Sustained low oil prices could reduce exploration and production investment

The United States Energy Information Administration (EIA) has said that sustained low oil prices could mark the beginning of a long-term drop in upstream investment.

According to the agency, oil prices reflect supply and demand balances, with increasing prices often suggesting a need for greater supply.

It added that greater supply, in turn, typically requires increased investment in exploration and production (E&P) activities. “Lower prices reduce investment activity”.

The EIA said that overlaying yearly averages of the domestic first purchase price (in real terms) on oil and gas investment reveals that upstream investment is highly sensitive to changes in oil prices.

“Given the fall in oil prices that began in mid-2014 and the relationship between oil prices and upstream investment, it is possible that investment levels over the next several years will be significantly lower than the previous 10-year annual average”, it added.

EIA noted that oil production is a capital-intensive industry that requires management of existing production assets and evaluation of prospective projects often requiring years of upfront investment spending on exploration, appraisal, and development before reserves are developed and produced.

It stated: “Previous investment cycles provide insights to how investment responds to crude oil price changes. In 1981 and 1982, after crude oil prices significantly increased, investment topped out at more than $100 billion and then averaged $30 billion to $40 billion per year into the early 2000s as crude oil prices fell and remained in the $20 to $30 per barrel range. From 2003 to 2014, investment spending increased from $56 billion to a high of $158 billion as crude oil prices increased from $34.53/b to $87.39/b, including several months of prices reaching over $100/b”, it added.

EIA’s 2015 Annual Energy Outlook Reference case projects real domestic first purchase prices to average about $70/b in 2020.

This, it noted, could result in substantially lower annual oil and gas investment over the 2015-20 period than the annual average of $122 billion spent during the 2005-14 investment cycle crest.

It disclosed that oil and gas investment represented one per cent of U.S. gross domestic product in 2014. “The sector’s fixed assets totaled $1.5 trillion, approximately 3.8 per cent of total U.S. private fixed assets, and the sector’s 2014 investment spending of $158 billion represented approximately 5.7 per cent of total U.S. private investment in fixed assets. During the high point of prices in 2012-14, when real U.S. oil prices averaged $94.20/b, oil and gas sector fixed asset investment totaled $458 billion, or 5.8 per cent of U.S. private fixed asset investment over the three-year period.

During a comparable period of high oil prices (1980-82), oil and gas fixed asset investment was $314 billion, or 8.1 per cent of U.S. private fixed asset investment, adjusted for inflation”.

The EIA hinted that crude oil prices are a key driver of upstream investment, but several other firm-specific factors also influence decision-making. “Besides managing existing assets and maintaining and replacing property and equipment, E&P firms have a portfolio of prospective projects of varying cost, risk, and technical complexity”.