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Underinvestment challenges in hydrocarbons cause concerns for more volatility

Underinvestment in oil and gas could result in further volatility, a new report suggests.
Underinvestment in oil and gas could result in further volatility, a new report suggests.

Underinvestment in oil and gas development extended into a second year in 2021 even as global energy demand rebounded, raising the prospect of price shocks, scarcity and growing energy poverty, according to a new report by the International Energy Forum (IEF) and IHS Markit.

The report underlines widespread concerns about the stability of global energy markets in the wake of the COVID-19 pandemic and follows a decision by several countries including the United States, Japan and India to release strategic petroleum reserves to cool prices.

"The energy crisis in Europe and Asia this winter is a preview of what we can expect in the years ahead. Two years in a row of large and abrupt underinvestment in oil and gas development is a recipe for higher prices and volatility later this decade," said Joseph McMonigle, secretary general, IEF.

"More frequent boom-bust cycles will harm consumers and producers recovering from COVID, set back UN Climate and Sustainable Development goals and threaten global security," he added.

Upstream investment in the oil and gas sector remained depressed for a second consecutive year in 2021 at $341 billion, 23% below the pre-pandemic level of $525 billion, the report found. Investment slumped by 30% in 2020. Global demand for oil and gas, meanwhile, has rebounded to near 2019 levels and is set to keep rising for several years.

Oil and gas investment will need to return to pre-COVID levels and stay there through 2030 to restore market balance, the report states.

However, several factors are currently making it more challenging to meet adequate investment levels this decade compared to decades past, the report says. These include record price volatility, changing government regulations, divergent long-term demand scenarios and non-standardized ESG criteria that are driving up investment hurdles and hiking the cost of capital for long-cycle projects, the report says.

Pressure on governments and industry for a green recovery is further constraining availability of capital, it says. As a result, investment decisions are becoming increasingly complex. The unprecedented level of uncertainty increases the risk profile of hydrocarbon investments and the cost of capital, reshaping investment decisions, the report states.

"Additional layers of complexity and the uncertainty that brings is fostering an environment of ‘pre-emptive underinvestment' for oil and gas supply, where capital expenditure lags demand," said Daniel Yergin, vice chairman, IHS Markit and author of The New Map: Energy, Climate and the Clash of Nations.

"While the energy transition proceeds, underinvesting in oil and gas before renewables and other low-carbon technologies are ready to scale up to meet energy demand could create recurrent energy crises of the kind we saw in Asia and Europe over the last few months, resulting in elevated prices and adverse economic consequences," he added.

The next two years will be critical for sanctioning and allocating capital toward new projects to ensure adequate oil and gas supply comes online within the next 5-6 years, the report states.

Insufficient upstream investment could result in more price volatility and spur adverse economic consequences, such as wider energy poverty, more frequent scarcity and fuel switching to more polluting energy sources such as wood and coal, the report found.

"Increased price volatility would weaken the prospects for the inclusive and sustainable economic recovery that producers, consumers and governments all want. It would also complicate policy choices during the energy transition," said McMonigle.

"Reduced investment will also make it more difficult to increase affordable access to modern energy services and improve healthy living conditions in rapidly urbanizing regions as well as remote rural areas of developing economies. While the obstacles are high for achieving adequate investment, the consequences of underinvestment are greater," he added.

The report was written by Roger Diwan and Karim Fawaz from IHS Markit and Mason Hamilton and Allyson Cutright at the IEF. The full report is available on the IEF website.

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