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Inflation, Transition Mute Capex Hike Payoff

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Oil and gas companies around the globe are putting the finishing touches on 2023 budgets, and all signs point to higher spending next year. Integrated majors, national oil companies (NOCs) and E&Ps have hinted — to varying degrees — that capital expenditure (capex) will rise in 2023, as budgets recover from the decimation wrought by the Covid-19-led downturn of 2020. But it would be wrong to read these early tea leaves as an indication that the shackles are coming off upstream capex. Energy Intelligence forecasts upstream capex will rise by 9% next year, to $475 billion. But while that marks a near-30% recovery from the 2020 trough, absolute spending still remains below pre-downturn levels. A return to the $500 billion mark — last seen in 2015 — is not expected until mid-decade, our forecasts show, but the days of $700 billion-plus annual capex as seen before the 2014-15 price crash have likely passed for good.

For one, cost inflation has become an inescapable headwind. Supply-chain issues, labor shortages and stiff competition for limited services in places like the US Permian Basin mean producers will spend more next year even without plans to increase activity. Larger companies like the majors are better positioned to mitigate some cost impacts, but no one is immune. And that means fewer barrels and Btus will flow from each incremental dollar spent. Oil sands players Suncor, Canadian Natural Resources and Meg said this week that their 2023 capex will rise by 6%-20%. Yet Suncor might see output fall next year and the others will see growth capped below 8%. More than 80% of Morgan Stanley’s universe of US E&Ps already hiked budgets this year due to inflation, and additional increases are expected for 2023. Higher costs and shortages have driven extensive downward revisions to US oil output growth outlooks for this year and next. Even Chevron, which can use its heft favorably in services negotiations, says its Permian output will track the lower end of guidance this year, in part to preserve capital efficiency. And while not upstream projects, several recently approved developments further illustrate industry price tag pressure: the ChevronPhillips-QatarEnergy US petrochemical cracker will cost $500 million more than guided, a 6% increase, while Occidental Petroleum says its initial direct air capture project will now cost $1.1 billion, above its original $800 million-$1 billion estimate.

Decarbonization demands are another major inhibitor on upstream capex, as bigger company budgets are forced to distribute those funds across more diverse initiatives. This internal competition for capital is most acute within the European majors, but NOCs and others are also starting to put firm capex to low-carbon ventures. These new calls on capital will only increase over time if companies are to hit their emissions targets. Even the transition-minded European majors will add incremental oil and gas capex amid robust prices and fresh energy security considerations — but within firm ceilings that sit well below historical norms. By 2025, BP plans 40% of its capex for “transition growth” businesses, led by renewables. BP, Shell and TotalEnergies are folding meaningful low-carbon acquisitions into existing budget ranges. China’s NOCs are balancing mandates for higher domestic oil and gas output with initiatives to lead in green hydrogen and carbon capture. China National Offshore Oil Corp., for instance, will spend 5%-10% of its capex on new energy through 2025 and raise that to up to 15% through 2030 — among the highest percentages from an NOC.

All this is not to say that higher oil and gas prices are incapable of signaling a need for higher investment, or that companies aren’t trying to squeeze out as much output as they can within these constraints. But the perennial question is — will it be enough? The answer remains to be seen, and the trajectory of global demand will factor heavily. Saudi Aramco and Abu Dhabi National Oil Co. are arguably those acting in the most traditional sense to underinvestment risks, with the pair planning to spend tens of billions more to add production capacity. Southeast Asian NOCs are plotting their highest budgets in years, with a focus on gas and LNG — albeit also balanced with energy transition priorities. In some cases, efficacy of spending will matter more rather than the commitment to spend. Sinopec, for instance, has tripled upstream spending since 2018 but with limited output impact. Beyond inflation, US E&Ps are also contending with the impacts of shifts in activity on capital efficiency; with hefty inventories of drilled but uncompleted wells wound down, the amount of incremental money required to get the next barrel is higher, as new output requires both drilling and completion capex.

Topics:
Capital Spending, Shale, NOCs, Majors, Independent E&Ps
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