The upstream movement: Oil producers must invest to avoid another crisis

While oil producers continue to debate a reduction in output, attention is also flowing towards upstream operations.
By Parag Deulgaonkar
Sat 12 Nov 2016 02:42 PM

Deal or no deal, oil producers must ramp up investment or risk a new “shock” by the end of the decade. That is the industry warning from analysts to oil ministers.

While bickering continues over a preliminary agreement to cut output, due to be confirmed at the next meeting of the Organization of Petroleum Exporting Countries (OPEC) on November 30, several of the 14 oil cartel members are refocusing on upstream capabilities to help counter a slide in crude exports.

UAE Energy Minister Suhail Bin Mohammed Al Mazrouei last week implored both OPEC and non-OPEC oil producers to increase investment in the industry to avoid another tumultuous hit to the global economy within two to three years.

 “The world economy cannot face another shock. We need minimum investment in the industry as we don’t want to run out of supply,” the minister said during the Abu Dhabi International Petroleum Exhibition and Conference (ADIPEC).

“Yes, shale oil will re-bounce, but in how many days when you know that 450,000 people have been laid off from the services. Those people are not going to come back overnight to bring a million barrel per year in the US. It needs time and that shortage is there, [then] you will need someone to take action.

“Some of the responsible producers like us and Saudi Arabia have buffers; that is to ensure that we can attain to any crisis that happens due to geopolitics.”

OPEC statistics show investment in 117 upstream (exploration and production) projects worth a total of $270bn. It describes such investment as an “essential element to meet the expected demand growth and stem the decline of oil production from existing wells”.

Saudi Arabian Oil Company (Aramco), the world’s largest oil exporter, has boosted its spending in international upstream businesses and plans to use much of the proceeds of its upcoming initial public offering (IPO), which could be worth as much as $125bn.

“We have a lot of global investments in downstream. Post-initial public offering and even as we prepare for the IPO, you will find Aramco quite interested going into international upstream,” Saudi Energy Minister and Aramco Chairman Khalid Al Falih said in June.

Another dominant OPEC member, Iran, is investing $130bn in upstream industries as it ramps up its oil production capacity after the easing of international sanctions. The country’s Petroleum Minister, Bijan Zanganeh, says upstream operations are pivotal for Iran’s oil industry recovery.

In the UAE, state-owned Sharjah National Oil Corporation (SNOC) has commenced 3D-seismic onshore surveying to ascertain potential deep reservoirs of oil and gas. The study, covering an area of 500 sq km extending from Al Soyouh in the north to Al Madam in the south, is scheduled for completion by the end of the year.

“This is the first exploration activity since the company was established. We are mandated to identify and quantify all possible underground structures that may contain oil or gas in the emirate,” SNOC CEO Hatem Al Mosa says.

Abu Dhabi National Oil Company’s (Adnoc) updated 2030 strategy, released in the first week of November, states upstream will remain its most profitable business as the company continues to concentrate on new technologies to increase the quantity and efficiency of oil recovery.

London-based KBC principal consultant Ehsan Ul-Haq tells Arabian Business that OPEC countries cannot ignore investments in their upstream sector, as the world will continue to require oil in spite of growing investment in renewables.

“Many international oil companies believe that we might have a supply crunch by 2019 if not enough is invested in [upstream]. Saudi Arabia is a member of G20 countries and sees itself as responsible for ensuring enough supply, although other OPEC countries also need investment in the upstream sector for their revenue, as well as to guarantee supplies.”

Justin Dargin, a Middle East energy expert at the University of Oxford, says Saudi Aramco has a twofold interest in moving upstream.

“On one hand, Aramco and the Saudi government believe that due to global population increases, international oil demand is on a trend for long-term growth. Therefore, according to this logic, Saudi Arabia should continue to invest in domestic oil production to meet these demand increases, despite what it considers to be a temporary decrease in global oil prices over the past several years.

“Additionally, in terms of global upstream investment, Aramco is seeking to become a more flexible national oil company. With its investments overseas, it wants to be able to have a foothold in international gas production and other downstream ventures. One of the reasons Aramco is focussing on gas is that if it has more gas for domestic power production, then it is also able to export more oil to the global market,” he says.

Frost & Sullivan associate director and regional head of Middle East energy and environment Abhay Bhargava says there are some obvious benefits for many of the oil-producing countries to continue investing in their upstream assets.

“This is more [of] a function of their ability to produce crude at reasonable prices, and the fundamental value it can create for their economy, either in the form of exports in a competitive environment, or downstream value generation through refining and petrochemical activities. An additional factor that can govern a country's decision to continue or not with investments will be the rate of decline in their existing assets,” he says.

The optimism of looking upstream is also reflected in International Energy Agency’s (IEA) comments. The Paris-based organisation, created after the 1973 oil crisis, says in its recent report that upstream oil investment remains robust in the Middle East and Russia.

“The relatively low cost of developing reserves in these regions and currency movements that mitigated the fall in the dollar oil price helped to support investment there. While the Middle East produces over one-third of the world’s oil, it accounted for only 12 percent of global upstream investment due to exceptionally low drilling costs. In Russia, capital spending even increased in Ruble terms, helping to stabilise Russian production at a post-Soviet high,” the IEA report says.

Dargin believes the financial gains from upstream industries will assist OPEC nations to build up their secondary and tertiary industries, leading to economic diversification.

“Additionally, the OPEC member states, particularly in the Gulf, are facing demographic increases and per annum domestic oil and gas demand growth. Therefore, they need to not only export more oil for foreign revenue to maintain budgetary outlays but to provide more gas and oil for domestic consumption,” he says.

UK-based Wood Mackenzie, a global energy research and consultancy group, has sketched a gloomy outlook. It expects global upstream development spending to fall 22 percent, or $740bn, between 2015 and 2020. However, the Middle East will be less impacted as several countries in the region spend to maintain their market share.

“Saudi Arabian investment, for example, will not decline during 2016-17,” Wood Mackenzie says in a recent report.

IEA agrees investment in the oil sector has declined in 2015 and 2016 — the first consecutive annual drop in three decades — by more than $300bn. US-based consultancy Deloitte says the industry will need a minimum investment of $3 trillion, or $600bn a year, between 2016 and 2020, to maintain the current reserve levels. 

Bhargava says: “We have seen a very restrained approach towards new oil investments from the GCC region in the past. Going forward, we expect to see a mixed bag of sorts, with different methods and plans expected from the different countries.

“Key aspects that will define the intent and extent of investments would be the OPEC decision on production cuts, the economic situation each of the GCC countries are in, and the extent to which these countries can improve production through the brownfield route, thereby reducing capital outlay.”

Aramco as an example of a GCC-based oil firm moving against the flow, Bhargava says, citing the oil giant’s recent signing of contracts for the $13bn Fadhili Gas project, due to be completed in 2019. Others are conducting efficiencies in parallel with new investments, in an indication of the importance of upstream operations, he says.

“We have seen Abu Dhabi National Oil Company focus on bringing efficiencies in the organisation, and yet go ahead with an offshore field exploration plan, like with companies such as OMV and Occidental. Other GCC countries are expected to move at a slower pace, though,” Bhargava says.

The International Monetary Fund (IMF) projects oil prices to barely reach $60 a barrel by 2021, but the impact of the sharp decline in prices has left oil companies, particularly state-owned, to embrace austerity measures, primarily through layoffs. But now experts believe stable oil prices will create more employment opportunities.

Bhargava says a price greater than $50 per barrel will have a stabilising effect on the GCC countries and can bring in adequate investments from the national oil companies to result in job creation.

“However, regional operating companies will first focus on streamlining the existing workforce, before heading out for new recruitments,” he adds.

Institute of International Finance chief economist for the Middle East and North Africa Garbis Iradian says if prices of crude remain above $50 per barrel, then gradually the energy sector will stabilise and job cuts may come to an end, particularly if investment in the energy industry improves.

But for prices to remain steady, OPEC needs to reach a consensus on a production cut on November 30. In Algeria in September, the group agreed to a preliminary cut in output to between 32.5 and 33 million barrels per day (bpd), from 33.39 million bpd.

Saudi Arabia and the rest of the GCC will need to be ready to bear the biggest burden of any production cut. Iran, Libya and Nigeria have been promised special conditions, while Iraq is requesting either a higher quota or an exemption and others such as Algeria and Venezuela are not financially able to contribute to a production cut.

Doubts resurfaced at the end of October after reports that Riyadh had said it could raise oil output steeply to bring down prices if Tehran refused to limit its supply. Iran has said it would only cap its output at 4.2 million bpd, while Riyadh is insisting on 3.6-3.7 million bpd.

Riyadh-based Jadwa Investment raised questions in its October report over whether a production cut would benefit OPEC producers. It expected a reduction in crude would encourage shale producers — who have been hard hit by the lower price of oil because of higher costs – to increase output. Already in the US, oil rig counts have rebounded and production forecasts have been revised upwards even before OPEC’s production cut has been confirmed.

“Such an agreement will underline OPEC’s intention to limit further rises in production and help stabilise oil prices at current levels [around $50 per barrel]. At this price level, OPEC members facing more acute financial pressure will be provided with some relief, but, prices would not be high enough to encourage too strong a supply response from US shale oil,” Jadwa says.

Stabilising oil prices also will depend on how Russia, the largest non-OPEC oil producer, plays its cards. Though it has so far shown interest in reaching a deal with OPEC, experts remain doubtful, given the country’s history of not backing such deals.

“A Russian freeze at record levels [11 million bpd] will do nothing to accelerate the rebalancing. Given the country’s lack of compliance with previous agreements with OPEC to curtail production, many remain dubious that Russia will provide any meaningful cut,” S&P Global Platts OPEC Specialist Herman Wang says.

Regardless of what transpires at Vienna later this month, a separate verdict is in — oil producing countries must invest and build upstream competencies to ensure they are equipped to meet the demand when the global economy is back on the recovery mode.

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