Peak Investment Has Probably Already Happened

Peak Oil and Gas Investment Has Probably Already Happened – So What does that Mean?

The subject of Peak Demand remains a top-level oil and gas issue. Peak Investment should be one too – especially as it’s probably already happened.

The IEA in its new World Energy Outlook suggests it could be many decades before oil and gas demand reaches a maximum, whilst the CFO of Shell proposed it could be as close as five years from now. Even OPEC have a scenario where oil goes into decline in just a dozen years – barely time to get a decent-sized project scoped and built.

Whatever actual date the history books and spreadsheets mark as the eventual high-point, its clear Peak Demand won’t just come by itself.

For a start, even having these discussions indicate that demand is slow and flattening, and beginning to wear out: the classic plateau of an industry technology curve as it reaches late-life, nearing decline.

BP’s review of World Energy charts that energy demand has decelerated globally to less than 1% per year, with coal and oil dropping off well below this value.

In fact, in the OECD oil and coal peaked a decade ago – the only real debate is how long China or India can keep overall demand growth above water, especially as both are attempting to avoid a long-term path of hydrocarbon dependency, via renewables, to escape air quality and security issues.

But whilst Peak Demand remains a hot debate, Peak Investment may just quietly have taken place.

Of course, oil and gas companies will need to keep investing at reasonable rates for many years, but it will almost certainly not be at the extreme levels of the past decade, when expenditure grew at a breath-taking, and ultimately unsustainable, clip of almost 15% per annum. By 2014, Big Oil was spending five times as much per year as in 2004. When oil prices fell by over 60% in that year, it sparked a downturn of over 40% in capital spending across the industry, and future investment forecasts are still coming down.

Despite this, the oil and gas industry still sees a robust future of major investment ahead. The driving narrative is a looming “supply hole” that will need to be fixed with a re-start in massive capex programs. The hole occurs because that dearth of investment over the past three years has removed the supply necessary to make up for decline rates and new demand – Peak Investment is yet to come.

That assumption is likely to be wrong. Here’s why.

First – productivity.

The industry spent well over $400bn per annum over the past decade, but that capital was largely unproductive. Aggregate investment was over $1.8trn but production increase was zero, causing return on capital metrics to collapse. When oil prices then dropped, investment plans mostly based on $100/bbl oil or higher were cancelled leading to major cut-backs, lay-offs and sell-offs that continue today. The industry’s almost exclusive reliance on high-complexity megaprojects, prone to cost and schedule blow-outs, became an economic dead-end almost overnight.

If the previous era was hugely inefficient, it has at least spawned a far more productive legacy. As the investment dollars dry up, much more focus is being given to optimizing and de-bottlenecking all the expensive new kit constructed in the boom, and extracting a lot more juice from existing fields.

This also provides a solution to the concern about field decline causing supply shortfalls. In its latest update, Conoco-Phillips presented a eye-popping capex reduction from $17bn in 2014 to $5bn in 2017. However, with a precise focus on mature field-management and limited growth investment in its legacy megaprojects, it predicts flat or modestly-growing production at these new levels “for decades”.

The new discipline learned from the previous era? – a simpler, more flexible, more adaptable and scalable set of assets. And COP are unlikely to be unique in pursuing this strategy. The US tight oil industry is effectively built on this model.

On top of this, as Amy Myers-Jaffe also points out here in a WSJ piece, Citigroup calculate that by 2022 up to 15million bd-1 of new production is possible from investments already in motion, and current cuts are mainly in line with falling costs in the supply chain.

All this suggests the high-cost segment of the industry production curve – non-OPEC, and especially the major oil companies – is switching its focus to extend or increase output at vastly lower rates of investment.

So, even if OPEC succeed in pushing oil prices higher by curbing their own production, this will likely only excite the low-cost and newly-productive non-OPEC production back to market. The high-cost, high-risk mega-sized investment tail will not be revisited – unloved by investors and uncompetitive in revamped company portfolios.

A chart developed by Accenture highlights what a new trajectory could look like based on IEA scenarios – even with weak but continuing demand growth, the profile of investment looks very different to the past.

Second – competition.

In a vexing irony for the industry, modern fossil-fuels now have a new top-line competitor for energy provision at the very point when overall demand has decided to level off. High-growth renewables have reached cost competitiveness and the steep part of the adoption curve, providing over 50% of new global power capacity last year, and displacing coal in total capacity installed.

And unlike hydro and nuclear, which require vast capital and natural endowments, high-growth renewables, wind and solar, could not be more different – distributed, flexible, scalable, repeatable, manufactured, and available everywhere.

As a result, in the power market, gas projects now compete for investment dollars not only with legacy coal, hydro and nuclear programs, but with strongly-financed large-scale wind and solar.

In the past, gas had a much clearer run at these markets, as demonstrated in the upsurge in LNG investment. Now, as Chatham House label it, gas is “an uncertain residual” between supported coal, and the expanding high-growth renewables.

In transport, major oil projects do not get off easily either. If prices rise, Russia and US shale can leverage their low-cost assets: in the previous era, these two blocs contributed significantly to production growth, for only 15% of the total investment. And alternative external competition from electric vehicle (EV) technology is also rapidly emerging: over 200 models of EVs are now in various stages of production, and exponential fleet growth has led to estimates they will cause a displacement of 1-2million b/d of demand by 2025. This will switch low hydrocarbon growth into full decline in just a few years.

In sum, the future investment landscape for oil and gas looks to be one of simpler, smaller-scale efficient projects, competing with rapidly emerging energy technologies.

Peak Investment, driven by sky-high prices and grand-scale megaprojects, is therefore probably behind us, with 2014 the high water-mark – see the IEA chart below.

Why is this important?

As demand flattens, productivity rises and competition increases, oil pricing will transition from controlled and cost-plus, to market-driven. This was put succinctly recently by former Saudi oil minister Ali al-Naimi: “Anybody who thinks he or any country is going to influence the price in today’s environment is out of his mind.“ “Let the price be decided by the market”

Peak Demand, and Peak Investment are not flat historic markers: they are indicators of this shift in the oil market. The mantra lower-forever is the colloquial short-hand.

So oil firms at the high end of the cost curve, and still with ambitious plans for major investment programs, need to avoid leaning too heavily on headline assertions and primary energy ratios that suggest the system will take forever to change.

Instead, they need to observe the more immediate moves on the ground: new incremental investments are rapidly turning towards the flexible, scalable, simple – and renewable.

Fossil fuels will of course be needed for decades to come, albeit at lower volumes – but the business that provides them will have to redesign itself to stay competitive.

Acknowledging Peak Investment, and acting on it, is a key part of this process.