The Last Barrel

Although I don’t usually quip about the holidays, I am certainly “happy” to welcome the new year. After enduring seemingly endless years of painful reductions/consolidations, excess supply and low prices, it appears the industry has finally put the worst of this down-cycle in the rearview mirror. The unlikely Saudi-Russian alliance has reduced excess inventory successfully, and, despite ample “undeveloped” acreage in the major U.S. shale plays, producers showed amazing restraint, holding the rig count steady around 920 units during the second half of 2017. Michael Plante, a senior economist at the Dallas Fed, said, “Oil prices appear to be high enough to support some additional drilling in 2018, but not high enough to significantly boost activity just yet.” Respondents think WTI needs to exceed $60/bbl to substantially increase the rig count. So job one is complete: drilling steady; production contained; stockpiles draining; markets recovering.

Discoveries hit rock bottom. The price collapse that started in 2014 caused a massive reduction in capital expenditures that led to an all-time low for discovered resources in 2017. A report by Rystad Energy stated that less than 7 Bboe were discovered in 2017, lower than any year on record. The low rate is the result of three consecutive years of reduced exploration budgets. Operators began cutting back in 2014, and have been slow to increase spending. “We haven’t seen anything like this since the 1940s,” said Sonia Mladá Passos, a senior analyst at Rystad. “We have to face the fact that the low discovered volumes on a global level represent a serious threat to supply levels some 10 years down the road.” The previous low was set in 2016, when reserve additions totaled just 8 Bboe. Those figures are down significantly from earlier discoveries, when additions topped 30 Bboe in 2012. Rystad also reported that the volume of reserves/discoveries also declined in 2017. The average offshore find in 2012 contained 150 MMboe, but totaled only 100 MMboe in 2017. “Most worrisome is the fact that the reserve-replacement ratio in 2017 reached only 11%, compared with over 50% in 2012.” We can now check box two—i.e.—discoveries and exploration levels low enough to create panic demand (in the foreseeable future), in the event of a major supply disruption. 

Shale is not intrinsically permeable. Some deepwater plays are still economically attractive. According to a white paper by Wood Mackenzie, “When prices were high, the industry could achieve healthy returns in deep water across a wide spectrum of different plays and basins. Now it must focus on the sweet spots.” Explorers are directing their scarce capital toward traditional, high-quality reservoirs with natural porosity and permeability—“exceptional reservoirs at unexceptional depths.” 

Deepwater exploration reflects this new focus. Well counts are down sharply. Since 2015, the number of deepwater wildcats is down 50%, to around 80–90/year, versus about 150 in each of the previous three years. Also, the exploration wells drilled largely focus on plays with the lowest break-even prices and easiest commercialization. “This restricts deepwater drilling campaigns to fewer countries.” In the three years before the downturn, (2012–2014), there were 23 countries with more than five deepwater wildcats completed. Since the start of 2015, only nine countries have reached that mark. Check box three off the bucket list: drilling/seismic activity severely restricted in the only geographical areas that hold the potential for giant field discoveries; lengthy ramp-up time for offshore projects; very few suitable wildcat prospects (ROI).

No box four, yet. The industry has made progress developing deepwater finds. Projects sanctioned since 2012, and greenfields approaching a final investment decision, will together recover approximately 30 Bboe. “These fields need just $42/bbl, on average, to achieve a 10% return,” according to Wood Mackenzie.  

The three countries with the largest discoveries in 2017 were Senegal, Mexico and Guyana (Rystad). In Senegal, Kosmos Energy discovered Yakaar gas field, with another promising find announced in Mexico. Discoveries in Zama and Ixachi, combined with smaller finds, added approximately 1 Bboe of recoverable resources. The Zama discovery, in only 546 ft of water, was the first offshore exploration well drilled by a private company (Talos Energy) in Mexico’s history. 

In Guyana, Exxon Mobil added another 1 Bboe of recoverable resources in 2017. Most recently, the company announced positive results from its Ranger-1 exploration well, marking the sixth oil discovery offshore Guyana since 2015, which holds 3.2 Bboe. “This latest success operating in Guyana illustrates our ultra-deepwater (8,970 ft) and carbonate exploration capabilities,” said Steve Greenlee, president of Exxon Mobil Exploration.  

Majors poised for best year in decades. Now that the belt-tightening is done, companies are looking to deliver profitable growth and build for the future, said Tom Ellacott, a senior V.P. at Wood Mackenzie. “The sector has reset itself to operate at lower commodity prices.” In 2018, the majors should have sufficient resources to fund dividends, according to Michele Della Vigna, Goldman Sachs head of energy industry research. “The industry’s success in cutting costs, paired with low oil prices, will keep smaller competitors out of the biggest projects, creating an environment where only major players can compete.”

Three-out-of-four is not bad. While the threat of too much shale production still looms large, producers are less eager to ramp up drilling. More significantly, the unprecedented contraction in investment for the future has set the stage for increased drilling activity generated by tightening supply and increased demand. “The market is tightening, and it’s tightening very quickly,” said Amrita Sen, Energy Aspects’ chief oil market analyst.  

About the Authors

Craig Fleming

World Oil

Craig Fleming Craig.Fleming@WorldOil.com