Oil Companies Just Had Their Worst Year Since 1940

By Matthew DiLallo Markets Fool.com

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Image source: Getty Images.

It would be an understatement to say that 2016 was a tough year for the oil patch. Plunging crude prices heading into the year forced producers to reduce investment spending so deeply that many couldn't even drill enough wells needed to keep production flat. Because of these market conditions, oil companies spent minuscule amounts of capital exploring for new oil and gas sources. As a result, the industry found the fewest new barrels of oil in 70 years.

According to a report by energy research firm Rystad Energy, oil companies discovered a mere 6 billion barrels of oil equivalent (BOE) last year outside of North American shale plays. For perspective, the U.S. alone consumes more than 7 billion barrels annually, which meant the industry did not come close to replacing consumption last year. Meanwhile, offshore discoveries, which is where companies uncovered most of the new sources of oil in recent years, fell 90% from 2010's level to just 2.3 billion BOE last year. This trend is not one that can continue given that world oil demand is not expected to peak until 2040, according to the International Energy Agency.

Image source: ConocoPhillips.

What happened?

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The primary driver of last year's decline was the continued drop in exploration spending. Energy companies only spent $40 billion on exploratory drillinglast year, which resulted in 40% fewer wells drilled than in 2014 when prices started on their downward spiral. Global oil giant Chevron (NYSE: CVX), for example, cut its global capital and exploratory budget by 24% from 2015's level to $26.6 billion. However, Chevron only earmarked $1 billion of that budget for exploration, well below the $3 billion budget the company set for 2015. Meanwhile, ConocoPhillips (NYSE: COP) cut its global exploration and appraisal budget down to $1.4 billion last year, a decline of 22% from 2015.

Another culprit behind last year's low level of oil discoveries is that several exploration prospects came up dry. For example, a joint venture between ConocoPhillips, Suncor Energy (NYSE: SU), and Royal Dutch Shell (NYSE: RDS-A)(NYSE: RDS-B) struck out in its initial attempt at finding oil in the Shelburne Basin off Canada's Atlantic Coast. As a result, Suncor Energy noted that it had to write off its share of the costs, which totaled 105 million Canadian dollars.

That dry hole was one of a growing number of deepwater exploration failures for ConocoPhillips in recent years. In 2015, the company noted that a deepwater exploration well in Angola found a non-commercial gas column and another in the Gulf of Mexico did not encounter any hydrocarbons. As a result, it plugged and abandoned both wells, writing off $142 million in dry hole expenses. These and other dry holes drove its decision to exit deepwater exploration altogether.

Image source: Suncor Energy Inc.

Where did companies find oil and gas

While oil discoveries were down significantly, oil companies still found several notable new oil and gas deposits. ExxonMobil (NYSE: XOM), for example, announced in June that an offshore well in Guyana confirmed a world-class oil discovery. According to ExxonMobil, this deposit contains between 800 million to 1.4 billion BOE of recoverable resources. Then, in October, the oil giant confirmed a discovery offshore Nigeria that holds between 500 million to 1 billion barrels of oil. Finally, the company capped the year off with a December announcement of a new onshore natural gas discovery in Papua New Guinea.

Energy companies made several other smaller discoveries around the world last year. Norwegian oil giant Statoil (NYSE: STO), for example, finished up its Canadian Atlantic exploration program last year, which resulted in two more discoveries and the confirmation that its 2013 Bay du Nord find contains between 300 million to 600 million barrels of recoverable oil. Meanwhile, Royal Dutch Shell made a discovery in the Gulf of Mexico at its Fort Sumter prospect, uncovering more than 125 million BOE. That was one of three new Gulf finds last year, though that is down from seven in 2015.

Image source: Apache Corporation.

While offshore discoveries proved tougher to locate, North American onshore shale plays continued to be the gifts that keep on giving. One of the most notable shale discoveries was Apache's (NYSE: APA) Alpine High play in a sleepy part of Texas' Permian Basin. Apache believes that there's at least 3 billion barrels of oil and another 75 trillion cubic feet of gas in just two of the five rock formations underneath its acreage position in the region. Apache believes that the other formations could also contain significant quantities of recoverable hydrocarbons.

On top of that, several other producers increased their estimates for ultimate hydrocarbon recoveries from their acreage position in various shale plays. One of the most notable wasEOG Resources (NYSE: EOG), which more than doubled its Permian Basin net resource potential from 2.35 billion BOE to 6 billion BOE. That upward revision came just a year after EOG Resources boosted its resource estimate in the region by 1 billion BOE due to improved recoveries resulting from advances in technology.

A problem for future years

The decline in offshore oil and gas discoveries will not have an immediate impact on global oil supplies. That is because it can often take a decade or more to turn offshore finds into production due to the high costs and long construction lead times. Furthermore, there's plenty of prior deepwater discoveries to develop as well as a plethora of shale resources to unleash.

That said, the lack of newdiscoveriesin recent years could prove problematic a decade from now as producers deplete currently producing fields. Given the forecast that oil demand will not peak for several decades, it suggests that the world will need to continue uncovering and developing new oil deposits. That means the industry cannot continue the recent history of failing even to come close to replacing production because there will come a point where this shortfall will impact supply. Such an event could cause a significant run-up in oil prices while producers race to meet the market's needs.

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Matt DiLallo owns shares of ConocoPhillips. The Motley Fool owns shares of EOG Resources and ExxonMobil. The Motley Fool recommends Chevron and Statoil. The Motley Fool has a disclosure policy.