What are the main reasons for projects cancellation
Since the WTI and Brent barrels prices have lost 20 to 25% of their value in a couple of months we assist to a frenzy of publications and speculations on the consequences of this dip on the Oil & Gas and Petrochemical projects that could be cancelled or postponed as a result.
Every day we receive this same question and there is no way to start a meeting without addressing this point first.
As we trace the 1000 largest projects upstream, midstream and downstream for nearly 20 years, we had the opportunity to observe this phenomena a couple of times and we are pleased to share our experience here below on such a topic.
– N°1: Spiraling costs
– N°2: Geo-political uncertainty
– N°3: Local Content regulations instability
– N°4: Tensions with local inhabitants
– N°5: Environmental impact
Since the painful experiences in Australia or around the Caspian Sea with projects capital expenditure running out of control, the operators and especially the international oil companies (IOCs) which are listed, have been extremely shy in engaging upstream projects calling for more than $10 billion investment.
But we can notice that the decision to put on hold these giant projects because of their spiraling costs were made far before the barrel price decrease.
For all the companies the projects costs running out of control are unacceptable regardless the barrel price as it questions the fundamental expertise of the company and the capability of its management to handle complex projects.
So to answer straight forward to the critical question of the day, we do not see any negative impact of the current barrel price evolution in projects decision and we see number of good reasons for that.
Still high price
Even if the WTI and Brent crude oil historically considered as the reference for the barrel prices have decrease by nearly 25% since last June the current price around $80 is still a high level in absolute value.
If we compare this price with production costs in the worst operating conditions, including shale oil, $80 per barrels remains very attractive.
In addition the production sharing agreement (PSA) signed these last years between the companies and the producing countries have introduced a lot of flexibility where excessive profits generated by high barrel price stay in the country while depressive prices will anyway guaranty minimum return to the companies to cover their costs.
Therefore the minimum barrel price level that the market can accept is governed by political agenda, especially between the biggest producers USA, Russia and Saudi Arabia for which nobody can predict where it is.
Light crude vs Heavy crude
All the world put its eyes on the WTI and the Brent barrel prices, but currently these light crude oil indexes represent less than 50% of the world consumption.
Most of oil consumed in the world belongs to the heavy crude traded in conditions far below the light crude.
In addition nearly all the new projects are about developing heavy crude oil fields since new light crude oil fields become very rare or hard to reach.
The global market switch from light crude to heavy crude had a positive impact on the projects activities over the last five years since the companies invested heavily to revamp and upgrade their refineries in North America, Europe and Middle-East to accept heavy crude oil in competitive conditions.
This trend should continue on the next five years and contribute to boost the great number of refining projects in world at this moment.
The light crude is mainly interesting commodity traders and hedge funds who speculate on every $ up and down generating billions good will.
The fact that Tony Hayward, former BP CEO, was appointed as Glencore Chairman in May 2014 indicates how much crude oil is becoming a playground for the commodities trading companies.
At least we can notice that the interest of these commodities trading companies is boosting storage and terminal projects more than ever.
30 years project life cycle
On that long period of time the barrel prices may comes down to $10 but on a such short period at the scale of the project that it cannot be relevant in the decision to cancel a project.
Unless to discover suddenly a substitute to the oil for transportation applications, the overall trends in demography and the global economical development can only push the prices up on the next 30 to 50 years.
IOCs vs NOCs
The IOCs are listed and must respond to stock exchanges expectations in term of revenues and profits.
Even if a lower barrel price may affect their revenues, it may not impact their profits in the same way because of the nature of the production sharing agreements introduced some 15 years ago and giving more flexibility to the profit and loss sharing with the producing countries as mentioned above.
Anyway to preserve their cash-flow capability to finance new projects, we can observe that IOCs prefer to optimize their assets and spin off the less attractive ones than to cut investment.
For NOCs the agenda is far different and has nothing to do with barrel price.
The NOCs invest to support their home country economical and social development in a long term perspective far beyond any quarterly results.
The advantage of the integrated business model
Even it is too early to predict the same course to the shale oil as the shale gas, we can see that the pressure of the oil and gas prices has a significant impact on the companies’ strategy with positive effects on the projects numbers where the profitability is no longer measured on one side of the process but all along the hydrocarbon value chain, as the NOCs do.
As a side effect the labor costs went to the roof in beginning with Australia and expending all over the world in engineering companies and contractors because of the scarcity of the competent resources.
In this context, any stress about the crude oil prices going down is only accelerating this in-deep conversion of the sector.
Of course some projects may be announced to be cancelled or postponed because of low crude oil prices and we shall be very pleased to analyze these cases to assess fundamental reasons of these decisions.
But for now we never saw so many projects being executed on fast-frack, where the engineering, procurement and construction (EPC) contract is following the front end engineering and design (FEED) conclusion without call for tender.