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Breaking News:

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Oil Industry No Longer Discovering Oil, Only Growing Through M&A

Eagle Ford rig

It is becoming increasingly difficult for the oil majors to discover new sources of oil. The industry is in a state of crisis and could be at a turning point. Low oil prices have made a large chunk of yet-to-be developed oil fields unprofitable. That means that the even more challenging task of exploring for oil in frontier regions and developing those reserves is essentially off the table. Without the ability to grow through exploration, what is an oil major to do?

Wood Mackenzie says in a new report that the largest oil companies are scaling back their exploration budgets and instead shifting their long-term plans towards a strategy of growing by acquiring already producing, or at least proven, oil assets. The consultancy estimates that oil companies will depend on M&A activity to make up about half of their “reserve replacement” going forward. "Now their reserves replacement will also require inorganic, brownfield or shale investments," Andrew Latham, vice president of exploration research at Wood Mackenzie, told Bloomberg in an interview. "Exploration has become incremental."

Between 2015 and 2020, Wood Mackenzie expects the global oil and gas industry to slash spending on exploration and development by a staggering $1 trillion. That will make it increasingly difficult for oil companies to replace all of the oil they produce in a given year. This so-called “reserve-replacement ratio” is a key metric for the value of oil companies. A stagnant, or falling reserve-replacement ratio could act as a huge weight on share prices.

In 2014, a year that saw the start of the decline in oil prices, the oil majors posted the worst reserve-replacement ratios in a half decade. But in 2015, as exploration budgets started to see even more severe cuts, the largest companies only replaced about 75 percent of the oil they extracted, the worst result in over a decade. ExxonMobil, for instance, only reported a reserve-replacement ratio of 67 percent last year. Royal Dutch Shell fared even worse, posting a negative 20 percent replacement ratio. Related: Is U.S. Shale Nearing Collapse?

There is little prospect that those metrics will substantially improve this year or next. With exploration budgets cut to the bone, fewer and fewer discoveries will be reported. Last year saw the least amount of oil discovered in almost 70 years, and 2016 will likely be worse.

The inability to produce even some of the proven oil reserves out there has forced companies to issue massive write downs. ExxonMobil is the one exception to that trend – the oil company has not written down any assets over the past two years, a fact that has the New York Attorney General looking into the company’s accounting practices, investigating it for fraud. Related: The Next Hot Thing In Oil – Permian Land Rush Continuing Unabated

With no room to discover new oil through drilling, Wood Mackenzie expects the oil majors – always under pressure from Wall Street to continuously grow – to add new reserves not by drilling, but by buying. Royal Dutch Shell, for example, scrapped its ill-advised drilling program in the Arctic, which it had hyped up as a major new frontier for oil exploration. The failed campaign was a shift in focus for the company, and it instead spent more than $50 billion to purchase BG Group, which provided Shell with oil and gas assets in Brazil, East Africa and Australia. Also, Exxon recently spent $2.5 billion on some LNG assets in Papua New Guinea.

Those were some higher profile transactions; Wood Mackenzie sees smaller acquisitions as the most common trend moving forward. “The need for M&A in exploration is likely to be here for a considerable time," Wood Mackenzie’s Latham said. Oil majors will spend money on “assets rather than on taking over companies.”

The other factor to consider is that so many companies have rising debt levels and limited cash on hand. The oil majors themselves are in the midst of enormous asset disposal programs in order to improve their balance sheets. Shell alone is hoping to sell off $30 billion worth of assets over the next few years. For the lucky companies that have the resources to go on a spending spree, it is a buyers’ market out there with so many indebted companies looking to offload assets. Exploration is at a standstill, so these asset sales will become more central to the growth prospects of the oil industry.

By Nick Cunningham of Oilprice.com

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  • Bill Simpson on September 20 2016 said:
    Expect an oil shortage leading to global economic shrinking (it's physics) leading to debt defaults, spiraling into the Great Depression II, in between 5 and 15 years from today. Canada and Venezuela then boom. Coal mines are reopened by the New People's Government which develops a synthetic fuel from coal industry. A lot of coal miners are working on the Northern Alaska Coal Mine and synfuel plant, connected to the Alaska pipeline. (There is a LOT of coal in Alaska.) All coastal areas are leased for offshore drilling. Protesters are sent to work in Alaska. Work, or you starve as a prisoner up there. Start trouble in work-prison up there, and you get shot by the New Revolutionary People's Courts (no jury, Army officers).
    Life will get hard without enough oil. Desperate people will do desperate things to avoid starvation. Especially when they have never gone a single day without eating.
  • David Hrivnak on September 21 2016 said:
    Actually life can be easier without oil. We now have two plugin cars and rooftop solar so we fill our batteries easily at home. It truly is a better future.

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