The oil sector is at a crossroads. Since the downturn, state-owned oil companies have gained a larger role: they accounted for nearly half of total global upstream investment last year. Electric vehicle growth, the rise of renewable energy and the resulting fight for capital all make the nature of the next oil cycle uncertain.
NOCs play a larger role
Since the oil price downturn, government-owned National Oil Companies (NOCs) have filled the investment void left by private and other players, as emerging markets still rely heavily on oil revenue to fund social and economic development. While Global Majors, US Independents and Privates slashed CAPEX by nearly 50% from 2014 highs, NOCS reduced expenditure by less than 30%. Today, NOCs generate nearly 60% of both global energy production and reserves. Meanwhile, governments across the globe are playing progressively bigger roles in shaping energy policy and the future of fossil fuels.
Existential Threats?
To understand the forces at play during the next cycle, one has to look beyond the traditional supply/demand scenario. Although the commonly held view is that recent CAPEX reductions will likely lead to a supply gap in the market during the next cycle, the ‘elastic’ nature of US shale should somewhat address it. What is more interesting is understanding the potential existential threat created by electric vehicles and the shift to renewables. Although investment into fossil fuels has slowed markedly over recent years, global interest and investment into renewable energy has not abated. While admittedly the notional level of new investments in renewables has slowed and global investment over the past two years is off the 2015 highs, the dramatic reduction in the cost of renewables alters how we think about investments in the space. The average spot price for solar panels have fallen by nearly 80% since the turn of the decade. This drop in pricing equals greater energy intensity per dollar invested, meaning that a similar notional investment goes a further distance.
An upcoming battle for capital
However, traditional finance sources for oil and gas producers like private equity, venture capital and public markets have been slow to invest in renewables. This could change. Investors now seek a faster return on investment - as illustrated by the influx of majors that have made large investments back into US shale. Furthermore, traditional sources of capital markets financing are now becoming increasingly meticulous with capital allocation amid the rise of ESG (Environmental, Social and Governance) investing mandates. Several high profile pension and sovereign wealth funds have already committed to trimming exposure to fossil fuels. While the rhetoric has been part of a larger movement to tackle climate change, this move is also supported by broad lackluster performance of the oil sector over recent years. These factors all have wide ranging implications for the shape and the duration of the next oil cycle.