Capital expenditure from now until 2020 is projected to be about USD $2 trillion lower than was forecast just two years ago.
The energy industry moves in cycles that can last for years and sometimes even decades. From 1986 to 2004, oil hovered at around USD $35 per barrel (in today’s dollars) before rising rapidly to an average of USD $95 per barrel from 2005 to 2014. That cycle ended in late 2014 when the price of oil collapsed from more than USD $100 per barrel to less than USD $30 per barrel, returning to its long-term average in the previous down cycle. After three years of unsustainably low prices, OPEC intervened to bring the price back to the mid-USD $50s, where it sits today.
As the industry adjusts to a new reality, the outlines of a new cycle are beginning to take shape. As the price of oil declined, so too did companies’ willingness to invest in the future. In 2015, the volume of conventional crude oil resources that received approval for development fell to its lowest level since the 1950s, and spending fell even further in 2016. Capital expenditure from now until 2020 is projected to be about USD $2 tn lower than was forecast just two years ago, setting the industry up for a possible shortfall in supply by the early 2020s, although this should not be relied upon.
As the industry adjusts to a new reality, the outlines of a new cycle are beginning to take shape.”
Unconventional oil sources – chiefly shale – can compensate for some of the shortfall from conventional projects that have been deferred or cancelled. Shale projects are highly responsive to price signals. Companies are able to invest and bring new production online within approximately 18 months compared to the five years or more it takes to bring conventional drilling projects online. Technology has improved the economics of key shale basins, such as the Permian and Eagle Ford basins in Texas.
Many of the core properties in these basins break even with oil at USD $40–$50 per barrel. Less attractive properties have higher break-evens, but the combined impact of this supply curve means that the US can now act as an ‘economic swing producer’, with the potential to boost shale oil production by about 50% if oil prices rise to USD $70 per barrel.
There are a variety of strategies that companies might pursue to create value in this new age of energy. L1 Energy is focused on two.
The first is resilience. We seek to bias our portfolio toward energy production with low break-even prices, which will help us generate superior returns during periods of low prices. This means paying greater attention to costs and productivity and adopting a lean manufacturing mindset.
The second is flexibility. By investing in a combination of short-cycle and long-cycle projects, we can remain responsive to price changes while maintaining exposure to investments which deliver very attractive returns as prices rise.
L1 Energy is building a portfolio with these criteria in mind, designed to deliver superior returns to investors and to society in a new age of energy.