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New Year cheer for E&P spend

WoodMac expects first capex rise in two years as field investment decisions to double in 2017 and deep-water back in play

Global exploration and production spending is set to rise this year and the number of final investment decisions is expected to double from 2016 as the industry “turns a corner”, according to a bullish forecast from Wood Mackenzie.

A near halving of oil prices over the past two years to the present level of around $55 per barrel has triggered drastic cost-cutting by oil companies that has resulted in a slump in exploration activity, cutbacks in field operations and postponement or cancellation of greenfield projects.

However, WoodMac’s principal oil and gas analyst Malcolm Dickson said: “The global investment cycle will show the first signs of growth in 2017, bringing the crushing two-year investment slump to a close.”

According to the UK-based research firm’s global outlook for this year, E&P spending is predicted to rise by 3% to $450 billion in the first increase since 2014 as “confidence returns to the sector” after capex deflation of 20% over the past two years, with the US tight oil sector leading the nascent revival.

“Though a corner is being turned, this is still 40% below the heady days of 2014”, before the oil price drop, it stated.

FIDs.jpg Rebound: for final investment decisions on field projects

Furthermore, WoodMac forecasts the number of final investment decisions (FIDs) on field projects will increase to 20 this year, compared with nine in 2016, mainly for smaller, cost-efficient schemes with low average capex of around $7 per barrel, compared with $17 per barrel in 2014.

This figure is though still way below the annual average of 40 projects in the period from 2010 to 2014, it stated.

The firm said oil companies are starting to feel the benefits of cost-cutting that has led to increased efficiency, with “a leaner industry starting to emerge”.

"Companies will get more bang for their buck as development incremental internal rates of return (IRR) will jump from 9% to 16%, comparing 2014 to 2017," said Dickson.

"This is in part a result of a shift in capital allocation away from complex mega projects towards smaller, incremental  projects in the Canadian oil sands and deep water."

There is though little leeway for further cost reductions in the current cycle as service sector margins are “wafer thin”, with the firm expecting only marginal capital cost cuts this year of an average of 3% to 7%.

Dickson highlighted major efficiency gains in the US shale sector, and in particular the Permian basin, due to low break-even levels, scale and flexibility, with spending in the Lower 48 states expected to grow this year by 23% to $61 billion.

There is also potential upside to this figure from higher oil prices and the upcoming presidency of Donald Trump that could embolden independents, according to WoodMac.

"Nowhere is the mantra ‘doing more with less’ more evident than onshore US. There has been a dramatic increase in efficiency in the sector, exemplified by the drillers, who are managing to complete wells up to 30% quicker," Dickson added.

There is also potential for further improvement in drilling speed of 20% to 30% in some early-life tight oil plays.

The firm warned however there is a risk of cost inflation this year as the US tight oil sector heats up, though this could be offset by further efficiency gains.

The New Year will also see a deep-water comeback as several projects in the commercially challenged sector are sanctioned for investment, with the best development assets being moved forward by oil companies.

However, further cost-cutting is required in the long run in this arena to bring to fruition the next wave of projects, given around half 40 of the larger pre-FID deep-water schemes fail to meet a 15% IRR at an oil price of $60 per barrel, according to WoodMac.

In addition, the firm believes governments will have to offer improved fiscal terms to incentivise investment, even in resource-rich hotspots such as Iran and Mexico.