Cobas AM: Nueva Gestora de Francisco García Paramés

 Lastly, in an interesting turn of events, several bitcoin mining operators announced partnerships with SMR developers to provide carbon-free electricity. Bitcoin mining has come under scrutiny over its substantial energy requirements. Were bitcoin mining a country, it would be the 25th largest electricity consumer in the world. As a result, major bitcoin operators have become sensitive to their carbon emissions. Instead of looking at renewable sources, with their inherent limitations (please see our 4Q 2020 letter), several bitcoin mining operators have partnered with nuclear power providers. Bitcoin miners are nothing if not economically sensitive. Given their need to reliably consume huge amounts of power and their newfound desire to reduce carbon emissions, it is telling they chose nuclear power as their preferred solution.

We now have another set of anecdotal data points suggesting the Marcellus is suffering the early stages of resource exhaustion. Two major Marcellus gas producers made significant acquisitions outside the basin during Q2. It is our belief they did so to bolster their quickly eroding inventory of remaining high quality drilling locations. On May 24th, 2021, Cabot Oil and Gas, long believed to be the best Marcellus operator, diversified into the Permian by merging with Cimarex Energy for $9 bn including debt. Our models have always suggested that, while Cabot had the best acreage in the gassier portion of the northeast Marcellus, its drilling inventory was not as extensive as most investors believed. Our neural network confirmed this view. We found it extremely telling when Cabot announced their unexpected merger despite never having discussed diversifying outside of the basin. 

On June 2nd 2021, Southwestern Energy acquired private Haynesville operator Indigo Natural Resources for $2.7 bn. Just as with Cabot, the market was not expecting a material acquisition that diversified exposure away from the Marcellus. What is interesting about Southwestern is that they were the first mover in the Fayetteville shale in Arkansas in the early 2000s and an early pioneer in shale gas overall. They diversified basins by acquiring Marcellus assets from Chesapeake in 2014, making them one of the few operators to have fully developed a basin and then successfully reoriented into a new play. Perhaps they sense similarities between the Marcellus today and the Fayetteville in 2014.

Between 2000 and 2010, the four supermajors spent $615 bn on upstream capital expendi- tures. Over the same period, they produced 50.3 bn barrels of oil equivalent (boe) and found 41.1 bn boe of new reserves, resulting in a reserve replacement ratio of 86% (not very good) at an average finding and development cost of $14.30 per boe.
Between 2010 and 2020, upstream capital expenditures surged to $1.15 tr. Over the same time, the companies produced 50.6 bn boe and found 43.3 bn boe of new reserves — very much in line with the decade prior. Even though upstream capital spending nearly doubled, the companies were still unable to replace production with new reserves. In fact, reserve replacement was unchanged at 85% despite the increase in spending. As a result, the cost to find and develop a new barrel of reserve nearly doubled from $14.30 per boe to $26.40.

These numbers highlight the challenges facing the supermajors. With the addition of ESG pressures, the future for these companies has gone from challenged to incredibly bleak.

The impact of ESG will show up in two places. First, upstream capital spending will be diffi- cult if not impossible to grow going forward. The supermajors are already under intense pressure to cutback traditional upstream spending and redirect the cash flows into renew- able energy projects. Because the cost to find and develop new reserves has more than doubled over the last 20 years, any cutback to upstream spending will have a magnified impact on both reserves and production.
Second, the ESG movement has already made clear its hostility towards the Canadian oil sands. Because of its degraded state, bitumen must be upgraded into crude oil before being refined. This process releases large amounts of additional CO2 compared with conventional lighter crudes. Furthermore, the Canadian oil sands are either mined or extracted through a process known as steam assisted gravity drainage (SAGD). Both techniques consume additional energy, further adding to the CO2 output.
….
Between 2010 and 2020, the cost to find and develop oil and gas reserves more than doubled compared with the decade prior. To merely hold reserves and production flat, ever more capital spending is required. What would happen if upstream capital spending instead remained at 2020 levels due to rapidly escalating ESG pressures? Upstream operational results for all four supermajors would be dire. Assuming finding and development costs stayed at $25 per boe and that capital spending holds steady at ~$65 bn per year, holding the R/P flat at 9 implies that all four supermajors will shrink significantly. 

At the end of 2020, the four supermajors had 43.3 bn boe of proved reserves split between 25.5 bn barrels of oil and 17.8 bn boe of natural gas. Production totaled 13 mm boe per day split 7.7 mm b/d oil and 5.7 mm boe/d natural gas. If capital spending remained at $65 bn per year through 2030, total proved reserves would fall from 43.3 bn boe to 30.2 bn boe — a reduction of 30%. Oil production would likely fall from 7.7 mm b/d to 5.4 mm b/d while natural production would fall from 5.7 mm boe/d to 3.9 mm boe/d. Under this scenario, reserve replacement would fall from the 2010–2020 average of 85% to only 40% over the 2020–2030 period. 

In other words, restricting capital spending to 2020 levels would successfully accomplish the primary ESG goal: the four supermajor energy companies would shrink significantly in terms of production and reserves and become shells of their former selves. The only way for the supermajors to maintain their reserves and production is for upstream capital spending to surge. We estimate the four supermajors would need to see upstream spending double to $125 bn per year just to maintain flat production and reserves. 

We believe the supermajors are a good proxy for the entire global oil industry. Unless spending increases, reserves and production will fall. The 2020s will likely be remembered as the decade non-OPEC production rolled over and began its steady decline. Mounting ESG pressures will only make the looming declines that much worse. While the ESG industry can celebrate, the rest of society will suffer the unintended consequences of higher oil prices and a lack of energy security.