Deep dive into oil and gas exploration – then, now, and ahead

With the oil and gas industry in early stages of pivoting to a lower carbon future, the level of investment drastically shrinking first during the 2014 downturn and then again, even quicker, during the 2020 downturn, what will become of the oil and gas exploration efforts in the near- and longer-term?

To answer that question, we must first look into the events of the last several years, with an emphasis on drastic changes that occurred in 2020 following the Covid-19 pandemic, which is considered by many as one of the most important events for the oil and gas industry ever.

In the 2014 downturn, the operators were not so fast to reduce their spending as they were following the 2020 downturn. This time around, the E&P players slashed their budgets much faster than they did in the previous downturn due to the strength of financial discipline gained in the years before.

It is also important to note here that, once the crisis hit the market, the oil and gas operators were falling from a much lower position compared to the previous crisis as the investments never recovered to pre-2014 levels.

According to energy intelligence group Wood Mackenzie’s report in November, the investment has fallen by two-thirds since the inglorious peak of 2013, while financial constraints and the gathering pace of the energy transition have marginalised exploration on company agendas.

However, Wood Mackenzie also believes that, in oil and gas exploration, less could be more.

An analysis of exploration companies between 2010 and 2019 by Wood Mackenzie Exploration analysts Dr Andrew Latham, Huong Tra Ho, and Will Austin shows that exploration learned brutal lessons early in the decade and has come back stronger as it bids to find a role in energy’s future.

Their report shows that in the period from 2010 to 2014, 39 companies drilled 400 wells a year on average, making on average of 21 ‘large and giant’ discoveries a year. This number was halved in the 2015-2019 period to 200, but the number of ‘large and giant’ discoveries still averaged at 16.

In fact, according to Wood Mackenzie, 2019 had the best wells-to-big-discoveries ratio of the decade.

Following an increase in activity in 2019, a similar level was initially expected in 2020.

However, the impact of Covid-19 and oil price crash in early 2020 changed the plans of many operators, forcing them to cancel or postpone their previously planned exploration wells.

According to Rystad Energy, its forecast for spending in 2020 has dropped 47 per cent from its January estimates and is down almost 33 per cent compared to 2019.

Both Norway and the UK saw a sharp drop in exploration drilling during 2020. Figures from the Norwegian Petroleum Directorate give the idea of the level of decrease in exploration in Norway.

Namely, the directorate expects that only 30 wells will be drilled on the Norwegian Continental Shelf in 2020, which is about half the level from the previous year.

In Norway, average unit costs for discoveries in the 2000-2019 period were around 22$/bbl. The NPD said that, if the costs could be kept at this level, then future exploration would be profitable even with low oil prices.

Over in the UK, Covid-19 measures also resulted in significantly reduced drilling rates.

According to a recent report by the Oil & Gas UK, the offshore oil and gas industry’s trade association, only 54 wells were spudded in the first ten months of 2020. This means that 2020 will almost certainly see the lowest total levels of drilling activity since the early 1970s and the lowest exploration and appraisal activity in the basin’s history.

Only six exploration wells have been spudded so far and it is possible that there will be no more exploration drilling this year. Out of the remaining 48 wells, there was only one appraisal well and 47 development wells.

However, the Oil & Gas UK noted there might be some potential for a small number of further appraisal wells and a limited number of development wells to be drilled for the remainder of the year.

The E&P companies reducing their activity levels to preserve cash now means that we may see a negative effect on production levels in the coming years.

Furthermore, lower investment and activity levels will also hit the oil and gas industry’s already hard-pressed supply chain, especially the drilling contractors many of which are entering Chapter 11 bankruptcies and scrapping their assets to stay afloat.

The decisions taken now will have a lasting impact on the capabilities across the industry.

As the initial shock of the Covid-19 pandemic subsided and the world somewhat adjusted to “the new normal”, Moody’s credit rating business in September 2020 changed its outlook for the global exploration & production sector from negative to stable.

Moody’s said in the report that the industry earnings would slowly rise over the next 12 to 18 months on the back of slightly higher oil prices, while natural gas producers would continue to benefit from the reduced supply.

The company said that spending in the sector was down 40 to 50 per cent this year and, absent higher oil prices, spending would continue at these low levels in 2021. As a result of lower spending, volume growth is expected to be flat in 2021.

Rystad Energy said in an upstream webinar on Tuesday that, in 2020, sanctioning activity hit the lowest level since the 1950s.

Moody’s expects that an increase in capital spending will come only after companies use any extra cash flow to maximize shareholder returns or pay down debts first.

“Meanwhile, constrained access to capital and looming debt maturities will remain the biggest hurdles for speculative-grade companies with high debt loads, limited hedging and tight liquidity.

“Default risk will remain high for weaker companies through 2021, with oil prices at $45 per barrel or higher needed to sufficiently reduce elevated solvency risk”, Moody’s concluded.

When it comes to oil price next year, the U.S. Energy Information Administration (EIA) forecasts Brent crude oil prices will average $47/b in 2021.

EIA expects U.S. crude oil production to generally decline to an average of 11.0 million b/d in the second quarter of 2021 because new drilling activity will not generate enough production to offset declines from existing wells.

Later in 2021, EIA expects drilling activity to rise, contributing to U.S. crude oil production reaching 11.3 million b/d in the fourth quarter of 2021.

On an annual average basis, EIA expects U.S. crude oil production to fall from 12.2 million b/d in 2019 to 11.4 million b/d in 2020 and 11.1 million b/d in 2021.

In order to discover, develop, and produce more oil and gas for future demand, the operators need to maintain activity levels and acquire new exploration acreage. Improved acquisition terms certainly contribute to a healthy interest in new exploration.

Rystad Energy analysis shows that the licensed acreage awarded in 2020 holds the second-lowest position within the decade with the first one being in 2016.

Some of the new leasing rounds expected to be held in 2021 are those in Norway, Uganda, Senegal, Somalia, Liberia, Suriname, China, Brazil, and Canada, which has two leasing rounds lined up for next year.

Back in July 2020, Offshore Energy reported that, despite low oil prices, the risk appetite in the North Sea remains.

But when it comes to future exploration and available acreage off the UK and Norway as well as in the U.S. Gulf of Mexico, what are the leasing plans and what is ahead for E&P players?

Funny you should ask because there have been some significant developments in this aspect as well.

One of the first developments to mention here is related to the UK and its future approach to oil and gas leasing.

The country’s petroleum regulator, the Oil and Gas Authority (OGA), in September revealed it was taking ‘a temporary pause’ from its annual licencing rounds and said it would not run a licence round in what would have been the 2020/21 period.

This decision was announced following the award of 113 licence areas over 259 blocks or part-blocks to 65 companies in the 32nd Offshore Licensing Round. The awarded areas are located in the Northern, Central, and Southern North Sea as well as in the West of Shetland area.

Meanwhile, the UK government also announced a review of its policy on the future UK offshore oil and gas licensing regime as part of the wider aim of achieving net-zero emissions by 2050.

Gathering the information needed to plan for future oil and gas production in the UK in a way that is aligned with tackling climate change was cited as the reason behind the announced review.

Norway, on the other hand, has two types of licencing rounds – one for mature areas and the other for frontier areas.

This year’s mature areas round, known as the Awards in Predefined Areas (APA), was launched in June, comprising the predefined areas with blocks in the North Sea, the Norwegian Sea, and the Barents Sea. The deadline for applications expired in September and the plan is to grant new production licenses in the announced areas in early 2021.

This year’s frontier areas round – designated as the 25^th licencing round – was launched in November, encompassing 136 blocks, 11 in the Norwegian Sea and 125 in the Barents Sea.

The award of new production licences in these announced areas is expected in the second quarter of 2021.

“This licensing round contributes to predictable access to acreage for the industry, and towards maintaining the activity level”, Torgeir Stordal, NPD Director Exploration said.

The Gulf of Mexico is extremely important to the United States’ energy production and releasing new acreage for exploration is a way to ensure its energy security by reducing the reliance on foreign countries.

According to the EIA, in 2019, U.S. net imports of petroleum from foreign countries averaged about 0.67 million barrels per day, equal to about 3.3 per cent of average daily U.S. petroleum consumption. This was the lowest percentage since 1949.

The U.S. government each year holds two Gulf of Mexico lease sales, offering available areas for oil and gas exploration.

The first lease sale of 2020 was held in March, just as the situation in the oil and gas market was heating up amid an oil price war between Saudi Arabia and Russia and the governments around the world started introducing lockdowns due to the Covid-19 pandemic, resulting in a sharp decrease in global oil demand.

The Lease Sale 254 generated over $93 million in high bids for 71 tracts in Federal waters of the Gulf of Mexico with a total of 22 companies participating.

In the second Gulf of Mexico lease sale of 2020, the oil and gas operators showed more enthusiasm.

While initially scheduled for August, the second lease sale was postponed for November to allow more time for additional analysis of oil and gas markets in light of the Covid-19 pandemic.

Held on 18 November, the Lease Sale 256 was the last one under the Trump administration. It yielded more than $120 million in high bids for 93 tracts with a total of 23 companies participating.

Meanwhile, before leaving the office in January 2021, Trump is still trying to open up more acreage for offshore drilling. The plan is to do this through a proposal, which would loosen the Obama-era safety regulations for the oil industry in the Arctic Ocean offshore Alaska.

With Trump administration heading out, the next planned lease sale will be held under Biden. While some believe that Lease Sale 256 could have been the last lease sale ever due to Biden’s pledge to ban all new drilling in federal lands and waters, the U.S. government agency Bureau of Ocean Energy Management (BOEM) has already scheduled the first Gulf of Mexico oil and gas lease sale for March 2021.

If held as planned, the Lease Sale 257 will include approximately 14,594 unleased blocks – i.e. all of the available unleased areas in federal waters of the Gulf of Mexico.

Commenting on the latest Gulf of Mexico lease sale, National Ocean Industries Association (NOIA) President, Erik Milito, said: “The past year has been tough, but the noted increase in winning bid totals and number of bid on tracts demonstrates the continued resilience of the U.S. Gulf of Mexico. Long-term projections still show rising energy demand, including for oil and natural gas”.

Milito added: “Every dollar spent today is just the start of additional investment in America. Companies will spend millions of dollars exploring, evaluating, and, hopefully, producing from many of today’s lease blocks”.

Milito also emphasized America’s dependence on the Gulf of Mexico.

“Continued safe and responsible development of the Gulf of Mexico will continue to benefit every American. Otherwise, the energy will be produced elsewhere, serving to diminish our energy, economic and national security”, Milito concluded.

A recent analysis by Rystad Energy has revealed that investments from global exploration and production companies in 2021 are projected to reach around $380 billion, which is almost flat year-on-year.

However, about 20 per cent or $76 billion of this amount could be at risk of deferral or reduction, while roughly $300 billion is considered low or medium risk.

As the 2014 downturn brought significant supply chain and efficiency improvements, the E&P players in 2020 needed to come up with further ways to cut costs. This included deferring infill drilling programs, projects FIDs and start-ups, reporting significant write-offs on stranded assets, and reshaping their portfolios to stabilize returns.

The most recent example of this would be the U.S. oil major ExxonMobil, which this week announced it expects to write off up to $20 billion of assets from its development plan and reduce spending plans for the next year.

ExxonMobil will prioritize near-term capital spending on advantaged assets with the highest potential future value, including developments in Guyana and the U.S. Permian Basin, targeted exploration in Brazil and Chemicals projects.

Olga Savenkova, an upstream analyst at Rystad Energy, believes that it is possible that this time, too, upstream investments will not return to pre-crisis levels in the long-term, even if they do recover somewhat over the next few years.

Without a drastic global change happening in the coming years, it appears that the world will still rely on oil and gas as energy sources for decades to come.

This means that new discoveries and project developments will be needed to sustain production.

However, the commercialization of these discoveries should depend on them being low-cost and low-carbon intensive.

As a final takeaway, perhaps a glimmer of hope can be seen after a year of turbulent market conditions, which have left many in a dire state. Rystad Energy believes that we should exit the year 2020 with a balanced oil market.