Substantial spending cuts brought on by the ongoing downturn are taking a toll on oil and gas companies’ abilities to grow or replace reserves worldwide, according to some energy consultants.

“What’s really interesting and noteworthy here is, it is not even close,” Scott Sanderson, principal for Deloitte Consulting, said during a recent webcast.

The oil and gas industry needs to replenish drawdown in reserves to serve an annual demand of 33.5 billion barrels of oil, or enough to fill about 5,790 Olympic-sized swimming pools every day, he said. Plus, the industry needs to meet a demand growth of 1% to 2% and overcome natural field declines of between 7 % and9% annually.

Before commodity prices began to plummet about two years ago, E&P companies were replacing about 125% of their production. However, today, companies are spending about 80% of their capital just to keep the proved and developed reserve share flat, Deloitte said. Chevron Corp. (NYSE: CVX) and Total are among the exceptions.

Adding to the concern is that E&Ps have announced capex cuts of 27% in 2016, following a year with 25% in capex cuts, and sizeable spending ramp-ups are not expected in 2017, Deloitte said.

The gap between spending and levels required to keep the reserve replacement rate flat is about $100 billion per year, Sanderson said, adding that is roughly the equivalent of about 550 land rigs and associated crews at today’s rates.

E&Ps have been forced to cut back spending and seek cost cuts and discounts amid a global oversupply of hydrocarbons. As production has grown, including in the U.S. where shale operators have successfully used new technology and improved techniques to unlock oil and gas from the subsurface, demand has failed to keep pace. Although the market has recovered some of its loss as rig counts rise, the consequential hit on commodity prices is still being felt.

But it’s not all bad. Other factors coming into play may decrease the financial requirement needed to replenish and grow reserves. These, Sanderson said, include slowing oil demand growth.

“Global oil demand growth is expected to slow from 1.4 million barrels per day (MMbbl/d) in 2016 to 1.2 MMbbl/d in 2017, as underlying support from low oil prices wanes,” the International Energy Agency said in its Aug. 11 oil market report. “The 2017 forecast—though still above-trend—is 0.1 MMbbl/d below our previous expectations due to a dimmer macroeconomic outlook.”

Other factors include:

  • Gaining market share by OPEC, which in turn reduces investment opportunities elsewhere;
  • Pre-downturn investments, such as those offshore, starting production and lowering near-term investment needs;
  • Falling costs and continued efficiency gains for shale oil and gas development and
  • High OECD commercial crude stocks, according to Deloitte.

Based on the finding and development costs of 50 to 70 of the world’s largest oil and gas companies, the industry will need to invest at least $3 trillion between 2016 and 2020, or about $600 billion annually, to maintain its long-term health, Deloitte said. The problem is that the figure is about 40% higher than what companies are expected to spend this year.

“Disrupting past trends, natural gas will likely need more capital allocation in coming years—from about 40% in the past to more than 50%,” the firm said. “Prioritization of development over exploration in the past calls for an increase in exploration spend to about 20% by 2020.”

Andrew Slaughter, executive director of the Deloitte Center for Energy Solutions, pointed out that limited capital to fund capex and competing cash priorities—which vary depending on whether the company is an E&P, IOC, resource-rich NOC or resource-poor NOC—further complicate the matter.

Annual cash flows at $55/bbl suggest a $750 funding gap over the next five years, according to Deloitte. Add shareholder payouts and debt payments to the mix and the gap could jump to $2 trillion.

However, “the lenders are still out there and they need to make money. The question is: What are they going to underwrite? How aggressive are they going to be?” Sanderson said. In the past, they could lend against 60% to 75% of proved underdeveloped reserves at an agreed-upon price deck. “But with that price deck being such a moving target, they really don’t know what to underwrite today.”

Added Slaughter: “I suspect they are also looking for some return on their previous extension of debt in the upcycle.”

Good news is that rising oil prices help cash flow. Not so good news is that cost changes have historically followed price changes. Oil and gas companies have benefitted from significant drops in oilfield service costs, but those days may be numbered. Oilfield service companies such as Schlumberger are thinking about recovering the temporary pricing concessions.

In the near term, cash-strapped E&Ps could benefit from altering their business models and being proactive in managing capital. Examples provided by Deloitte were in line with what some oil and gas companies are already doing:

  • Pursuing brownfield expansions, bolt-on acquisitions and farm-ins or farm-outs to de-risk capital structures;
  • Diversifying by resource, geography, market, fuel type or business; and
  • Stabilizing returns by “bolstering the portfolio contribution of shale plays.”

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“This downturn has been longer than previous downturns. It’s been deeper than previous downturns, and the recovery—if it’s coming—it’s coming slowly,” Slaughter said. “But I think these are real issues that the upstream business will have to grapple with over the next several years.”

Velda Addison can be reached at vaddison@hartenergy.com.