Upstream sector on the rebound
The oil and gas sector will continue to rebound in 2022, says Wood Mackenzie. But the positive outlook will be tempered by concerns about its future. In its Global Upstream Outlook 2022, Wood Mackenzie points out the upstream industry must respond to the implications of the pledges made at COP26 and governments must set a course for the industry to follow.
Fraser McKay, Vice President, Upstream Research, says, “The upstream sector is going into 2022 facing ‘peak uncertainty’ – with record cash flows but increasing scrutiny. At a Brent price of around USD 70/bbl, oil and gas cash flows will be at near-record levels. At USD 80/bbl, it would soar towards USD1 trillion (on a post-tax, post-capex, pre-financing and dividends basis). Despite this, for many stakeholders and even some chief executives, the sector’s risks outweigh its upsides. This tension will define 2022.”
Governments are aligning around net zero aspirations. It is likely that next year will see more enact carbon taxes to align with COP26 pledges. Other fiscal moves will target outsized cash flow to fill pandemic-induced budget deficits. While windfall taxes are possible, so are holistic energy fiscal terms and more carbon capture and storage (CCS) incentives. Mr McKay says, “Financing oil and gas was getting harder before COP26, but the pressure will ratchet up in 2022. Institutions with over USD 130 trillion of capital under management have joined the Glasgow Financial Alliance for Net Zero. Watch for the pool of backers to shrink, borrowing costs to increase, and project financing for oil to get harder. But lending will not dry up immediately. And gas – especially where aligned with coal retirement or CCS – will be spared the worst.”
Overall investment will go up, but capital discipline will prevail. A 9% year-on-year increase will take spend over USD400 billion again in 2022. Despite this, at 40%, the global reinvestment rate (capital investment divided by pre-dividend post-tax operating cash flow) will remain near record lows at our forecast price. More than 40 projects over 50 million boe will be sanctioned in 2022. The focus will be on advantaged barrels. Low-breakeven, low-carbon deepwater projects will dominate greenfield FIDs. While project economics are robust, short payback periods and low emissions are also prime considerations. Mr McKay states, “Companies will allocate more capital to upstream decarbonisation. Value accretive solutions, which increase product sales, will continue to lead the way, but CCS projects will gain momentum and attract new participants.”
Increased transparency and emissions benchmarking reporting will drive more action on decarbonisation. The biggest gains are in production and processing; electrification will remain top of the agenda. The Global Methane Pledge, announced at COP26, is a tangible step towards regulations, penalties and fines. It’s a win-win for governments, capturing lost value, mitigating leakage and progressing net zero goals. However, 2022 looks difficult for the service sector. Operators will experience inflation of between 4%-10% next year, depending on the sector. But how much of this reaches the service companies depends on the pace of the increase in activity. Global supply chain disruption, labour costs and increasing commodity prices will be passed through to operators, but this is unlikely to support service sector profit margins. Increased utilisation is required before the service sector can exert price pressure. In the meantime, the intense pressure on an already weak supply chain adds project execution risk as well as increased costs. Hotspots like Norway and the US Lower 48 will be impacted first.
Wood Mackenzie expects the exploration sector will accelerate its repositioning for the energy transition in 2022. Advantaged resources will be targeted, replacing maturing legacy assets. Even oil and gas companies with demand doubts will look to high grade their project pipeline. Conventional exploration will follow the disciplined path set in 2021, despite improved prices. Spend will total between USD 20 billion and USD 25 billion, with wildcatting led by the Majors and larger NOCs. These companies will find about 75% of the 15 billion to 20 billion barrels of oil equivalent we expect from new discoveries. Success at this scale will deliver double-digit full-cycle returns at USD 50/bbl.
Deepwater plays with highly productive reservoirs will be prioritised, including giant prospects in Brazil, Guyana, Suriname, Namibia and South Africa. Deepwater is likely to account for half of all new volumes. Mr McKay adds, “Gas will account for around half of the discovered resources, again. With a focus on lead times and carbon, explorers will favour piped gas over liquefied natural gas, for emissions as well as payback purposes. Subsurface organisations will continue to be restructured to champion emerging themes such as CCS, geothermal and hydrogen storage in 2022. Keeping options open for the future, operators will want to retain experts, while being agnostic to the application of their skills.”