The Return to a More Profitable Oil & Gas Industry

The article below is from our BRIEFINGS newsletter of  01 April 2019

Goldman Sachs Research's annual survey of the world's most critical oil and gas assets -- a series called Top Projects -- reveals an industry in transformation. The global push to reduce the energy sector's carbon footprint is streamlining the market, with fewer, better-capitalized companies set to lead simpler, more profitable developments. The result: a boost for returns across the industry and more market share for the biggest players. We sat down with lead analyst Michele Della Vigna to delve into his conclusions.

Michele, you've titled your 2019 Top Projects report The Restoration. What is being restored?

Michele Della Vigna: In short, profitability. Over the past five years, Big Oils have doubled their market share in long-cycle developments and US shale oil, re-establishing the attractive returns lost during the oil and gas revolutions of the 2000s. Going forward, we expect the internal rate of returns for new projects to range between 15 and 30 percent, 50 percent higher than the returns of projects authorized in the decade through 2014. Big Oils are also showing early signs of leadership in the highly-fragmented US shale market.

What's driving this new phase?

MDV: The amount of capital available for new oil mega-projects has decreased significantly over the last five years. Financial institutions are re-directing investments towards renewable developments. At the same time, the biggest energy companies are attempting to reduce their carbon footprint, which limits their ability to accelerate oil field projects. As a result, barriers to entry are higher and the equity risk premium on new long-cycle developments is increasing, ultimately driving consolidation. This leaner market structure -- not higher oil prices -- forms the core of our prediction that industry returns will improve.

You note that companies are shifting their focus away from resource expansion and embracing more short-cycle developments. What's the impact on resource life?

MDV: Our analysis shows that resource life -- a term for the amount of remaining recoverable resources -- has declined by 20 years since 2014, mainly driven by national oil companies and exploration and production companies. Another consequence of the move toward production efficiency is a more dynamic cost curve -- in this year's edition, we model a second consecutive year of resource contraction, driven by limited exploration success and a second year of downward revision in our shale oil estimates. Still, while resource life has diminished, resource profitability has improved. We note that while only 18% of undeveloped resources were profitable under $60/barrel in 2014, 73% are profitable today. This bodes well for the industry's ability to improve asset turnover and overall returns.

“The biggest energy companies are attempting to reduce their carbon footprint, which limits their ability to accelerate oil field projects. As a result, barriers to entry are higher and the equity risk premium on new long-cycle developments is increasing, ultimately driving consolidation. This leaner market structure – not higher oil prices – forms the core of our prediction that industry returns will improve.”
- Michele Della Vigna,
Goldman Sachs Research

What's the roadmap for the biggest upcoming projects?

MDV: In our view, the first wave of final investment decisions will likely take the form of brownfield developments with quicker payback, particularly in West Africa, the Gulf of Mexico and the North Sea. We should see a strong recovery in the number of projects in 2019 and 2020, led by Big Oils' deepwater and liquefied natural gas investments. We expect roughly $120bn in LNG projects during those two years as the industry catches up with the production gap resulting from four years of low investments and strong underlying demand.

What does this mean for the global shift to renewable energy?

MDV: The restoration of profitability helps the Big Oil companies invest in their own transition to renewable energy. We believe it is strategic that the energy industry drive a low carbon transition to contain global warming, and the industry's biggest players have many tools to become broader, cleaner energy providers. We call this the transition from 'Big Oil' to 'Big Energy' as the companies establish a deeper presence in global gas and power chains, including areas like renewables, electric-vehicle charging, biofuels and carbon capture. The profitability of their oil and gas developments means these companies can invest in those areas while still improving corporate returns.