Oil and gas investments will have two main drivers in the short to mid-term, according to Gaffney Cline and Associates: an oil price in the $US45-60/bbl range and forward trends in capex.

GCA looked at operating margins achieved in 2015 by the industries supporting oil and gas capital projects and concluded that unit rates could not fall beyond a further 20% from the position at the end of last year. This would be a 40-50% drop from the peak experienced in mid-2014.

This low point in costs has mostly been reached in North America, with the rest of the world not far behind, according to a GCA presentation The Impact of Lower Commodity prices on the E&P Sector given in London last week.

Capex dives

This drastic reduction in costs has been driven by industry wide capex reductions in the order of $US100 billion a year.

However, the dramatic fall in capital expenditure threatens the industry's ability to sustain current production, according to Deloitte's report, Short of capital? - Risk of underinvestment in oil and gas is amplified by competing cash priorities.

Deloitte suggests that capex requirements in the near term will be lower.

High crude stocks, shale's lower capital to commence production, slowing demand growth, and OPEC's capability to maintain and even grow market share with low cost developments all depress investment.

The final factor lowering capex identified by Deloitte is one felt strongly in Australia: the completion of many LNG mega- projects in the next few years.

How much spend is enough?

Major oil and gas companies have spent 80% of their capex over the last decade just to add sufficient reserves to offset production.

Even with capex deflation the industry is experiencing, Deloitte predict the industry is spending insufficient capex to maintain reserves.

The world's oil reserves to production ratio (R/P, ie the number of years' worth of production covered by current reserves) rose to 54 years, its highest level in 2013. But in 2015 discoveries of new oil were at a 60-year low and developed reserves had little cushion.

The R/P situation for gas is less comfortable, with gas R/P at a 25-year low. Developed reserves, however, are in reasonable shape due to the recent surge in LNG projects.

Deloitte concluded that development spend must be maintained for oil, whereas for gas, development spend can slow but exploration is required to add reserves.

The firm modelled three R/P scenarios and calculated the capex required. Even their lowest R/P scenario requires US$3 trillion of investment over the 2016-2020 period.

Expenditure is fairly evenly shared between gas and oil, with an 80/20 development/exploration split.

Is the money available?

The upstream oil and gas industry directs its cash to capex, debt repayments and to its investors, and Deloitte noted that profit sharing with governments has dropped to near zero.

Even if there were no debt repayments or investor payouts, industry operating cash flows would fall $750 million short of what is required to achieve Deloitte's lowest R/P case.

And Deloitte does not expect capex to have first call on available cash, believing the IOCs will prioritise dividends, with smaller producers focussing on debt repayments.

Deloitte concluded that underinvestment was likely over the next few years, identifying three major risks if the industry does not spend sufficiently to maintain its reserves position.

• A greater dependency on OPEC will increase supply risk and price volatility;
• Reducing exploration spend and only developing identified reserves helps short term cash flow and return metrics. However, in the future large scale acquisitions will be required to replenish reserves hurting long term performance; and
• Lastly, the industry will be highly exposed to unexpected production disruptions.

When do things improve for the contractors?

As the industry begins to accept they are living in a "lower for longer" oil price environment, GCA's analysis has little good news for the oil and gas construction sector.

"Unit capex appears to trend upwards with a significant lag after commodity prices increase, whilst unit capex tends to fall rapidly after a commensurate commodity price decline," GCA said.

For the construction sector the bad news arrives on time, but the good news comes late.

The lag is driven by the underutilised capacity available when oil prices, and hence construction activity, pick up.

Deloitte also believes that typically costs follow upward price movements.

This time however, given the significant cuts oilfield drilling and service companies are making, there is a high possibility that construction cost inflation will precede the price recovery.

This possibility of an earlier pick up in rates will be little comfort to those in the construction sector as it is based on a significant shrinkage of their industry.

"Rebuilding the supply chain will not be fast or cheap", Deloitte warned.

The firm believes a recovery in prices may well increase the gap between the cash available to spend on capex and the capex required to maintain reserves, as rates rise faster than oil prices.