Oil price volatility is spurring short-term investments, mainly in the US

Oil producers are invariably in it for the long haul. Investing billions of dollars to find and develop new resources entails an almost clairvoyant understanding of future demand cycles. However, volatile prices and uncertainty over global growth may see more short-term thinking in 2019.

This change in mindset has already happened in the US, now the world’s largest producer. The Permian shale oil basin is the world’s epicenter for so called short-cycle investment -- where capital employed drilling wells can be recouped over a briefer period than in conventional fields.

S&P Global Platts Analytics forecasts Permian oil production will more than double over the next two years. Output is expected to average 4.9 million barrels per day in 2020, climbing to 5.5 million bpd in 2021. These figures compare to 2.5 million bpd last year.

Few basins elsewhere in the world can boast similar growth in production, or investment.

According to the International Energy Agency, investment in oil projects globally fell 25 per cent between the end of 2014 and 2016. In 2017, upstream spending flat-lined, with the IEA warning earlier this year investment in conventional projects “may be inadequate to avoid a significant squeezing of the global spare capacity cushion by 2023.”

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Without the kind of short-cycle production coming on stream in the Permian and elsewhere, the world will be staring down the barrel of a new supply crunch early in the next decade.

"I'm confident we'll say in 2020, even in 2021, short-cycle production is likely to be sufficient to meet demand,” said Jeff Currie, global head of commodities research at Goldman Sachs in an interview with S&P Global Platts.

But the success of Permian shale and short-cycle investment also brings problems. Oil production rocketing towards 12 million bpd in the US has encouraged Opec and its allies led by Russia into cutting production to try and boost prices. Brent crude has retreated 30 per cent since it reached $86 per barrel in October amid growing signs of oversupply, weakening demand and rising inventories. “The rapid growth in shale output will push us into a lower-for-longer price environment,” said Mr Currie.

Some oil majors are also waking up to the opportunities of short-cycle investment. BP has beefed up its upstream presence onshore in the US with the $10.5 billion acquisition of BHP Billiton’s shale assets. Meanwhile, ExxonMobil has said it plans to triple its production from the Permian by 2025 a year after it acquired a 275,000 acre plot in New Mexico from the Bass family. Shell, which took a $2.1bn write-down in 2013 on failed unconventional oilfield bets in the US and Canada, has said it could return in the near future.

Of course, conventional and offshore upstream investment has perked up since the slump in prices seen in 2015, but confidence remains fragile. Although rising global demand is expected to hold firm at a record 100 million bpd this year, international oil companies remain cautious.

“We have started to see an increase in global upstream investment. Regions that we expect to see the strongest growth over the next few years are North and South America, Middle East and Africa,” said energy consultant Rystad’s head of upstream research Espen Erlingsen.

In the Middle East, the first quarter of 2019 should see movement on some key upstream projects. The biggest expected is the $12bn development and upgrade of Saudi Arabia’s giant Marjan field. This alone could bring on stream an additional 800,000 bpd of spare capacity in the kingdom. Saudi and Kuwait are exploring ways to reactivate their shared Neutral Zone fields, which would add another 500,000 bpd to output.

Elsewhere, Brazil is eyeing projects in 14 subsalt areas, which could add 2.1 million bpd to output by 2028.

These projects still pale into insignificance when compared to the scale of short-cycle investments already underway in the Permian. But the prolific basin – which straddles New Mexico and Texas – also has its challenges. Transporting Permian crude to markets remains difficult without adequate pipeline capacity and the quality of shale produced also presents a problem for refiners used to processing heavier blends.

“Growth of US shale production, the only domestic output which can react relatively fast to price changes, may be capped because of takeaway constraints in the Permian which is unlikely to be relieved until late 2019,” said Platts Analytics analyst Rene Santos.

This short-cycle paradox created by the Permian basin’s productivity could continue to distort oil markets in 2019 and beyond. However, with the world requiring potentially another 6 million bpd of supply by 2040 there is still a place for longer term thinking.

Paul Hickin is associate director for oil at S&P Global Platts.