An absolute cracking business in 2022, the Upstream Oil and Gas industry – that’s the exploration/production side of putting petrol in motors – looks set to have a far more… let’s call it interesting time in 2023.

After all, it’s not every year companies this large look a shot to land back-to-back record annual cash flows.

While there is certainly some excitement – particularly given the ongoing need to provide secure and affordable energy into the tight European gas markets – the sector is going to have to answer some very curly questions this year if it wants to both thrive and survive.

They’ve called it the – ‘Global upstream: 5 things to look for in 2023’ report – and the authors don’t shy away from some hard truths warning there’s work to do if headwinds like supply shock aren’t a big part of the next 12 months.

Analysts at Wood Mackenzie believe the social licence for the upstream industry depends on its ability to ‘capture and broaden the energy narrative’ while relationships with stakeholders ‘need to keep pace with societal and policy change.’

They calculate that even after a stupendous year, activity levels have to increase, starting yesterday, to avoid hitting the black ice of future supply shocks while decarbonising and developing resources have to start getting sorted today. They’re going to factor into almost every equation.

With this in mind and without further ado, the energy research and consultancy firm has whittled down its top 5 troublemakers for the upstream industry this year.

And this is them in 5 minutes:

Windfalls and incentives

It noted that country risk will be at the top of investment considerations as higher or sustained prices will likely lead to more government intervention.

This can go two ways.

It could lead to market intervention such as price caps, higher domestic market obligations or other market-driven methods to protect consumers while some countries could harvest upstream economic rent to relieve pressure on public finances.

At the other end of the spectrum, countries could look to accelerate oil and gas activity by introducing licence awards, incentives and infrastructure support.

Countries with aggressive low carbon agendas could also treat capital spent on decarbonising upstream and on carbon capture utilisation and storage (CCUS) as recoverable – perhaps even uplifted – against petroleum taxation, which creates predictability and fairness regardless of prevailing price.

Restrained investment growth

Woodmac also noted that while investment is expected to grow, it will do so with significant restraint as oil and gas industry cash flow drops 9% to US$1.3 trillion in 2023.

At current run-rates, reinvestment rates will rebound to just 28% from 2022’s all-time low of 24% which while positive for shareholders, represents a level of underinvestment that could lead to further volatility.

Development spend is expected to increase 10% to between US$460bn and $480bn though further increases will be needed in subsequent years to avoid future supply shocks.

The need to appease shareholders will make corporate strategies while caution will be the name of the game around major projects with about 30 projects expected to reach final investment decision this year, which is essentially unchanged from 2022.

Continued cost inflation and rising execution risks

Woodmac also believes inflation will continue albeit at lower levels than in 2022 though the impact on operations will continue to be material.

It noted that investments by service companies will receive even more scrutiny that upstream projects with capacity additions likely to be minimal with most additions at the high-tech end of the market, which will increase efficiency but do little to reduce costs for operators.

More projects are also expected to be recycled through project stages in the hopes of optimising and reducing costs.

Additionally, efficiency gains are unlikely to offset cost inflation due to experienced labour and equipment being spread increasingly thin.

Decarbonisation at the core of Upstream 2.0

International oil companies looking to be part of Upstream 2.0 will need to demonstrate and disclose further emissions reductions while governments and national oil companies will seek to marry low-carbon credentials with increasing upstream production.

It follows COP27 driving new regulations and a focus on methane as big producing countries announce methane reduction plans and new regulations to enforce change as part of the global effort to reduce emissions.

This will likely lead to further increases in decarbonisation spend. This includes investment in measurement, monitoring and mitigation.

Woodmac also envisions the emergence of a new decarbonisation service sector business model that offers remedial services and certification, first for methane, then CO2.

CCUS business models will be critical to the reimagining of upstream with the consulting firm expecting licensing to accelerate and upstream companies to build carbon storage expertise.

Additionally, projects in the Upstream 2.0 era will be designed with carbon storage expertise with Eni’s ‘net zero’ Baleine leading the way.

Upstream developments will become ever more entwined with renewables, hydrogen and offsetting projects to balance emissions while licence extensions are likely to include decarbonisation terms.

This means that by the end of 2023, it will be extremely hard for mainstream operators to sanction projects without emissions mitigation plans.

Changing gas business models

Last, but certainly not least is the change in gas business models – to one that can make serious money – due to the European gas crisis and the price spreads it created.

Near-term investment will be channelled into raising domestic European production and new development concepts that can unlock stranded gas.

Some steps will includes a focus on floating LNG as well as scalable, modular LNG to reduce execution and payback times.

Gas is also expected to stay investible due to displacing coal in Asia or diesel and wood use in Africa as well as having its transition fuel status preserved at COP27.