Oil sector squeezed by rising costs and investment slump

Above, pump jacks on the Bakken shale formation in North Dakota. Costs in the US shale sector have fallen by half in the past two years. Robyn Beck / AFP

Two of the oil industry’s most closely followed forecasters have raised warning flags about pressures building due to sharply lower investment in the aftermath of the boom-bust cycle of the past decade.

The International Energy Agency (IEA), the Paris-based watchdog for the world’s largest economies, has previously voiced concern about an impending oil shortfall because of the investment slump. But in its latest warning, the agency says the remarkable rebound in the US shale sector in recent months risks masking the continued slump elsewhere.

Costs in the US shale sector have fallen by half in the past two years, so that the oil price recovery since last autumn – spurred by output restraint by Opec and some other producers – has encouraged a rebound of 500,000 barrels per day of US shale production.

“This growth in US shale production has become a fundamental factor in balancing low activity in the conventional oil industry,” the IEA said.

But conventional oil production, which accounts for 80 per cent of the world’s total output, is seeing ever-dwindling investment and exploration spending is forecast to drop again this year, the third year in a row of falling investment, the IEA said.

“Every new piece of evidence points to a two-speed oil market, with new activity at a historic low on the conventional side contrasted by remarkable growth in US shale production,” said Fatih Birol, the IEA’s executive director, in a report released on Thursday.

“The key question for the future of the oil market is for how long can a surge in US shale supplies make up for the slow pace of growth elsewhere in the oil sector,” he said.

Meanwhile, in a separate report, oil industry consultancy Wood Mackenzie warned that the sharp increase in activity in the US shale sector has already begun to squeeze the oil services providers – who provide the rigs, pumps and other essentials of drilling – and is beginning to push costs back up.

“The recovery in oil prices and capital-spend increases signal the beginning of an upward trend in activity [and] the speed of increase in 2017 is squeezing the service sector, supporting our view on cost inflation,” according to Jackson Sandeen, a US oil industry analyst for Woodmac, which forecasts costs will rise on average by 15 per cent in the US shale sector this year.

One of the consequences of rising costs is that it could push back up the oil price level at which new investment breaks even, thus abruptly stalling investment in the sector, Mr Sandeen noted.

The US shale sector has become the world’s “swing producer”, to some extent, because of its ability to respond so quickly to market conditions.

However, the IEA highlighted the difference in scale between US shale plays, which it forecasts will expand by another 2.3 million bpd by 2022 at current oil prices, and offshore oil supplies, which require much larger and longer-term investment commitments and which account for about a third of world supply.

Last year, offshore investment was only 13 per cent of the total in conventional oil, down from an average of 40 per cent from 2000 to 2015, the IEA said. North Sea oil investments alone fell by half from 2014 to just below US$25 billion last year.

There is still plenty of discovered oil in relation to expected demand – the BP Statistical Review estimates there are about 1.7 trillion barrels of proved oil reserves, compared with the IEA’s estimate of demand of 880 billion barrels for the period from last year to the end of 2040.

But the dwindling rate of investment still risks energy security even in the short term, the IEA said. “It brings an additional cause of concern for global energy security at a time of heightened geopolitical risks in some major producer countries, such as Venezuela,” the agency said.

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