Well-respected energy-industry consultancy Wood Mackenzie recently issued a startling report. It concluded that low oil prices could lead to a delay in a staggering $1.5 trillion worth of oil and gas projects in the near term. It's a rather dire warning not only because of the economic implications, but also because of the potential for a massive disruption in oil supplies down the road that in theory could lead to a super-spike in oil prices.
Holding out and holding back
Investments in oil and gas projects are already down $220 billion over the past two years versus Wood Mackenzie's projections before the oil-price plunge. That's because 46 major projects have been deferred. Among the many projects is BP's (NYSE:BP) Mad Dog 2 project in the Gulf of Mexico, which is also co-owned by BHP Billiton (NYSE:BHP) and Chevron (NYSE:CVX), as the long-delayed project was put on hold again earlier this year. While BP has said that it still hopes to make a final investment decision on the project this year, given the continued weakness in the oil price, further delays are very likely.
It wouldn't be the only project to face a delay, as Wood Mackenzie estimates that "as much as $1.5 trillion of investment spend destined for new (pre-sanctioned) and tight oil projects is now out of the money, or in starker terms, uneconomic at a $50 oil price." As a result, it only expects the industry to sanction six major projects this year and 10 next year. This is for an industry that can accommodate 40 to 50 new projects each year. That's a significant under investment that could have big consequences in the years ahead.
The upward battle
The reason this is a potential problem is that new oil supplies are needed to both overcome the declining production from legacy wells in addition to growing worldwide demand. It's estimated that nearly $10 trillion will need to be spent over the next decade and a half just to keep the oil market balanced, which the following slide shows:
Now, to be clear, this is a longer-term concern, as most of the major projects being deferred are capital-intensive, long-lead-time projects such as offshore and oil sands projects. Just to put the timing in perspective, the Mad Dog Field was initially discovered in 1998, but first production from that field didn't begin until 2005, when Mad Dog 1 came online. Appraisal drilling for the Mad Dog 2 project didn't start until 2009, and initial development wasn't commissioned until 2012, with plans for first oil in 2017. That plan, however, was delayed in 2013, after skyrocketing costs caused BP, BHP Billiton, and Chevron to go back to the drawing board and look at a more economical approach. The new plan, if it were to be approved by the end of this year, wouldn't deliver first oil until 2020. The key takeaway is that once the trio gives the final go-ahead, it will be nearly five years before Mad Dog 2 will produce a drop of oil.
Now as the Mad Dog development shows, offshore projects get delayed all the time for various reasons. However, we're talking about 46 projects currently being deferred, or a whole year's worth of project capacity, with the potential for dozens more to follow, and this adds up quickly. These are enormous projects each capable of producing well over 10,000 barrels per day and therefore it implies a pretty wide gap in supplies if demand growth is as expected. It's a scenario that could lead oil prices to skyrocket.
If oil prices do remain lower for longer. it could have dire consequences for the industry both in the short and long term. In the short term there could be more job losses, bankruptcies, and investor pain from falling stock prices. However, in the long term, the consequences of not investing in future oil production could lead to future supply shortages and potentially a major spike in oil prices.
Matt DiLallo owns shares of BHP Billiton Limited (ADR). The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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