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Upstream oil and gas: record cash flows and peak of uncertainty

Wood Mackenzie’s pre-World Energy Summit day of discussion addressed some of the biggest issues facing the industry. How will the upstream industry use a US $ 1 trillion price windfall? Should Asian governments do more to revive declining gas production? And what is the future of exploration in this region?

In previous upward cycles, the pattern tended to be the same: higher income and cash flow lead to increased spending upstream. But the energy transition has changed the outlook for oil and gas producers, changing the rules of the game not only for international oil companies (IOCs), but also for national operators and host governments. Crucial decisions will be needed on the allocation of capital, the pace of decarbonization and future energy policy.

“At current Brent prices, the upstream industry will generate a wall of silver,” said research director Kavita Jadhav. “We estimate that the 42 largest IOCs will generate a windfall of over US $ 1 trillion if prices continue to exceed an industry planning price of US $ 50 / bbl. But how to invest this premium? Oil at $ 80 / barrel offers companies options and a chance to do it all: return money to shareholders, maintain investments in oil and gas, and accelerate investments in low-carbon opportunities. The current upcycle presents a golden opportunity to reposition itself for a very different future. “

The energy transition has created unprecedented uncertainty over long-term demand for oil and gas, changing stakeholder expectations and business strategies. The challenge is to create an economic model that is both resilient and sustainable.

A dilemma is to create a profitable but also carbon-free upstream activity. “Carbon is now an existential threat,” Jadhav added. “The value at risk of only Scope 1 and 2 exposures from the world’s leading CIOs is enormous. “

Using our emissions benchmarking tool, Wood Mackenzie estimates that below a carbon price of US $ 150 / tonne, the 38 largest IOCs in the world would lose US $ 465 billion in value, or 27% of their total value.

A temporary windfall, coupled with rising global oil and gas prices, also raises important questions for governments across Asia. The decline in domestic gas production increases exposure to international LNG markets and prices. Spot LNG prices in Asia have more than quadrupled in recent months to over US $ 30 / mmbtu. As security of supply issues reverberate around the world, should Asian governments be doing more to revive declining gas production?

“It may seem counterintuitive and unpopular to talk about incentives for upstream investment at a time when IOCs are set for record profits, but a decreasing share of this upstream spending is being invested in Asia,” said Research Director Angus Rodger.

The current gap between Asian gas production and demand is nearly 5 million boe / d. With production on a downward trajectory and demand appearing robust – due both to the shift from coal to gas and the need to safeguard intermittent renewables capacity – this gap is expected to reach 17 million boe / d by the time. 2040.

This means that Asia will continue to be the engine room for the growing global demand for LNG over the next two decades. While this is great news for LNG producers, it will increase the exposure of national governments to global price fluctuations and supply risks.

“But Asia is not short of gas resources,” Rodger said. “Across the Asia-Pacific region, more than 90 billion boe of resources are currently considered commercial and are currently in service or in development. An additional 47 billion boe are currently discovered but not commercial. We have significant resources that are stranded due to a high carbon footprint or unattractive tax conditions. “

The same challenges apply to the current round of pre-IDF gas projects in the region. Many have high levels of CO2 content, tough economies, long lead times, and often a significant history of delays and false starts. Other barriers to progress include risks on the surface and relatively high government uptake.

“The world, and Asia in particular, may not be lacking in resources,” said research director Andrew Harwood. “But what it needs are advantaged barrels – low-cost, low-carbon oil and gas that can be quickly marketed. This is why it is crucial that we continue to explore in Asia to find more of these advantaged barrels. “

Asia-Pacific is well positioned, with extensive infrastructure providing quick and low-cost access to hungry gas markets. “And it can be done. Of the 32 billion boe discovered with the bit in Asia-Pacific over the past decade, a quarter is already in service,” Harwood added. “A lot of these resources, such as the great discoveries of shale gas and tight reservoirs in onshore China were made possible by easy access to major pipelines combined with government incentives. ”

One of the key issues debated at the upstream summit is the importance of good fiscal conditions. With a dearth of exploration activity underway and a string of large pre-IDF gas projects urgently needed to improve domestic supply but struggling to move forward, governments must rethink how to incentivize new investment. , production and decarbonization.

“Because there is no guarantee that higher prices will lead to high levels of upstream reinvestment, as we have traditionally seen in the past, Asian governments have to compete more for international investments,” he said. Rodger said. “The key is to decide what you want your fiscal policies to achieve – to reap the remaining upstream value, to spur new investment, or to accelerate the transition to renewables?”

The first provisional measures are already underway. For example, Australia is pushing forward the regulation and accreditation of carbon capture and storage (CCS), while this week the Indonesian House of Representatives agreed to a carbon tax tariff of around $ 2. , USD 10 per tonne of carbon dioxide equivalent (CO2e). But do these policies go far enough to bring countries closer to their final goals?

Governments need to create adaptable tax systems that can scale and support these new forms of investment. Rodger said: “It is crucial that fiscal conditions complement and support each nation’s energy goals. The tax structures of previous decades are probably no longer suited to their purpose in a world experiencing an accelerating energy transition.

“At the same time, the upstream industry needs to redouble its efforts to communicate to regulators that large-scale upstream decarbonization is not just an added cost. For many IOCS, it is now associated with all other forms of upstream investment. If the decarbonisation expenditure cannot be activated, then the whole investment machine will come to a halt. “
Source: Mackenzie Wood

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