More than $1tn of capital expenditure is earmarked for oil and gas projects that will ultimately reduce investor returns because they do not make economic sense even at today’s elevated price levels, according to a new report.
About $1.1tn of capital expenditure is destined for projects that are viable only with an oil price of $95 per barrel or higher, most of them in oil sands, deepwater projects and the Arctic, according to the Carbon Tracker Initiative.
The organisation said that such projects are at risk from a lower oil price as a result of reduced demand caused by climate regulations. To meet international climate targets demand for fossil fuels must fall substantially, it added.
Projects are also at risk from more secular factors such as slower growth in China, technological breakthroughs such as energy storage, increased carbon prices and competition from renewable-energy technologies, which are becoming cheaper month by month.
By contrast the cost of developing future oil resources is rising. The oil-producing areas most at risk in terms of value are the Canadian oil sands, western Siberia, the Caspian Sea and deepwater projects in the Gulf of Mexico and off the coast of Brazil.
For the largest oil companies, roughly 20-25 per cent of their future capex requires a $95 oil price. This is a problem because the costs of production in the industry are rising, said Martijn Rats, head of European oil and gas at Morgan Stanley. Bloomberg figures show that capex by the largest oil companies is now five times the level it was in 2000, but production has barely increased.
“The five European majors (BP, Shell, Total, Eni and Statoil) generated $121bn in cash flow in 2013 – at an average oil price of $108 – but they spent $126bn and paid $35bn in dividends. So there is a $40bn gap and that can’t go on,” Mr Rats said.
The cost of developing many new oil and gas assets is well over $100 per barrel, he added. “In the current environment many projects do not make sense from a cost perspective.”
The situation is even worse for smaller companies because a higher percentage of their future production is in high-cost, high-carbon, high-risk assets. Famfa Oil, Rocksource, Barra Energia, Queiroz Galvão and Teck Resources have 100 per cent of their assets in these segments, ranging from ultra deepwater to extra heavy oil to oil sands, the report said.
“Shifting into more sustainable companies is crucial for our long-term returns,” said Christine Tørklep Meisingset, head of environmental, social and governance research at Storebrand, the Norwegian insurer. “This means we need to divest from some companies whose whole business model is in high-carbon, high-cost assets.”
Investors do not care if the oil companies become smaller, as long as they remain profitable, said Craig Mackenzie, head of sustainability at Aberdeen Asset Management. “If they are smaller, we can invest in the companies of the future.”