High-levels of capital expenditure (capex) in the oil and gas sector and the potential for a sustained softening of prices are the two main areas of risk confronting companies in the sector in 2014, Standard & Poor’s (S&P’s) corporate ratings director for oil, gas and fertilisers Simon Redmond says.

Redmond, who was in South Africa this week to communicate changes to the group’s corporate ratings criteria framework, told Engineering News Online that most capital projects have also been afflicted by “massive” cost inflation, which is already depressing returns.

“There has been cost inflation across the oil and gas development and production sector and it is now costing a lot more to bring up a barrel of oil to the wellhead.”

He described the high levels of capex as a “structural trend”, given that much of the investment was being directed towards sustaining rather than growing production. Rising costs associated with projects had, thus, become a major threat factor, with a number of profit warnings having already been issued for 2014.

But Redmond is also concerned about the potential for a price correction, as the “free cash-flow profile of many oil and gas companies is relatively weak, after capex and dividends – and that’s at a time of pretty much all-time high oil prices over the past three years”.

Should there be a price correction that lops between $15 and $20 off a barrel of oil over a sustained period, the pressure on returns will increase. “I don’t see an immediate liquidity risk for most companies, however.”

The two dynamics, together with material changes to the energy landscape as a consequence of the US’s emerging self-sufficiency, would also have to be taken into account by companies hoping to exploit Africa’s newly discovered gas and oil resources.

The International Energy Agency forecasts that, by 2015, the US will overtake Russia and Saudi Arabia to lead the world in oil production, while BP’s Statistical Review of World Energy 2013 shows that US output rose by one-million barrels a day, while the country’s gas production rose by 4.7%.

BP calculates that, by 2030, about 9% of global oil supply will be from tight oil, while 16% of global gas supply will be from shale resources and that North America will continue to be the dominant shale energy market participant.

In a January report, S&P’s argued that surging shale energy output in the US was already leading to a marked decline in its imports of light crude oil and liquefied natural gas (LNG), which, in turn, was forcing producers to find alternative markets.

Redmond says that many of the prospective gas projects in Africa, including those that could be developed on the large-scale discoveries in Mozambique, would need to take account of the “shifting dynamics” in the LNG market.

“These would be long-term, multibillion-dollar projects and by the time they come onstream the market dynamics may have shifted again – the first exports from the US might even be a real factor.”

To mitigate that market risk, projects would need to lock themselves into long-term contracts and developers might attempt to secure a pricing link to an oil-price index. “Some consumers might be willing to tolerate a higher price for the certainty of supply.”

But he warned that there was a serious risk of a decoupling of LNG contracts away from being oil index-based to gas index-based in the longer term. All future African projects would also remain vulnerable to the current trend of capex overruns.

“But I think high capex and the potential for oil price softening are the two key risks we have front of mind at the moment.”