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Shell had to write-down some of its shale assets in the U.S., after spending $24 billion on a bet that failed to pay off, with company executives regretting ever having made the investment.

By James Stafford: Wed, 14 October 2015

A new report finds that the largest oil companies are set to cut spending on exploration by at least half, potentially leading to very few new oil discoveries in the years ahead.

The report from investment bank Tudor, Pickering, Hold & Co., and reported by Fuel Fix, estimates that exploration budgets among the oil majors will drop to $25 billion in 2016, down from $50 billion from just a few years ago. Obviously, low oil prices are taking their toll, forcing deep spending cuts in a desperate attempt to shore up profitability. But the cuts have large implications for the energy sector, increasing the chances that some large oil fields remain undeveloped for years.

“Many (exploration and production) companies are virtually abandoning exploration altogether, especially in the U.S.,” the report concluded.

Several once-promising frontiers for exploration have failed to attract the oil majors. Mexico’s two auctions this year for acreage in the Gulf of Mexico have largely disappointed. An auction held by the U.S. government earlier this year for Gulf of Mexico holdings in American waters also saw scant interest from the industry, the worst showing for the region in three decades. And last week, Brazil held an auction for some offshore blocks in the Atlantic Ocean, once a highly sought after region, and the results were an utter failure. Despite the fact that Royal Dutch Shell, Total, Statoil, ExxonMobil, and BP were all registered for Brazil’s auction, none submitted bids.

Shell also withdrew from the Arctic in late September, another area that the industry had believed would be a huge source of new supply. Shell decided to pull the plug for good, potentially killing off Arctic oil for decades.

Cuts to spending make sense in the short-run, but they also set up the oil industry for stagnant production in the years ahead. Once the backlog of projects currently under development begins to clear, there will be very few, if any, major sources of new supply to replace them. The Gulf of Mexico, the Arctic, and offshore Brazil – that is to say, deepwater projects – take years to develop. Not drilling now means oil won’t be coming online in 2020 or 2025.

Related: Can The Oil Industry Really Handle This Much Debt?

Add to that the natural decline of existing oil fields, which will cut into supplies on an ongoing basis, depleting production by an average of around, say, 5 percent per year (with wildly different decline rates depending on where the oil is being extracted). Despite the seemingly unending glut in supplies, the markets could tighten pretty significantly in the years ahead.

There is an argument that says that shale resources, so abundant around the world, could provide enough new sources of supply for a very long time. As soon as oil prices rise, new shale projects will come online, responding much quicker than the conventional fields of the past.

But even if that is true – and the extent of shale potential over the long-term is up for debate – it is not necessarily good news for the oil majors themselves. The largest companies, such as ExxonMobil, Shell, Chevron, or BP, thrive in areas that are difficult for smaller companies, such as deep offshore. Shale production, on the other hand, can be done by hundreds of smaller drillers.

The oil majors have had mixed experiences with North American shale. Shell had to write-down some of its shale assets in the U.S., after spending $24 billion on a bet that failed to pay off, with company executives regretting ever having made the investment. ExxonMobil was late to the shale gas party, overpaying for XTO Energy when it bought the company for $41 billion in 2010. And the experiences in shale basins outside of North America (Poland, for example) have also disappointed.

In short, the prospects for the oil majors are uncertain. Megaprojects are no longer in fashion, with costs that are unjustifiable. Shale projects, with shorter time horizons and lower upfront costs, are not the exclusive purview of the oil major. Deep offshore, where these companies have traditionally excelled, appears to be too expensive at this point.

How the oil majors pivot going forward is unclear. Meanwhile, low oil prices are putting significant pressure on these companies, potentially threatening their coveted dividend policies. Slashing dividends, which could become unavoidable if oil prices remain low, will tarnish the oil majors’ reputation with Wall Street. There are few good options right now.

By James Stafford of Oilprice.com

More Top Reads From Oilprice.com:

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