The world's biggest oil companies will have to be more disciplined in their capital spending plans as they re-evaluate growth prospects in light of rising costs and expected weakness in prices this year.
Super majors such as Exxon Mobil Corp., Chevron Corp. and Royal Dutch Shell PLC will report their fourth quarter and 2013 earnings this week.
And while crude prices remain high, such companies are seeing their profit margins squeezed by higher expenses and production problems around the world.
Shell set the tone by announcing last week that its fourth-quarter earnings – to be released Thursday – will be "significantly lower" than recent levels of profitability. Bank of America's Merrill Lynch analysts recently downgraded their rating on Exxon, saying the company faced "production headwinds" that would hurt its performance.
The major companies, like smaller competitors around the world, are grappling with two factors that have driven costs higher.
First, there is the long-term trend of greater reliance on high-cost resource plays (tight oil in the United States, oil sands in Canada, deep-water developments around the world). In addition, there is the pressure from suppliers such as drilling companies that are working full-bore as producers take advantage of $100 (U.S.) oil prices and new tight-oil opportunities in North America.
As a result, it is more difficult for the industry to maintain global production growth, even as North American's tight light-oil play and Canada's oil sands continue to attract investment. Given the need for long-term investment to keep up with growing demand in emerging markets, the industry may be laying the groundwork for future price shocks.
"There are certainly cost pressures, and that reflects the fact that oil prices are high and drilling activity is high the world over," said Pavel Molchanov, a Houston-based analyst with Raymond James Financial Inc. "When you have high oil prices and high levels of drilling activity, that puts upward pressure on cost structures – both operating costs, and finding and developing costs."
He expects that companies will rein in spending to focus on their best assets, noting that both Exxon and France's Total SA have indicated they will be cutting their capital budgets. In Calgary, companies such as Suncor Energy Inc. and Cenovus Energy Inc. have already indicated they will be more disciplined in their spending, delaying projects that don't offer an adequate rate of return.
"Capital spending is being closely watched, especially for large-cap companies," Mr. Molchanov said. "Investors are looking for greater capital discipline."
Raymond James forecasts that the industry is headed for a period of weakness in crude prices, and Mr. Molchanov said companies will therefore need to trim their sails.
Raymond James expects prices to fall by as much as 20 per cent some time in the next 12 months, with West Texas Intermediate hitting $70 per barrel and the international benchmark, North Sea Brent, slumping to $90. WTI closed Friday at $96.64, while Brent traded at $107.88.
In a report late last year, Ernst & Young LLP tracked how production costs have been rising faster than revenues. In 2008, global oil-and-gas companies averaged $64.91 per barrel of oil equivalent in revenues, with production costs of $15.29 per barrel. In 2012, revenues sat at $64.94, but production costs jumped to $18.88 per barrel.
The super-majors are particularly vulnerable to cost escalations in megaprojects, from liquefied natural gas projects in Australia to massive, ultradeep-water oil developments in Kazakhstan. But with state-owned oil companies controlling some 80 per cent of world reserves, the international giants are forced to hunt for elephants in high-cost, high-risk environments.
"We're in a period of significant structural change facing the oil and gas business – some of it positive, and some of it posing some real tough challenges," said Barry Munro, a Calgary-based E&Y oil and gas consultant.
Companies currently "don't see a lot of commodity price upside," he said, so "executives and boards and capital providers are really starting to get concerned about cost – 'Am I really going to generate adequate returns? Because I'm not going to get bailed out by a commodity price cycle.'"