On Monday, LNG Canada said the $40 billion project will proceed.  The announcement comes at a time when Big Oil executives admit they may need to boost spending to replenish reserves, cut output declines and take advantage of rising oil prices.  LNG Canada image.

Big Oil seeing higher labour, supply costs

On Monday, the consortium behind the LNG Canada facility in Kitimat, British Columbia announced the $40 billion project will go ahead.  The decision highlights the mood in the oil and gas industry where Big Oil executives are under growing pressure to spend more money to help replenish reserves, reverse output declines and take advantage of rising oil prices.

As oil prices settle in at around $85/barrel this week, oil companies’ exploration departments are looking to drill more.  As well, wages are rising slightly, service companies are warning that their rates will be increasing and investors are encouraging oil majors to grow.

But there are concerns.  Executives are weighing higher priced oil against a business cycle now in its 10th year of growth following the financial crisis in 2008.  As well, Big Oil companies know there is a very real prospect that there will soon be an end to growth in demand for crude as the world shifts to renewable energy.

Despite the apprehension, companies are making some decisions that will boost costs, but they say may make their operations more cost effective and productive.  For instance, Shell has opted to switch its UK North Sea workers to a less tiring rota of two weeks offshore then three weeks onshore.  Offshore staff had been on a gruelling schedule of three weeks offshore then four onshore.

For Shell, the more frequent rotations will mean more ships and helicopters will have to be chartered to ferry personnel, but the company says it will be worth it.

According to a survey with Rigzone, salaries in the oil and gas sector have climbed about 6 per cent so far in 2018 after three years of declines.

Along with boosting spending on day-to-day costs, there are more new project approvals, including LNG Canada.

“Shell’s motivations for the project are clear: without this project, the company’s upstream, LNG contract portfolio and LNG production was set to go into decline early next decade,” Wood Mackenzie www.woodmac.com analyst Dulles Wang told Reuters.

According to Reuters, Big Oil companies now generate as much money as they did in 2014 and while they vow to keep costs down so they can offer higher dividends, the industry recognizes that continued investment is crucial to offset reserves and production decline.

“We are likely in need of more long-cycle investments given the persistent and accelerating base declines observed in global conventional and offshore projects,” a Reuters source at in investment firm with large stakes in big oil companies said.

Some companies like BP have been able to use technology to improve production and reduce costs, but many companies see the drop in new production taking a toll on their longer-term outlook.

In 2014, overall oilfield decline rates were 3 per cent and in 2016, rates hit 6 per cent.  Morgan Stanley reports that for Big Oil, rates climbed from 1.5 per cent to just over 2 per cent in the same time period.

“I expect capex rises due to a significant drop in reservoir life. Some capex will be used to reinvigorate existing wells,” Darren Sissons, partner at Campbell Lee & Ross Investment Management told Reuters.  He added that increases would be cautious initially.

“There is lots of pressure from all the units to get more money,” an executive at a large European oil company told Reuters.

Morgan Stanley and Jefferies analysts expect spending by the world’s seven largest oil companies will rise to a combined $136 billion by 2020 up from $105 billion in 2017.  Boards of these companies are expected to prepare shareholders for higher spending beginning in 2020, Morgan Stanley analyst Martijn Rats told Reuters.

“New project awards will likely already accelerate in 2019, but for major developments, capex in the first year tends to be limited. From 2020 onwards, capex is likely to go higher.”

Having squeezed oil service companies during the lean years, Big Oil now sees increasing pressure from service companies who argue that their sacrifices to help oil majors weather the slump should now be rewarded.

“Current investment levels, particularly in the international market, are clearly not sustainable to meet either medium-term demand or long-term reserves replacement needs,” Reuters reports Paal Kibsgaard, Chief Executive Officer of Schlumberger, told a conference last month.

Kibsgaard says the international production base needs double-digit growth in investment in the foreseeable future to keep production at current levels.

But Big Oil companies are concerned that any boost in spending could signal that oil companies are circling back to their costly and wasteful ways noted during the first half of the decade when oil prices were at record levels.

“Historically, excess free cash flow above dividend cost has seen capex rise in the industry but the sector is trying to shake off the capital indiscipline tag and I believe they will stick to that,” Rohan Murphy, analyst at Allianz Global Investors told Reuters.