A year ago, with the outbreak of war in Ukraine and the disruption of energy supplies, Goldman Sachs Research predicted that the oil and gas industry would emerge from a prolonged period of underinvestment and embrace significant new projects. Now, the investment boom has arrived. The industry has 70 major projects under development worldwide, a 25% increase from 2020, according to Top Projects, GS Research’s 20th annual analysis of the energy sector. We spoke with Michele Della Vigna, head of Goldman Sachs natural resources research in EMEA, about rising investment, and what that means for OPEC and energy prices.
The surge in investment that you predicted a year ago is here. Will it continue?
Last year was the turning point — after seven years straight of underinvestment, it was the first up year. I think this year provides the confidence and the confirmation that this trend is definitely in place. We have projected out for the next five years close to 10% per annum growth in capital expenditures.
What caused this pivot, and what gives strength to this trend of more big projects and increasing investment?
I think three things. First, it was the Russia-Ukraine conflict, which gave a new urgency to energy capex. Second, the profitability of these new investments — which to be fair, has been high for two or three years — together with the urgency of the conflict provides all of the incentives for this to take place. Then third, it’s the ongoing recovery in demand post-Covid. These three elements have cemented the double-digit growth in capex.
Most of the capex growth last year was driven by U.S. shale. It was clearly a U.S. onshore-led capex recovery. This year, it’s led by deepwater and liquified natural gas (LNG). This is a confirmation of what we were starting to see last year, but there is a different mix. The leadership definitely switched, which has deep investment consequences in that value chain.
You mentioned that profitability has been strong for several years, but investment only began to rise last year. Why is that?
The energy industry has been so risk averse in the last few years, and under such tremendous pressure from decarbonization to not invest, that it has taken longer than usual for capex to react to the higher profitability.
The Top Projects research cites 70 major projects in development — a big jump from recent years but still below the peak prior to the drop-off in investment. Can you put that in perspective?
It's fascinating, and you can read many charts in this report in that way. Capex is coming back from the trough, but again, it’s well below what it used to be in the 2010 to 2013 period. We need to remind ourselves that even with the growth, we are still well below what we used to do, the investment we used to have, just a decade ago. And demand has now again crossed the pre-Covid level and is reaching new historic highs.
While capex has rebounded, energy output has remained flat. Can you explain why?
A lot of projects have five to six years time-to-market. So we are still paying for that underinvestment we saw in the 2015 to 2021 period. That's why even with the capex increase, it is very unlikely that non-OPEC producers can come back to output growth.
Shale production comes online more quickly, which is why we had it back in growth already in 2022. But interestingly, shale is facing other challenges: maturity of the acreage, cost inflation, tighter financing from the regional banks. That is driving a material decrease in rig count, which will then translate into growth next year that will be meaningfully slower than what we've seen in the last couple of years. Shale grew by close to a million barrels per day in 2022 and is expected to increase at that level in 2023. But we expect the growth to be cut in half in 2024, to below half a million barrels per day.
The capex increase also hasn’t added to reserves. Why?
The reserve life in the sector has halved over the last capex cycle. This is because the industry has moved away from exploration. The U.S. shale revolution is effectively over, and we’re going into shale maturity and actually shale decline after the middle of the decade. And all of this, I think, just gives back pricing power to OPEC. That is the only area in the world, especially in the Middle East, where there is meaningful remaining reserve life.
And what does this mean for energy prices?
The cost curve keeps shrinking and steepening, which means that a higher oil price will be required to balance the market. If we were using the same cost of capital as last year, the price would be $100 per barrel. We believe, however, that the sector cost of capital for new developments has moderated over the last year. We are now assuming a 15% hurdle rate simply because the industry, after the Russia-Ukraine conflict, has embraced the fact that more oil and gas investment is required. Therefore we get to a required oil price of $80 a barrel to balance the market over the longer term.
Can you explain why you are assuming a lower hurdle rate — a lower cost of capital — for new oil and gas projects?
I would characterize it as we probably reached peak ESG, or decarbonization concerns, one to two years ago, and now we are back into an environment where the need for decarbonization is balanced by the need for affordable and secure energy. That’s why in oil and gas, the hurdle rate for new oil developments, we believe, has moderated from 20% to 15%.
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