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The high volatility of the market has proven that is essential that the oil&gas industry rethinks its contractual and operational model, to reduce costs and risks

The last few months have seen the global oil industry engaged in a fast-moving series of calculations and analyses that may restore their hopes for a sustainable future. The climate of anxiety, though, is still tangible amid the increasingly obvious effects on the markets of the sudden drop in oil prices, as well as the appeal, by the major oil companies, for strategies on cost-cutting and downsizing investments. This highly difficult environment may, paradoxically, provide an opportunity for a thorough review of the model under which they’ve been operating, ensuring the economic viability of an increasingly complex production system and consequently ensures more stable, long-term growth. The success of shale oil, which has recorded a production, over just 3 months, of 3.5 mb/d, has added yet another layer of complexity to the system. In the U.S. alone over the last decade, an investment of approximately 25 percent of total expenditure between 2005 and 2014 has resulted in a growth in production amounting to 5 mb/d, or 75 percent of the global production of liquid hydrocarbons, mainly due to the positive production waste generated by shale oil. This, in turn, has undoubtedly affected the latest sharp fluctuations in crude oil price, reflecting the fact that the traditional dynamics between production cuts and price support have now been overridden by the American "spare capacity" which, moving as it does on shorter production cycles, allows rapid "start/stop" production operations tied to market conditions. It seems reasonable to assume that whatever price oscillations we see, we are unlikely to go above $100 per barrel in the near future. It is easy to understand, in the face of the high rate of investment over the past decade, how this trend provides a disincentive for new production initiatives. This one perspective, which draws the attention of all workers to the urgent need to identify the ways in which the industrial sector may preserve energy continuity and ensure, at the same time, adequate growth, especially considering that in recent years, despite prices being well above $100 per barrel, the industry has experienced difficulty in maintaining cash and increasing production. A complicated situation if traced back to the relationship between total capex in the industry, which, in 2014, was approximately $700 billion, equal to 250 percent more compared with a decade ago, and the increase in global production advanced by a mere 15%.

What will be the effects over the next ten years?

This environemnt includes the efforts of the major oil companies to stem, as far as possible, the difficulties resulting from a drop in oil production by approximately 10 percent, also considering the PSA effect, despite the substantial increase in investment. An alarming situation, directly linked to a not too distant past, when companies partly revised their investment strategies, increasing the technical complexity of their development projects, which were to be managed and run by contractors. The industry has allocated most of its capex to highly-complex, capital-intense projects such as the expansion of LNG and the development of tar sands and ultra-deep water projects. If we consider that, with regard to these types of projects, the breakeven point may exceed $100 per barrel, as things stand, the difficulties in sustaining the resulting economic effort in the long-term can be well understood. Faced with such a prospect, and under the ax of the decline in oil prices, the industry has found itself obliged to intervene by substantially cutting investments and cancelling or, at best, postponing more complex and costly projects. The forecast, to date, is that the effects of this action could have a negative impact in the relatively near future on the growth and sustainability of supply, threatening to cause a material gap between production and demand within the next decade, with direct results on the economies of importing countries.

A rational revision of investment

This environemnt includes the efforts of the major oil companies to stem, as far as possible, the difficulties resulting from a drop in oil production by approximately 10 percent, also considering the PSA effect, despite the substantial increase in investment. An alarming situation, directly linked to a not too distant past, when companies partly revised their investment strategies, increasing the technical complexity of their development projects, which were to be managed and run by contractors. The industry has allocated most of its capex to highly-complex, capital-intense projects such as the expansion of LNG and the development of tar sands and ultra-deep water projects. If we consider that, with regard to these types of projects, the breakeven point may exceed $100 per barrel, as things stand, the difficulties in sustaining the resulting economic effort in the long-term can be well understood. Faced with such a prospect, and under the ax of the decline in oil prices, the industry has found itself obliged to intervene by substantially cutting investments and cancelling or, at best, postponing more complex and costly projects. The forecast, to date, is that the effects of this action could have a negative impact in the relatively near future on the growth and sustainability of supply, threatening to cause a material gap between production and demand within the next decade, with direct results on the economies of importing countries.

A rational revision of investment

The only viable solution for the oil industry is regain profitability, impacting on the cost structure, by selecting investments and optimizing production and, even more effectively, developing proven exploration basins through the introduction of new technologies that contribute to a reduction in spending and emissions. It is therefore inevitable to proceed rapidly towards a detailed and functional reflection, which goes beyond cuts, purely and simply, to investments, and promotes a thorough revision of operating procedures. Companies will increasingly have to move towards restoring operational simplicity, focusing on conventional assets and directly managing development projects through a rigorous control of every stage of the process. On the other hand, producing countries will also inevitably have to reconsider their business models, reviewing oil contracts in order to align them with current conditions, reducing risks and costs. It will be essential to create competitive contractual formulas to make "conventional" crude oil extraction opportunities economically attractive, offering investors a chance to capitalize on price spikes under flexible terms in order to gain competitive efficiency in an increasingly volatile market. All IOC, NOC and producing countries will have to revise their goals for optimizing investments. At this point, the oil industry needs to make a profound reconfiguration to achieve greater flexibility, linearity and operational effectiveness, by optimizing investments, production capacity and revenues, and relying on the resilience that has always distinguished it in order to constructively address the vulnerability of the markets and to regain confidence and competitiveness.