Rising costs of production threaten energy profits, IEA warns

Global energy companies will have to adjust their expectations for profits in order to make the investments needed to meet future world energy demand, the International Energy Agency warns.

The capital cost of producing a unit of energy – whether oil, natural gas or power – has doubled since 2000, and continues to rise even as prices for key commodities have flattened out, the Paris-based energy group said in a report being released Tuesday.

"The doubling of capital costs is a serious issue," IEA's chief economist, Fatih Birol, said in an interview from Paris. "Companies have to improve their capital discipline and they have to be a bit more realistic in the future about rates of return, so long as prices remain at these levels."

In its report, the agency – which advises rich countries on energy matters – said corporations and governments invested $1.6-trillion (U.S.) in 2013 to produce and process oil and natural gas and to build power plants – a figure that has more than doubled in real dollars since 2000. Over the next 20 years, that annual spending will have to grow by 25 per cent to meet demand growth and replace existing energy supplies.

But there is a real risk that private and state-owned companies will under-invest – due to smaller profit margins, current fears about over-supply, and competition for financial resources – and that will ultimately drive up prices.

International oil companies like Royal Dutch Shell PLC, Exxon Mobil Corp., and Chevron Corp. have highlighted the need for greater capital discipline in their investment plans due to higher costs and shrinking profit margins, and have pulled back from some riskier investments.

Shell pulled back its plans to develop U.S. shale gas, while France's Total SA has shelved the planned development of Joslyn North oil sands mine. Companies are expected to bring that sense of discipline to the much-hyped liquefied natural gas business, after Chevron experienced massive cost over-runs at its Gorgon LNG plant in Australia.

Mr. Birol said the soaring costs suggest that global energy prices will remain high, and will continue to rise in some areas, notably in the power sector where aging infrastructure must be replaced just to maintain current production.

Of the $40-trillion (U.S.) that the IEA says must be invested over the next 20 years, 60 per cent is needed to replace depleting oil and natural gas reserves and power plants. Indeed, 80 per cent of the required spending in the oil business is required to replace declining fields.

More than 70 per cent of oil reserves are held by governments, so the international oil companies need to look at places like Canada to invest in future production. "Canada's importance [as a source of new energy supplies] once again needs to be underlined," he said. He said the oil sands represent an important new source of crude supply and adequate investment must be maintained.

While North America is currently leading the world in the growth of oil and gas production, the Paris-based agency expects the U.S. crude production will level off by 2020, and then start a slow decline after 2025.

"By 2020, the world will need more Middle East oil desperately in order to meet growth in Asia," Mr. Birol said. "Unfortunately, the appetite for investment is not there."

Key producing countries in the Middle East are siphoning off oil revenues to pay for subsidies to keep fuel prices low, and to provide other social spending needed to satisfy a young, rapidly growing and politically restive population. Failure of countries like Saudi Arabia, Iran and Iraq to adequately invest in new production will mean tighter and more volatile oil market after 2020.