Are E&P Capex Levels Really Too Low?

Industry officials from Opec to international oil companies (IOCs) continue to sound alarms about the dangers of underinvestment in the upstream sector, citing the likelihood of a supply crunch and sustained high oil prices. Upstream capital expenditures are down significantly from their peak of over $700 billion annually nearly a decade ago. However, the industry’s capital efficiency has improved dramatically since then and peak oil demand could be around the corner. Analysts at Evercore ISI see global upstream spending increasing by 14% in 2023, decelerating from 20% growth in 2022, with overall investment expected to come in near $500 billion next year. The closely watched annual Barclays E&P Spending Survey, which queries 160 companies, estimated capex would increase a similar 13% to total $412 billion in 2023. On a percentage basis, the spending increases are predicted to be largest in Latin America (plus 30%), which was driven by aggressive plans from Brazil’s state Petrobras. It was followed by Africa (plus 22%), the Middle East (plus 17%) and North America (plus 17%). Global upstream spending peaked in 2014, before the oil price crash, as companies pushed E&P capex north of $700 billion annually on the back of a multiyear upcycle that saw Brent near or over $100 per barrel from late 2010 to late 2014.

The last time oil companies pushed E&P capex to record heights it was a disaster for industry returns. Indeed, today’s laser focus on capital discipline is a continued reflection of investor frustration with these bad old days, which were marked by rampant cost overruns and budget blowouts at mega-projects. The result was often paltry single-digit returns on capital employed (ROCE) from IOCs despite triple-digit oil prices. In 2013, when Brent averaged nearly $110/bbl, Shell acknowledged that its ROCE, the holy grail of financial benchmarks for the Western majors, was lower than a decade earlier, when oil prices were around $30/bbl. This was typical of an industry chasing growth under the misguided belief that “$100 is becoming the new $20" for oil prices, in the words of former Chevron CEO John Watson in 2014. But IOCs famously failed to deliver on upstream production growth targets during that era, which led to intensifying investor demands for capital discipline and cash returns.

Although absolute E&P capex may be lower today, oil executives insist that smarter spending, technological advancements, innovation and collaboration have generated significant efficiency gains compared to the past.  “It’s a bit misleading to look at the absolute numbers and conclude that the productivity of that number is the same today as it was just four years ago,” Exxon Mobil upstream boss Liam Mallon told the Energy Intelligence Forum in London in September. In the Permian Basin, acreage that was taking 50 rigs to exploit in 2018 is now taking around 15 for the same output, he notes. “Cycle times have reduced as companies have innovated,” he said, citing Exxon’s success in Guyana as an example. The company in February started production at Guyana’s second offshore oil development at the Stabroek Block, Liza Phase 2, bringing total production capacity to more than 340,000 barrels per day in only seven years since the first discovery was made there. Industry returns are also in a far better place today, with majors on pace to deliver record dividends and buybacks to shareholders this year. Shell recorded a ROCE of nearly 15% year to date.

To be sure, lower absolute E&P capex levels pose some risk, particularly since recent budget increases partly reflect high inflation. In Canada’s oil sands, Suncor, Canadian Natural Resources and Meg recently said that their 2023 capex will rise 6%-20%. Yet Suncor might see output fall next year and the others will see growth capped below 8%. Morgan Stanley reckons that more than 80% of its universe of US E&Ps hiked budgets in 2022 due to inflation, and additional increases are expected in 2023. Indeed, higher costs and labor shortages have factored into downward revisions to US oil production forecasts for this year and next.