by Nick Cunningham of Oilprice.com
One casualty of the oil price downturn could be the megaproject.
For years, as conventional oil reserves depleted and became increasingly hard to find, oil companies ventured into far-flung locales to find new sources of production. Extracting oil from these frontier areas required more advanced technology and a lot more capital: Ultra deepwater, Arctic offshore, heavy oil sands, and increasingly, the Lower Tertiary.
Often these megaprojects projects were only the purview of the largest oil companies, as smaller players did not have the resources—financial or technological—to make them work. Meanwhile, smaller drillers, at least in North America, turned to shale, which required less upfront cash and could be turned around on a quick timetable.
The collapse of oil prices, however, could kill off the megaproject. The oil majors are scrambling to cut costs, and large-scale projects with high costs and long time-horizons are not making the cut. A combined $19 billion in write-downs was recorded in the last week of October as the oil industry reported third quarter earnings.
Spending on deepwater exploration is expected to be cut 20 to 25 percent industry-wide, according to Barclays, substantially higher than the 3 to 8 percent cut for exploration on all varieties of fields.
One problem for these large projects is chronic delays and ballooning costs. Around 80 percent of large projects fail to stay on budget and come online at the expected start date, according to Bloomberg. About three-quarters of them have suffered delays, and two-thirds have blown through their original cost expectations.
That could force even the oil majors to start to back away from large-scale oil projects. Royal Dutch Shell recently scrapped its Arctic program and wrote off a costly oil sands asset at Carmon Creek. The completion of Chevron’s Big Foot project in the Gulf of Mexico will be pushed back by a few years because of equipment problems.
In a glaring example of shifting priorities, ConocoPhillips announced that it was backing out of deepwater altogether. By 2017, the company says it will cease deepwater exploration and will sell off its offshore leases that it does not plan on developing. Conoco has the rights to 2.2 million acres of Gulf of Mexico territory, and it could still develop some fields, but it will stop searching for new discoveries. The decision will save $800 million in exploration costs, money that will be redirected to exploration in other areas. “We are exercising flexibility in our capital program, dramatically lowering our cost structure and divesting assets that do not compete for funding in our portfolio,” ConocoPhillips CEO Ryan Lance said in a statement.
With the largest oil companies starting to back away from the megaproject, the result could mean a greater focus on shale. Production from an average shale well is a fraction of a deepwater well, for example, and output also suffers from dramatically steeper decline rates compared to offshore. However, drilling a shale well can cost a few orders of magnitude less than a large-scale offshore project. That is a feature that is hard to overemphasize in today’s oil pricing environment.
The narrower focus on smaller projects, especially shale, could mean the end of the megaproject. The collapse in prices may mean we don’t see more white elephants like the Kashagan project in Kazakhstan, an offshore boondoggle that has required more than a decade of development, tens of billions of dollars, and still won’t come online for a few more years. Or, LNG export facilities like the massive Gorgon LNG, led by Chevron, which saw costs balloon to more than $54 billion, could be the last of its kind.
Then again, there is a question about whether or not shale can really be a major source of supply over the long-term. The International Energy Agency sees North American shale peaking towards the early part of the 2020s and declining thereafter, all but making it a blip on the radar when looking at oil production from a long-term standpoint. By the 2020s, the IEA says, the world will once again be dependent on traditional sources of supply—largely from the Middle East.
But for new sources of supply that are not state-owned, the industry may have to shift back to the mega deepwater projects that they are beginning to shun today.
by Nick Cunningham of Oilprice.com
October has been billed as a pivotal month in which indebted shale companies would see their credit lines cut, precipitating a faster consolidation in the industry that would sow the seeds of a rebound.
But banks appear to be taking a more lenient approach than expected. A new Jeffries report says that only $450 million in borrowing bases have been cut, across more than 20 companies. That amounts to just 2 percent of available credit lines, much lower than the 15 percent reduction expected by analysts. In other words, banks are allowing drillers to continue to borrow, which could delay the inevitable balancing needed in the market.
The possibility of a wave of bankruptcies could be put on hold, after banks have been “surprisingly gentle,” as Jeffries put it in their report.
That doesn’t necessarily mean that indebted shale companies can right the ship. It may just delay the adjustment for oil markets. “It looks generally to me like it’s sort of kick the can down the road approach that’s being taken at this point but that really just pushes the day of reckoning into sort of the first quarter of next year,” Dave Lesar, Halliburton Chairman and CEO, told investors on October 19 when reporting quarterly earnings.
In fact, Jeffries sees the spring of 2016 as a more critical deadline for struggling drillers hoping to keep their credit lines open. “We think that banks are generally giving producers more time to improve financial health and that spring ‘16 redeterminations could be much tougher without significant commodity price improvement,” said Jonathan Wolff, an analyst with Jeffries, according to SNL.
It is not a total win for the companies that are trying to hang on. Maintaining access to finance can come at a price. Jeffries expects that companies will have to offer up more collateral or agree to more restrictive covenants.
Furthermore, Jeffries says that a large volume of high-yield bonds will mature in the coming years, raising the likelihood that refinancing will be needed. Bond markets have essentially been ruled out as a new source of finance for high-yield producers. That means that credit lines with lending institutions become the last resort. E&P companies could resort to loans in order to pay off maturing debt, not unlike charging one credit card to wipe clean the debt on another.
Still, in the short-term, the leniency from lending institutions could delay what many had hoped would be the start of a rebound. Kicking the can means that production may not fall as fast as expected, which will mean oil prices may not begin to stage a rally as quickly as some had hoped.
Moody’s Investors Service sees the contraction as too little to make a significant dent in the global supply gut. The ratings agency cut its forecasted oil price for 2016 to just $48 per barrel. “Although capital spending has dropped substantially and the U.S. rig count has declined by more than half, U.S. production has only recently begun to decline,” Moody’s concluded in a recent report. “Moreover, Saudi Arabia and Russia have both increased production to their highest levels since the early 1990s.” Moody’s sees global oil production rising by 1 million barrels per day in both 2015 and 2016.
Not only are Russia and Saudi Arabia keeping production elevated, new gains in oil production from the Middle East could offset any declines in the United States. Iraq has steadily increased output this year despite low oil prices and security issues related to ISIS. Also, although there was a lot of speculation about Iran’s ability to return some capacity to the market, such an outcome appears more and more likely. Iran’s oil minister insists that his country has secured buyers for 500,000 barrels per day of oil, the amount that Iran believes it can add pretty much immediately after sanctions are lifted.
That will keep the pressure on US shale. But for now, banks are helping to keep the most indebted companies alive.
Nick Cunningham is a Vermont-based writer on energy and environmental issues. You can follow him on twitter at @nickcunningham1.