Why oil and gas producers cannot slow down on the great energy treadmill

A seasonal slowdown in demand because of refinery maintenance in Asia is expected to lead to further price declines. AP

Oil and gas production is like running uphill on a treadmill with a merciless trainer who keeps cranking up the speed. It demands continuous investment just to maintain production and to meet even flat, let alone growing, demand. A new study highlights accelerating decline rates – and what they mean for oil companies, geopolitics and the climate.

The International Energy Agency (IEA)’s report indicates that, in the absence of new investment, oil production would fall by about 8 per cent per year and natural gas by about 9 per cent. This is up substantially from the 2010 levels, because of a much higher share of shale production – mostly from the US – and deepwater output. These decline more quickly than the onshore super-giant fields typical of the Middle East.

Even with new investment, natural decline rates are 5.6 per cent for conventional oilfields and 6.8 per cent for conventional gas. Effectively, each year, Iraq plus Oman disappears from global oil supply and Qatar plus Algeria disappear from global gas. This is despite strenuous efforts to sustain output from existing fields, including drilling new wells and injecting water, gas and other substances. These losses have to be replaced through developing new fields.

This does not mean that demand will necessarily increase. Oil consumption, in particular, may be close to a peak as electric vehicles become ever more capable and popular. But it is unlikely that global oil needs will decline by anything close to 5.6 per cent annually. Even a fairly rapid reduction of 1 or 2 per cent annually would require significant continuing upstream investment.

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Yet in 2021, the IEA’s net-zero report seemed to say the opposite: that no investment was required in new oil and gasfields. Not surprisingly, environmentalists seized on this, and it has been used as a justification for demanding that oil companies wind down production and for governments not to approve new field developments.

The puzzlement over the IEA’s apparently conflicting messages stems from confusing what should be, for the sake of the climate, with what is.

If we were really on track for a net-zero carbon world, or even a sustained decrease in hydrocarbon demand, there would be no need for bans on new fields. Oil and gas prices would be plummeting, and investment would be drying up.

Instead, oil prices today are modestly below the historic average while gas prices are still well above it. Upstream investment has been relatively low after the oil price crash of late 2014, but has still remained fairly steady at about $600 billion annually, excluding the Covid-hit years of 2020 and 2021. Nine-tenths of this spending goes to replace declines, while only a tenth increases supply.

Oil companies are very active in deepwater hotspots such as the US Gulf of Mexico, Brazil, Guyana and West Africa. Opec members Iraq and Libya are attracting major new spending after periods of political turmoil.

Environmental groups will doggedly fight new hydrocarbon production projects such as drilling in Alaska, developing the Rosebank and Jackdaw fields off the UK coast, or building a pipeline for oil from landlocked Uganda.

This is ineffective and counterproductive.

For a start, the distinction between new and existing fields is largely meaningless. Production can be boosted from existing fields by “enhanced recovery” methods or by exploiting additional reservoir layers or field extensions. From both climate and economic perspectives, new fields may be cheaper to produce from and lower in emissions than wringing the last drops from older fields, or extracting carbon-intensive resources such as Canada’s gigantic oil-sands.

If new fields in developed countries are blocked off, oil and gas will be imported from Russia or the Middle East or an overtly anti-climate US. With no new investment, Opec and Russia would collectively produce more than 65 per cent of global oil by 2050. That would be a politically unacceptable level of dependence for their key customers.

Far-right parties across Europe, such as the UK’s Reform, are using worries about high energy bills and opposition to “net-zero” carbon policies and bans on North Sea fields to boost support. They do not have to present any positive or practical energy or climate vision of their own.

Alternatively, investment in new producing countries could be banned. Financing for new fields from western banks or international financial institutions has been very hard to obtain for years. That policy bars new entrants, mostly lower-income countries such as Uganda, Mauritania and Guyana, while ensuring continuing hydrocarbon revenue flows to wealthy countries such as the GCC states, Australia, Norway and Canada.

If oil-producing countries themselves decided voluntarily to cease investment, the rapid loss of oil production would send prices through the roof. Something similar occurred in 2022, when Russia restricted gas supplies to Europe during its invasion of Ukraine. In the face of economic crisis, European politicians seized the chance to strengthen support for low-carbon energy and improve efficiency. But they also introduced price caps, restarted coal power stations, and flew to the Gulf and North Africa to beg for additional oil and gas.

The major producers in the Middle East have to invest steadily to meet their assessment of demand, not overproducing to crash prices, nor underspending and damaging the global economy. They learnt the bitter lesson of restricting supply too much in the 1970s, which was followed by a surge of competition elsewhere and a collapse in demand for their oil, leading to a decade and a half of slump. They should probably err – but only a little – on the side of over-investing.

Their giant, low-cost, low-carbon footprint resources mean they will inevitably gain market share both for oil and gas as long as they maintain consistent investment plans. Qatar and Saudi Arabia in gas, Iraq in oil, and the UAE in both, all have such programmes. The tyranny of the treadmill applies to them as much as to any hydrocarbon producer, but their superior fitness should make them the winners.