Oil Investments Not Ready to Meet Future Demand; High Prices to Come?

As oil companies and petroleum-producing countries cut investments and tighten their belts on costs, today’s oil oversupply will turn to oil shortage, a new study by Rystad Energy predicts.

Certainly, 2014 and 2015 were stinging years for the industry after price plunged nearly $100 a barrel in 2014 and suffered a further 30% in 2015 to end the year at $37.04. Overall, crude has fallen 70% since the summer of 2014.

As a result, the industry finds scarce motivation to spend its cash on exploration and production (E&P). Rystad, an Oslo-based energy consulting firm, reports in its study that E&P spending was cut by $250 billion in 2015 from the previous year; and it foresees another $70 billion cut this year.

Betting on global oversupply and an economically-weakened China, the industry is generally pessimistic about a breakthrough in prices. Bob Dudley, BP Chief Executive, told the AFP: “Prices are going to stay lower for longer. We have said it, and I think we are in this for a couple of years,” as reported widely, including by International Business Times.

But demand for oil will grow, Rystad believes, and industry will be unready to supply the need.

“We see that for most new developments oil prices are below life cycle costs. As oil companies need to pay dividends and have incompressible taxes and royalties, the majority of upstream players are destroying value as we speak and do whatever they can to cut costs. As a result, billions of barrels of crude are not being matured while global consumption growth is still very robust. Thus, a new shortage of crude is likely to come a few years down the road. When this happens, the oil service capacity will not be there to support the growth at the pace needed,” says Jarand Rystad, Managing Partner at Rystad Energy.

He warns: “There is then a risk that we will face a new era of steep cost inflation which again will drive up oil prices too much and negatively impact the global economy.”

This prediction is not rejected by industry insiders. “A big gap is forming in oil-industry investment,” says Claudio Descalzi, chief executive of Italian energy company Eni SpA, according to the Wall Street Journal. “That will lead in two to three years to an imbalance between supply and demand that will push prices higher.”

The Journal says the cuts that Rystad’s estimates – $250 billion in 2015 and $70 billion this year – amount to 20% for each year. Accordingly, this is the first time in 30 years that the industry has decreased investments in two consecutive years.

Specifically, Chevron and ConocoPhillips will each reduce capital spending by about one-fourth this year; and that European producers BP and Total are expected to follow with their own large spending cuts, according to the Journal.

As a result of about 150 delayed projects, an estimated 13 million barrels a day – 15% of total global output – is not reaching the market, according to Tudor, Pickering & Holt, an energy-focused investment bank, the Journal article reports.

All this reduction is striping the market of future needs. Rystad estimates that the industry needs to increase production by 34 million barrels a year to keep up with rising demand; but the industry only made investment decisions for an increase of 8 million barrels.

Naturally, there is an expectation that all this will eventually catch up with the market and force higher prices on oil.

“The stage is set for a supply crunch down the line,” Miswin Mahesh, an oil analyst at Barclays, told the Journal. “Supply from existing fields will fall, while new projects won’t come online to replace them.”

Another analyst told the Journal that prices could reach triple digits again.

“You could see prices shooting up from $30 to $100 pretty quickly,” said Iain Reid, head of European oil and gas at Macquarie bank. “At some point the chickens will come home to roost.”