|2014 IEA World Energy Investment Outlook|
Amidst the major gains in the oil and gas industry (and perhaps even contributing to them), OPEC released a report describing a global cut of $130 billion worth of petroleum investment spending. Multinational companies are not the only ones cutting capital expenditures as even OPEC governments now running trade deficits are experiencing this run on capital. Even with all this, everyone keeps pumping in a global dash for market share that has isolated many of the consumers looking for an industry with high profit margins. Instead, even the largest firms are racing to grind down costs of operations as the market appears less and less monopolized by OPEC oil wells. Saudi Arabia just recently was forced to cut their oil price because of the U.S. overproduction. In a miraculous year, the crude oil market has seemed to stumble into a semi-competitive system dominated by large firms that can apply economies of scale to succeed. But with the shifts, a brand new batch of success stories takes competitors by storm. The shale frackers, through innovation and technological breakthoughs (like most new success stories), developed a way to get that oil which was originally out of reach. In the figure above, the IEA researched fracking projects and forecasted what costs and cash flow in those projects would look like over time. With such high initial costs and long-term gratifications, bleeding governments can't afford to take on negative cash flow for almost ten years. It hurts economic conditions, weakens currency against the dollar (which prices most crude benchmarks), and makes borrowing costly. So what about American producers, why are they managing so much success with a project that returns almost -$300 million worth of cash flow in the first five years? The key is a capital system that provides many routes to the necessary credit to fuel long-term investments. Firms can use the assurance of future production and liquidity as collatoral as well as their current traditional assets. On top of that, smaller producers that wish to get in the mix have the ability to begin a capital intensive program and receive assistance from a larger firm with more experience and cash flow. Take for example a recent move by Suncor to work with Canadien Sands Ltd. Low crude oil and natural gas prices have caused these projects to become extremely unprofitable (as most are still in the appraisal or facilities and growth phase), but in the next couple of years the cash crops will pay outl, especially as prices stabilize once more. Global demand for these ligrter, sweeter products will increase after price drops increase consumption and economies of scale keep pricing competitive. That is why OPEC is scared, Because a technological breakthrough and a superior product will flood the market (as export bans are lifted), member economies based on the commodity will be strapped for cash. Asian demand is most likely slowing down and has already caused major cuts in the Saudi oil benchmark. OPEC Secretary-General Abdalla Salem el-Badri, according to Wall Street Jounal, has plead for U.S. production to negotiate for a higher price! What does this mean for the future in oil and gas? Production declines should be evident in the first couple of years. This may not be so evident as capital expenditures increase which would rightly prompt the expectations of productions of increasing. Not with initial large-scale shale production. As prices get higher, fracking innovation will only stand to get better. Appraisal and development costs will drop inevitably leading to more efficient production, and the price will react.The real question is how long the world is going to allow itself to remain petroleum dependent. There will be a push to electric cars, and there will be a tapering off of demand in the long-run even though shale fracking will get cheaper and cheaper. For now, oil and gas companies should come out on top due to these capital expenditure programs supporting new fracking projects. On Q4 reports, I would look at capital expenditures, operating costs, and lon-term debt to see where a company might be in its long-term agenda concerning shale interest.