Industry Trend

Upstream Capex Set for Growth Despite Pricing Headwinds

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  • Service companies expect a spike in upstream spending in 2022, supported by high commodity prices today and potential future supply shortages after years of underinvestment.
  • Increased exploration and production activity will drive capital expenditures, but high demand and general inflation will push spending higher and could moderate overall activity.
  • The largest publicly listed operators show no sign of easing their capital discipline, and remain focused on advantaged basins, leaving private companies and independents the main drivers of upstream growth.

The Issue

Oil and gas service companies, always hopeful of the next upcycle, are as bullish as they have been in a long time. They are projecting what Schlumberger believes will be an “exceptional” cycle of multiyear growth in spending and activity across all regions globally. With spending all but certain to increase considerably in 2022, the question is how E&P companies will balance the call for new supply with their pledges of capital discipline in a cost inflationary environment. The consensus is that exploration and production will have to ramp up in the near term to meet long-term demand. But the nature of the energy sector has changed dramatically in just a few short years, which could make this spending cycle harder to predict.

Multiyear Growth Ahead

Fundamentally, things are shaping up well for an E&P spending spree in 2022 and beyond. Oil and natural gas prices seem to be disregarding gravity and keep finding more room to rise, with both Brent and West Texas Intermediate crude prices well above $80 a barrel and spot gas and LNG rates at levels unthinkable just a short time ago.

Beyond the innate desire to chase high prices — an urge that has been largely offset by iron-fisted investor demands for continued capital discipline — there are serious questions about looming supply shortages as global demand continues to ramp up. Investments in oil and gas supply have shrunk over the past half-decade or so due to unprecedented market volatility, and, at the very least, producers are eager to stem baseline declines and reinvest in their assets.

But that alone will not be enough to meet the “anticipated deficit of supply,” according to Schlumberger CEO Olivier Le Peuch. “This demand will have to be met with supply and this supply cannot come with inventory, cannot come with only releasing the Opec spare capacity. More will have to be built. Hence, it will create activity growth in the coming years,” he said when Schlumberger presented its earnings last week.

International oil companies are not expected to lead the charge on supply growth this cycle, Le Peuch noted. “They will be the ones pursuing the advantaged basins to generate the cash they need to transition to new energy,” he said.

Instead, it is the national oil companies (NOCs) and independents that are best positioned to grow the global supply. The NOCs “have signaled that they are set to reinvest into their capacity going forward,” Le Peuch said, while independents prepare to delve into assets that they have either “inherited” through M&A or neglected in a lower price environment.

Still, the growth in spending “will impact all basins, every operating environment, short- and long-cycle activity and all customer groups.”

Cost Inflation

There is no question costs are on the rise. Global supply-chain constraints have been well documented, and operators are working with their service providers to keep pricing for raw materials in check. Halliburton CEO Jeff Miller said in his company’s earnings presentation that he expects the market tightness for raw materials to improve in 2022.

A bigger inflationary cost issue is likely to be labor. The oil patch lost countless experienced personnel over the last several years and service companies have redoubled their recruitment efforts in order to restaff. Precision Drilling CFO Carey Ford noted that most of its contracts already have provisions that pass on higher labor costs to customers, which suggests most other contractors have similar stipulations in place. Miller said Halliburton has already passed on inflationary costs to customers in a “fairly straightforward manner.”

But macro inflation only forms part of the expected price increases. Service companies are now in a unique position to raise their own margins after years of working at — and often below — cost.

Miller suggested that equipment shortages, particularly in North America, could be a significant driver of costs for E&Ps. Industry-wide underinvestment these last several years has not just been on producing assets, but also on the rigs and completion gear needed to bring wells into production. A hydraulic fracturing market that was once oversupplied is now rife with rusted or cannibalized kit. A consolidated slate of players know they can charge premiums for high-demand equipment, and some are now walking away from low-ball contract offers. Miller said customers have started the 2022 tender process early “in an attempt to lock in access to quality services,” as Halliburton reallocates equipment to regions where it can capture higher pricing.

Regional Breakdown

Halliburton and Schlumberger both expect spending in North America to increase by around 20% in 2022, largely as a result of tightening supplies and an “urgency” among operators to secure what they need to execute their development plans. Globally, industry watchers expect short-cycle barrels to attract most of the new capital.

Latin America looks set to be one of the most active regions in the near term and Le Peuch noted the anticipated “growth inflection” has already started there, with new exploration and long-cycle development campaigns under way in countries like Brazil, Argentina, Guyana and Ecuador. He said revenues in Latin America are already back at 2019 levels, with Schlumberger experiencing growth there at 30% year to date.

Middle East activity has been “more subdued” so far in 2021, Le Peuch said, but he echoed others in saying market conditions there “will result in a significant increase in investment throughout 2022 and beyond.” The long-term nature of contracts in the Mideast means pricing remains competitive and margins for service companies may be slower to recover than other regions.

Overall, Le Peuch expects percentage growth in international spending to be in the “low to mid-teens.” Spending growth will affect both onshore and offshore markets and will be driven by short-cycle activity and the onset of multiyear capacity expansion plans.

Capital Spending, Corporate Strategy , Oil-Field Services, Independent E&Ps, Regional Integrateds, NOCs, Shale, Offshore Oil and Gas, Conventional Oil and Gas
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