Big oil finding money for biggest projects

$36.8-bn project agreed by Chevron, Exxon and partners suggests oil's deep freeze may be thawing

There are signs the deep freeze in oil-industry spending is beginning to thaw.

Chevron Corp., Exxon Mobil Corp. and several partners on Tuesday committed $37 billion to expand an oil project in Kazakhstan known as Tengiz, one of the biggest investments since crude prices collapsed two years ago.

Last week, BP PLC gave the green light to a multibillion-dollar gas export expansion complex. It follows the U.K. oil giant’s announcement in June that it is fast-tracking a major offshore gas discovery in Egypt. Italy’s Eni SpA is moving ahead on an Egypt field as well.

In choosing to invest now, the world’s biggest energy companies get to benefit from a huge drop in drilling costs that has accompanied the oil-price fall. Pumps, valves, drilling rigs, construction and engineering services, steel and even labor are cheaper because the contractors that provided those services have less work than in the boom years after the financial crisis when oil prices traded around $100 a barrel.

The recent wave of investments may point to confidence in an oil-price recovery—after they collapsed from around $115 a barrel in mid-2014 to a low of $27 in January—but it is still early days.

Big-energy company executives have said they are treating the oil-price rally with caution, warning that as prices rise, investment could kick in from U.S. shale producers and American output could quickly ramp up again. Just on Tuesday, U.S. crude prices dropped almost 5% to $46.60 as traders worried about an uptick in U.S. drilling activity.

A similar price rally last year had quickly fizzled. Since oil prices started collapsing in the summer of 2014, companies have delayed or canceled about $270 billion in projects through March, including expensive Arctic developments, according to Rystad Energy. Great Britain’s vote to leave the European Union adds another level of uncertainty, with the effect on markets, oil demand and investment still to be determined.

But the Chevron announcement on Tuesday is “an inflection point,” said Jefferies senior oil analyst Jason Gammel, noting that it is the first investment of more than $10 billion this year.

Tengiz is already one of the most profitable projects in the past 40 years. “It’s a terrific time to be making this sort of investment,” said Todd Levy, Chevron’s president for exploration and production in Europe, Eurasia and the Middle East. Chevron is the project’s operator.

Since the start of 2015, Chevron and other big oil firms have slashed their budgets by a quarter—exceeding $30 billion overall—and cut more than 30,000 jobs to endure a prolonged period of low prices. That has forced them to scour the globe for opportunities that meet a very narrow set of criteria: They have to boost production in the years ahead so the companies avoid shrinking, and they have to be profitable at $50 oil.

Since prices began falling, they haven’t often been able to find such a sweet spot. Last year, Western oil companies approved just four such major projects, including in the Gulf of Mexico, Norway, Egypt and Ghana. So far in 2016, energy companies have taken the plunge on eight big expensive developments, according to Houston energy investment bank Tudor Pickering Holt & Co. And more are expected this year, the bank said.

Still, these won’t come online for years. The first oil from the Tengiz expansion, for instance, won’t come until 2022.

Exxon, Chevron, Royal Dutch Shell PLC and BP are turning to U.S. shale wells as well. Those operations require less upfront investment to begin producing but also don’t approach the scale or multidecade opportunity of the big projects.

Shale producers such as Pioneer Natural Resources Inc. have begun to add a small number of rigs in anticipation of higher prices at the end of 2016. They have also started tapping a vast pool of wells that were drilled but which have yet to be fracked, a way to keep producing without having to spend as much money.

Oil prices dropped across the board on Tuesday—Brent, the international benchmark, fell to $47.96 a barrel, a 4.3% decline—but the trend is up. Barclays forecast this week that Brent crude prices will average $57 a barrel next year, up from a forecast average of $44 this year.

A supply glut that has weighed on prices for two years is easing thanks to outages in Nigeria and Canada and falling output among U.S. shale drillers.

Some oil companies are now able to cover their costs with prices stabilizing around $50 a barrel in recent weeks, analysts said. Their spending cuts are allowing them to meet dividend payments and invest in new projects, Mr. Gammel said.

“It shows that the companies are at a point where they can consider investing in longer-term projects,” he said.

Oil companies are typically more comfortable making big investment decisions on future production when prices are stable. Tudor Pickering said it believes more projects will be approved this year, including BP’s huge deep-water project in the Gulf of Mexico known as Mad Dog II and Eni’s Coral floating liquefied-natural-gas development in Mozambique.

BP declined to say when it would decide on Mad Dog II. Eni said it planned to decide on Coral this year.

Tengiz is among a handful of oil-field projects that are feasible at today’s oil prices. Its production costs averaged around $6.50 a barrel over the past five years, according to Mr. Gammel. Some analysts estimate that it has brought Chevron more than $70 billion in revenue, and $40 billion in profits, since 1993, when it became the first foreign oil company to strike a deal with the former Soviet republic.

Source: The Wall Street Journal