Global Energy Investment: Staving off a Crisis

Without an increase in worldwide investment in oil and gas development, the economic consequences of the COVID-19 pandemic could be magnified, leading to greater energy market volatility, higher oil and gas prices and a slowdown in the global economic recovery.

A new International Energy Forum (IEF) and Boston Consulting Group report, "Oil and Gas Investment in the New Risk Environment," details how capital expenditures (capex) by oil and gas companies have fallen by 34 percent in 2020 and forecasts additional reductions of 20 percent to 30 percent in 2021. The report, which details the effects of capex reductions, was released December 10, 2020.

"The large and abrupt decline in oil and gas investment is sowing the seeds of volatile and high oil prices later this decade," said IEF Secretary General Joseph McMonigle. "More frequent boom-bust cycles will harm consumers and producers recovering from COVID, set back Sustainable Development goals and threaten global security."

Cutbacks in capex in oil and gas could have knock-on effects for the global economy, contributing to price instability, creating market volatility, increasing social disparities, reducing sector employment and hampering the transition to technologies offering lower emissions.

"We're seeing a much more direct impact of those capital reductions in today's supply chains around the world," said Alan Thompson, Global Energy Practice Group Leader at BCG. "Most of our clients are seeing capital expenditures into 2021 at similar levels to 2020. Capital is now being provided from a much weaker fiscal position. Balance sheets are stretched for many private companies."

Adverse Effects

Industry investment must increase 25 percent annually from 2020 levels over the next three years to stave off a crisis, the report suggests. Capex will need to rise by 86 percent by 2030 from where it is today to guarantee market stability and offset production declines over time.

The report notes that forecasts from the International Energy Agency (IEA) and OPEC suggest another 27 million to 30 million barrels of oil equivalent (mmboe) will be needed by 2022 to close the gap between production declines and demand levels. The agency projects that these required levels will increase to 68 mmboe to 70 mmboe by 2030, as oil demand peaks in the next ten years.

The next oil price boom phase will have an adverse impact on consumers, companies and governments worldwide, the report details. Higher and more volatile prices would reduce the number of people able to afford the cooking, heating, and transportation fuels they require. And volatility would further increase uncertainty for companies and governments.

"The COVID-19 pandemic has disrupted much of the global economy, and the oil market is no different. Since March, there has been an unprecedented decline in global demand for oil," said McMonigle. "While that may not pose an immediate threat to oil and gas markets, it won't be long before lower supply collides with resurgent demand."

Reduced investment in oil and gas could undermine progress toward achieving Paris Agreement climate goals, the report notes. Higher fossil fuel prices would mean weaker post-pandemic economic growth, which could impair the ability of governments and private-sector organizations to fund the R&D needed to spur a transition to lower emission technologies.

"Greater volatility will certainly cause further delays in project commitments. Here it's really important to highlight that includes clean technology investments that you need the oil and gas industry to commit to," IEF Energy Dialogue Director Christof van Agt added. "The oil and gas industry's ability to deploy clean energy technologies is diminished."

Price volatility could also have long-term effects on energy poverty. Weaker economic growth from reduced investment will make it more difficult to increase affordable access to modern energy services and improve healthy living conditions in developing economies. An estimated 1.3 billion people worldwide have no access to electricity, and 2.8 billion lacked access to clean cooking fuels. There are 800 million people living in extreme poverty today.

A Capex Cycle

The combination of weak demand and lower prices triggered capex cuts, which are helping companies shore up their balance sheets but threatening long-term stability, the analysis finds. Yet every dollar of capital reduced today will have twice as powerful an effect than similar cuts made following the 2014 global price decline cycle.

"This capex cut is deeper than what we had in 2014 and 2015, and much more intense," said Jamie Webster, Senior Director at BCG's Center for Energy Impact. "A dollar in capex cut in 2014 to 2015 had the impact of around 34 cents in reduced activity. A dollar capex cut in 2020, and this is where we see the cushion has been removed, would have the impact of 87 cents in reduced activity."

At this juncture, the oil and gas industry is contending with its third oil price crash in the last 12 years. While each crash has looked different, and had its own ramifications, companies have responded with their traditional oil crash playbooks – reducing capex to shore up their books. The intensity of this cycle could have far deeper ramifications to the industry.

"As prices falls, the reaction is quick in terms of capital preservation. If oil prices increase, the ability to respond is not quite as rapid," said Rebecca Fitz, Senior Director at BCG’s Center for Energy Impact, noting that the industry is large but struggling right now. "With earnings not holding up, the investor value proposition is less clear. It inhibits companies’ ability to raise the capital."

Given the risks associated with this capex shortfall, the IEF and its 70 member countries are committed to working in partnership with oil and gas companies to better articulate the impact of capex declines globally. The IEF will host no fewer than three ministerial dialogue meetings over the next two years to focus on energy security, market stability and investment, as well as emphasizing secure, sustainable market transitions and enhancing energy market data transparency.