major’ projects (commercial reserves over 50 mmboe) sanctioned in 2017 fell to only US$2.7 billion, the lowest in a decade. To put this into context, the average project capex for those sanctioned over the last decade was US$5.5 billion.

“We are seeing significantly smaller projects, alongside a greater appetite for brownfield and expansion projects, and more subsea tieb-backs. Brownfield developments are popular in the current capital-constrained environment, with less spend and execution risk than a greenfield project, and a faster route to first production. Both investors and operators want to see faster cycle times and quicker returns on upstream projects,” said Jessica Brewer, a principal analyst at Wood Mackenzie.

Wood Mackenzie also forecasts a 15 per cent decline in average breakeven* cost to US$44/boe (applying a 15% discount rate), with the most competitive projects in shallow-water Norway, UK and Mexico. Gas projects will take centre-stage, aided by big expansion projects in Norway, Iran and Oman.

“We should continue to see operators favouring a ‘leaner and meaner’ path in 2018. At the beginning of the year we selected 30 projects we thought were most likely to make FID, and they follow many of the trends we saw emerge in 2017. Average capex continues to fall – averaging only US$2.2 billion – while capex/boe is now only US$4.9/boe, versus US$11.3/boe back in 2011,” said Brewer.

The first quarter of 2018 ended with six projects already sanctioned – all from Wood Mackenzie’s original list of 30, including fields in the UK, Norway, Israel, the Netherlands, Malaysia and China. The latter is the Lingshui development, operated by state-owned CNOOC Ltd, and is China’s first wholly-owned and -operated deepwater gas project.

“While it is good news that operators have found ways to grow in tough business conditions, the big question is whether the industry is actually spending enough. We cannot rely on smaller projects forever, and when we look at LNG in particular, we see a lot of big projects on the horizon,” said Angus Rodger, research director, Wood Mackenzie.

The FID story could shift again in 2019, with multi-billion boe developments such as Mozambique LNG, Canada LNG, and expansions in Qatar and Papua New Guinea all eyeing final investment decisions.

“Can the industry apply the leaner lessons it has learnt through the downturn to these giant projects, or will we return to the boom and bust cost cycles of the past? Companies know they don’t want to be all rushing through that door at the same time and then see costs blow-out. So it will be interesting to see if any of these LNG projects push for a late-2018 sanction, thereby locking-in lower costs and pipping the competition,” concluded Rodger.

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