The inevitable demise of the fossil fuel empire

June 11, 2014

NOTE: Images in this archived article have been removed.

Image RemovedThe latest data from the International Energy Agency (IEA) and other sources proves that the oil and gas majors are in deep trouble.

Over the last decade, rising oil prices have been driven primarily by rising production costs. After the release of the IEA’s World Energy Outlook last November, Deutsche Bank’s former head of energy research Mark Lewis noted that massive levels of investment have corresponded to an ever declining rate of oil supply increase:

"Over the past decade, the oil and gas industry’s upstream investments have registered an astronomical increase, but these ever higher levels of capital expenditure have yielded ever smaller increases in the global oil supply. Even these have only been made possible by record high oil prices. This should be a reality check for those now hyping a new age of global oil abundance."

Since 2000, the oil industry’s investments have risen by 180% – a threefold increase – but this has translated into a global oil supply increase of just 14%. Two-thirds of this increase has been made-up by unconventional oil and gas. In other words, the primary driver of the cost explosion is the shift to expensive and difficult-to-extract unconventionals due to the peak and plateau in conventional oil production since 2005.

The increasingly dislocated economics of oil production

According to Lewis, who now heads up energy transition and climate change research at leading investment firm Kepler Cheuvreux:

"The most straightforward interpretation of this data is that the economics of oil have become completely dislocated from historic norms since 2000 (and especially since 2005), with the industry investing at exponentially higher rates for increasingly small incremental yields of energy."

The IEA’s new World Energy Investment Outlook published last week revised the agency’s estimates of future oil industry capital expenditures out to 2035 even higher, from $9.4 trillion to $11.3 trillion – an increase of 20%.

Oil prices could in turn increase by $15 per barrel in 2025 if investment does not pick up. Most of the investment increase required would be devoted not to new sources of production, but "to replace lost production from depleting fields," said Lewis.

In the IEA’s own words:

"More than 80% of this spending [of between $700 and $850 billion annually by the 2030s] is required just to keep production at today’s levels, that is, to compensate for the effects of decline at existing fields. The figure is higher in the case of oil (at close to 90% of total capital expenditure)."

But as Lewis pointed out, the "risk of insufficient investment" is not a hypothetical matter that might occur a decade from now, but is "already today a clear and present danger" as most of the oil and gas majors have revised down their plans for capital expenditure in recent months.

Stranded by post-peak oil price hikes

There is therefore "a medium to longer-term threat" to the oil industry’s "business model from high and rising oil prices." We just don’t get the same quality of energy from shale oil and gas as cheap crude – and what we do get comes at a higher cost.

Although oil prices are at record-high levels, production costs are rising so dramatically that they are fatally undermining oil company profits, forcing them to announce cut backs in expenditures this year.

ExxonMobil, Chevron and Royal Dutch Shell "are now signalling that they expect their capital expenditure (capex) to level off in the next few years," reported the Financial Times. "And they are likely to come under continued pressure to bring it down."

Mark Lewis thus concludes that "the upstream oil industry is already struggling to make the returns that shareholders require for the kind of upstream risks that are now being taken." Profits are being squeezed, and they’ll only get slimmer with time.

Other factors likely to push oil prices higher over coming decades include the increasing reliance on shale gas "to fill the supply gap… in the face of stalling crude-oil production since 2005," which has "significantly lower energy density than crude oil"; "declining exports of crude oil globally since 2005 as OPEC consumes more and more of its own production"; and "the ever-present but recently heightened geopolitical risks in key oil-producing regions."

Lewis’ verdict for the future of the global oil industry is devastating. In Kepler Cheuvreux’s April report ‘Stranded Assets, Fossilized Revenues’, Lewis argued that a pending global climate treaty would seriously endanger the profitability of fossil fuel majors due to emissions restrictions enforcing ‘stranded assets’ (unexploited fossil fuel reserves that, having become obsolete, are recorded as a loss of profit).

Far from simply facing this risk due to a potential climate treaty, Lewis said, this risk arises even due to rising oil prices alone – prices driven primarily by the end of the age of easy crude.

The bubble is starting to burst

According to oil company director Bill Powers of Arsenal Energy Inc. based in Calgary, Canada, the demise of the fossil fuel industry is already in motion and will pave the way for the inexorable rise of renewable energy. In a presentation at the IEA in April, Powers told agency staffers that:

"Renewables, especially rooftop solar, will take a leading role in a distributed power revolution now underway. The utility industry is vigorously fighting distributed power’s advancement."

The US shale gas bonanza was largely enabled by bubble economics – "low interest rates and easy financings" – but is unravelling as financial wishful thinking hits the wall of production reality, and is already a "commercial failure," Powers told the IEA. Almost "every player" has experienced "huge debts on balance sheets" and "enormous write-downs of shale gas reserves."

In 2012 alone, he said, Southwest Energy wrote down reserves of Fayetteville from 5 to 3 trillion cubic feet (tcf); Chesapeake Energy wrote down Haynesville and Barnett proven reserves by 4.6 tcf (erasing 20% of its proven reserves); EnCana wrote off $1.7 billion in shale gas assets; British Petroleum wrote off $2.1 billion due to failed investments in Fayetteville and Woodford shales; and BHP Billiton wrote off $2.84 billion in shale assets – to name just a few.

Since the beginning of the shale boom, total asset write-downs by the largest shale players are approaching $35 billion, reports the Oil and Gas Journal.

Powers, whose book Cold, Hungry and in the Dark: Exploding the Natural Gas Supply Myth anticipated many of the challenges being experienced by the industry, warns of an imminent 1970s style "natural gas deliverability crisis," which through the course of the next decade will "destroy consumer confidence and shake the American economy to its foundation."

The crisis will follow a decline in the Marcellus shale which, although originally claimed to contain 410 tcf of gas reserves, in fact likely has just 50 tcf of technically recoverable reserves.

Powers forecasts that Marcellus will peak before the end of 2015, pointing out that Chesapeake Energy, the largest landowner and producer in the Marcellus has already "dropped most of its rigs and is running down its inventory of wells."

Are 60% of US shale ‘recoverable’ reserves commercially unviable?

Such reservations are increasingly recognised by industry experts. In a new paper for the Oxford Institute for Energy Studies, Ivan Sandrea – a senior partner at Ernst & Young London for global oil and gas in emerging markets – points to an analysis of 35 independent shale gas and tight oil focused companies "active across the major US plays and accounting for 3 million barrels of oil per day per of production," showing that in the last six years "their financial performance has steadily worsened" despite production growth.

In the new age of expensive, difficult-to-extract unconventionals, investment expenditures in production costs nearly match total revenues every year, and "net cash flow is becoming negative while debt keeps rising." Sandrea also blames the "close link between rising debt and production, the rising cost of debt to total revenues and negative cash flow, which add to concerns about the sustainability of the business." The cash flow per share of US independents investing in shale oil and gas "is negative" and "trending more negative with time."

Although he alludes to some vague optimism in the industry that these trends will reverse in a few years when shale explorations are more "fully understood and financially evaluated," there seems little evidence from the economic and production fundamentals that this is likely.

In North Dakota’s Bakken, for instance, Sandrea observes that despite robust production growth, "the average production rate per well is not increasing as before and the amount of new wells it takes to obtain a similar increase in overall production is rising."

Overall, he describes the shale oil and gas business as "analogous to an equation that operators have yet to solve." Based on "an holistic review of the consensus and experience to date, the equation may still not be workable for a few more years, if at all." His sobering conclusion is that only about 40% of purportedly recoverable US shale oil and gas reserves may be commercially viable:

"… who can, or will want to, fund the drilling of millions of acres and hundreds of thousands of wells at an ongoing loss? … The benevolence of the US capital markets cannot last forever for all players… A more realistic outcome is that sections of the industry will have to restructure and focus more rapidly on the most commercially sustainable areas of the plays, perhaps about 40% of the current acreage and resource estimates, possibly yielding a lower production growth in the US than is currently expected."

The king is dead. Long live the peasants.

Mark Lewis sees the increasingly unsustainable fossil fuel business model as being potentially wiped out over the next two decades by the renewable energy industry, which in contrast "has achieved tremendous cost reductions in recent years."

As oil costs and prices creep upwards due to "rising demand under increasingly constrained supply conditions… the greater the incentive will be to accelerate the deployment of renewable-energy technologies and to achieve greater energy-efficiency savings."

Under a business as usual scenario, Lewis warns of a "real risk to the oil industry from rising prices" which when "combined with continuing reductions in the costs of renewable technologies… could drive the accelerated substitution of oil in the global energy mix over the next two decades:

"In turn, this would risk creating stranded assets over the medium to longer term both for the oil industry itself and – owing to the central role of oil in energy pricing more generally – for the global fossil-fuel industry as a whole."

Powers agrees. "The biggest solutions to the coming deliverability crisis will be residential solar, energy storage and improved grid management," he said. But the "incumbent utilities will fight very aggressively."

In this context, throwing more money at the dying industry of yesteryear is clearly not the answer – no matter how much they disingenuously clamour for it. Cold, hard economic reality is staring us in the face: we need to ramp-up investments in the clean, decentralised technologies of tomorrow.


Abandoned oil well image via shutterstock. Reproduced on with permission.

Nafeez Ahmed

Dr. Nafeez Ahmed is a bestselling author, investigative journalist, international security scholar, policy expert, film-maker, strategy & communications consultant, and change activist.

The focus of Ahmed's work is to catalyse social change in the public interest by harnessing radical, systemic approaches to understanding the interconnections between the world's biggest problems, while developing and highlighting holistic strategies for social transformation. Whether it be foreign policy and terrorism, climate change and energy, or food and the economy, Nafeez deploys the techniques of critical, rigorous and interdisciplinary analysis to join the dots and challenge power, with a view to bring forth constructive change.

Tags: global conventional oil production, global unconventional oil production, peak oil, renewable energy production