The value chain for the energy industry is a simple one: Resources to Production to Cash Flow to Value.

At first glance, higher capital spending in the energy industry may seem a paradox during a period of weak global economic growth. However, it requires enormous capital to maintain — let alone grow — its business model. To that end, several tailwinds have helped fuel the industry’s relentless re-investment, simulative monetary policy – low interest rates, high crude prices, rising costs, increasing demand from developing nations, increasingly remote and difficult regions to explore for oil driven by globally constrained light sweet crude oil.

Particularly, high crude prices are a major catalyst driving spending higher. Since 2011, on average, crude prices — whether WTI or Brent — have been at a consistently historically high level; WTI at roughly $94/bbl, and Brent at about $112/bbl.

Looking at the overall energy sector that includes the oil & gas (U.S. E&P, Western Majors and Canadians), refining, pipeline, utility, and oil services sectors, the industry spent over $450 billion, or 58% higher in 2012 compared to 2007 spending, and 6% above 2011, at a per annum growth rate of nearly 10% from 2007 to 2012.





Refining

The refining sub-sector has grown the most on average from 2007 to 2012, at a per annum rate of 18.4%, and a 25% jump from 2011 to 2012. In no small part, fueled by the need to comply with increasing environmental regulations and the widening WTI-Brent differential that exploded in 2011 pushing margins wider, as operating cash flow soared 30% in 2012 from 2011.

Pipelines

Despite a falloff in operating cash flow in 2012 from 2011 by 14%, the midstream sub-sector – pipelines continued to re-invest in infrastructure. Spending in 2012 jumped 32% from 2011, growing at a per annum rate of nearly 10% from 2007 to 2012. The catalyst in North American pipelines was driven by the unrelenting production from unconventional tight oil – shale plays that have spurred the need for greater means of transporting oil and gas from producing areas to consuming markets.

E&Ps

The U.S. E&P sub-sector registered constrained overall spending in 2012, growing only 2% from 2011, and at a per annum rate of 6.8% from 2007 to 2012, the lowest among the energy sub-sectors. With their heavy exposure to natural gas (NG) production and despite turning to greater liquids (oil and NGL) production, the E&Ps posted minimal spending as operating cash flow dropped 17% in 2012 from 2011 — the highest decline among the sub-sectors.

Oil Services

The oil service sub-sector actually registered a decline in spending in 2012 from 2011 of 3%, as they began to pull back spending YoY in the back half of 2012, reacting to a slowdown in North American production activity driven by low NG prices in 2012. However, from 2007 to 2012 spending averaged 9% per year, roughly on par with the industry overall.

Utilities

The utility sub-sector posted a significant 21% jump in spending in 2012 from 2011, averaging nearly 11% per annum from 2007 to 2012. The main catalyst has been increased environmental regulations that have encouraged the retirement of older coal-fired generating plants replaced by relatively cleaner natural-gas fired combined cycle generation.

The Majors

Known for their steady hand in capital investing, the Majors consistently invest through the cycles, pulling back only slightly in global economic downturns. In 2012, the Majors known as the Integrated Overseas Companies (IOC) increased spending only 4% from 2011 to roughly $210 billion, at an average of 10% per annum from 2007 to 2012.

Looking Ahead

Initial announcements of investment spending for 2013 appear to be conservative in line with 2012 levels, with a number of U.S. E&Ps announcing slight pull backs in spending from 2012. I expect overall industry 2013 spending to range from 4% to 7%. Higher spending in North America among E&Ps and service providers will depend on NG prices, and whether economic activity can push ahead of 2% GDP growth. Crude prices above $90/bbl for 2013 will sustain industry spending closer to 2012 levels, while higher oil prices will push spending higher. I expect the pipeline and utility sub-sectors to continue to significantly re-invest in their infrastructure as they seek to service growing markets and get ahead of a more robust economic recovery perhaps in late 2013 or 2014. A lower WTI-Brent spread and higher ethanol mandates may limit further refining re-investment below 2012 growth rates.