ii) Underinvestment in oil and gas: What if the supply side transitions faster than demand?

Billion dollars (2018)

800

600

Natural gas

Oil

Between 2016 and 2018, actual oil and gas upstream spending averaged around USD 460 billion each year, compared with an average of USD 730 billion for the years between 2011 and 2015. This retrenchment was caused by the sharp drop in the oil price in 2014 and needs to be seen alongside a significant reduction in upstream unit costs over this period. The reduction in activity levels has been significantly less than the headline reduction in spending. But it remains the case that there has been a material slowdown in upstream activity over the course of the 2010s.

Oil and gas markets appear well supplied for the moment, but there are few guarantees that such conditions will persist. Current investment spending in both the oil and gas sectors is reasonably well aligned with the near-term needs of the SDS. It would, though, need to pick up considerably to meet the higher demand outlook of the STEPS.

In other words, there is a risk of a mismatch between today’s trends on the demand side, which point to robust growth in consumption, and investment dynamics on the supply side. Supply is being squeezed by tighter financial conditions, company strategies to limit investment only to the most favourable projects with low costs and risks, and (in some cases) by investor expectations.

If this mismatch persists – and assuming that short-cycle shale cannot expand indefinitely to fill the gap – then the world could be looking at a material tightening in markets by the mid-2020s associated with higher and potentially more volatile prices. The risks in this respect appear to be higher for oil than for natural gas.

From the perspective of the oil and gas industry, and of energy transitions, such a market tightening would have important implications:

•When a price spike is caused by a supply-side shock, this penalises consumers of the fuel in question and hits the economies in countries that are net importers. For example, around 70% of oil consumed in China is imported, closer to 80% in India, and 100% in France, Japan and Korea. The oil import bill in many cases is equivalent to a sizeable share of GDP.

•Periods of high oil prices could accelerate the policy momentum and economic attractiveness of alternatives to oil, especially in some of the emerging demand giants in Asia that are particularly sensitive to price swings.

•Producers of oil would benefit from higher revenues: the key strategic and environmental question would be whether those revenues are reinvested in new oil and gas production, or whether they would provide a spur for more diversified spending on cleaner fuels and technologies.

Rest of world

Southeast Asia

United States

India

European Union China

The possibility of underinvestment and price spikes could be heightened by new constraints on oil and gas supply, arising from geopolitics or from changing attitudes towards upstream oil and gas developments.

In recent months, a well-supplied oil market has been able to take deep geopolitical tensions and uncertainties in its stride, including a sharp reduction in exports from Iran, the decline in output from Venezuela and the attacks on oil facilities in Saudi Arabia.

For the moment, there appears to be ample capacity within the oil market to absorb such shocks, but this could steadily be eroded if there is a persistent mismatch between demand and supply trends (as described on the previous slide). Under these circumstances, further geopolitical tensions could be expected to provoke a much more significant market reaction.

The traditional focus when looking for constraints on upstream investment is on certain NOCs and INOCs, in part because of the membership of some of their host governments in OPEC. However, there are also rising pressures on the Majors and other independent oil and gas companies to limit their investment in new and existing assets.

This pressure is reflected in calls for policy makers to restrict new oil and gas developments, for example by raising fiscal terms or by introducing moratoria or bans. To date, countries including Belize, Costa Rica, Denmark, France, Ireland, and New Zealand have introduced partial or total restrictions on new oil and gas developments in specific areas

(e.g. onshore developments) or for certain types of resources or production techniques (e.g. those involving hydraulic fracturing).

These countries account for only a fraction of oil and gas production globally today, and these pressures are offset by efforts in other

countries to move in the opposite direction, i.e. to attract more upstream investment (see Section I). Nonetheless, these shifts could signal a wider change in attitudes towards upstream oil and gas development. At the very least, this would change the location of new investment and, at most, this could have significant impacts on markets.

As noted above, any period of higher prices for oil and/or natural gas could accelerate the policy momentum and economic attractiveness of cleaner alternatives to hydrocarbons.

However, if natural gas prices were to rise, this could also provide a market signal to bring coal plants back into the mix. Some power markets are particularly sensitive to a change in gas prices. In the

United States, a near-term rise in the Henry Hub price to USD 4.5/MBtu could see more than 300 Mt of CO2 emissions from coal returning to replace gas (raising power sector emissions by nearly one-fifth). This outcome would also depend on the stringency of federal and state-level emissions standards.

In developing Asian markets, natural gas is increasingly imported in the form of LNG and is thus a much more expensive option than domestic coal. The example of record-high LNG prices during the period 2010-14 shows that they did contribute to improving efficiency and the competitiveness of renewables; however, they also resulted in an upswing in coal use. Only in Europe would a rebound in coal use appear unlikely, as a commitment to phase out coal is locked in by political commitments in many countries.