OilVoice

Isn't it interesting that the same people who laugh at science fiction listen to weather forecasts and economists?
Kelvin Throop III

….and should perhaps laugh at people who try to forecast the oil price!

I’m not a person who believes that the dramatic rise in the price of oil during the second half of 2007 and the first half of 2008 was somehow the handiwork of a shadowy bunch of speculators. What I do believe is that OPEC is nowadays doing its best to maintain a tight balance between Supply and Demand so as to keep the price relatively high and rising; that this is an imperfect art due to unforeseen events such as unrest in Nigeria, threatened pipe-lines in Georgia, hurricanes in the Gulf of Mexico and so on, and so there is price volatility: speculators may make the associated price ‘swings’ larger than they would otherwise be.

Fundamentally, I think there is a medium-to-long term issue with Supply but as Demand now seems to be rising more gently than before, I guess the oil price should now ‘drift’ up over the medium term, rather than ‘race’ up as it has in the last 12 months. I find it difficult to envisage prices much below $100/barrel and regard around $80/barrel as a hard ‘floor’.

What is the issue with Supply?

Although global exploration volumes have been drifting downwards since the 1970’s (see Figure 9 in Peter Stark’s paper) it remains true that the most important issue is not geology or ‘below ground’ risk. With an important caveat, which I will come to later, one can say that the recent BP Statistical Review of World Energy (June 2008) demonstrates (see Figures 3-6) that the world has a great deal of oil left, indeed over 40 years of “Proven” reserves at current consumption rates to which can be added similar volumes of “Unproven” and very large amounts of Unconventional Oil (heavy oil, oil shales etc).

So the Supply road ahead is clear and if it is up-hill, only gently so? And oil-rich NOCs are getting by quite nicely without the help of Majors, using benevolent oilfield service companies (a 29th July 2008 article in the Financial Times under the headline “Nationals' champion: How the energy-rich rely on Schlumberger” only just stopped short of celebrating their role in bringing
world peace!)?

Well, they are both nice ideas but they don’t survive a close examination when we look at oil producers country by country:

Let’s touch on Saudi Arabia to begin with – where we may ask “is that a light at the end of the tunnel or an enormous truck coming towards us?” Who can tell! The caveat I mentioned above is that Saudi Arabia does not publish meaningful data that allows understanding of individual fields or intelligent analysis of its reserves and production promises.

In Venezuela, President Hugo Chavez has pursued an aggressive policy towards the Majors (for a data-free trip back to the rhetoric of the Cold War, the PdVsa web-site is worth a visit!) and seems to be paying the price.

There is a grand plan to increase total crude production to 5.8m barrels per day by 2012 and the government claims 3.3m barrels per day today; but estimates by independent analysts and others suggest the true number is perhaps 2.4 and OPEC notes 2.5m barrels per day for Venezuela. An opposition newspaper reckoned that production is down 400,000 barrels per day over the last year.

Eager to reverse such trends the Venezuelan energy is offering concessions in the Orinoco basin, allegedly containing in excess of 200bn barrels of extra-heavy crude. Of course this will require access to technology (but Chavez fired 18,000 workers including technical professionals in 2003) and more especially to finance (let’s say somewhere between $50bn and $100bn), especially as PdVsa funds many of the government’s national and regional, non oil & gas, programmes.

Syria (and the Syrian Petroleum Company) has naturally suffered from the long US-led embargo on involvement of any kind. Syrian oil production has been falling since 1996 when it peaked at 624,000 barrels per day, and now seems to be declining at about 5% per year (380,000 barrels per day in 2006, 370,000 in 2007, 360,000 estimated for this year). Despite all the efforts of the government to attract foreign oil exploration, there have been no net gains to reserves since 1996. Exploration results have been disappointing in recent years and no large new finds are expected.

And what can we say about Russia? Up to 2003, production was rising at around 9%, since then at a significantly lower rate, and is almost certainly flat this year (see below). Of course, 2003 was when the Russian government began to dismantle Yukos and we can now observe the outcome of this process in the political pre-eminence of Gazprom and Rosneft. But this doesn’t mean that either of these two companies has either the financial muscle to access the capital needed for future, difficult, developments in Yamal, Timan-Pechora and soon the Arctic or the “Know How” – the technical, project management and commercial expertise – to scope, design and execute these projects.

These difficulties are already beginning to bite – just this month the following story appeared on the news wires:

Russian oil output growth is unlikely to exceed 2.2% next year and will slow to under 1% by 2011, the government said today, confirming earlier forecasts of a slowdown in production growth. 

Falling oil production in Russia has become a major concern for the government, which relies heavily on export revenues.

The Kremlin quoted the Economy Ministry's updated forecast for Russian economic development to 2011 as saying oil output could this year reach 492 million tonnes, or 9.85 million barrels per day, almost flat from 491.5 million tonnes, or 9.87 million bpd, in 2007. This year, a leap year, has one extra day.

Under the Economy Ministry's optimistic scenario, oil production is expected to rise to 503 million tonnes in 2009 but growth would then slow to just 0.8% year-on-year in 2011, reaching 518 million tonnes, a Reuters report said. Last month, the Finance Ministry announced similar forecasts of oil production growth in the period.

The Economy Ministry's scenario forecasts no production growth at all. "In the environment of a worsening structure and quality of explored reserves, and moving to the later stages of developing oil deposits in Western Siberia, the scenario provides that oil production will stabilise at a level of 497 million to 500 million tonnes per year in 2009-2011," the government said in a statement. Russian oil production was down 1% year-on-year in the first seven months of 2008 after a 2.3% increase in 2007 and huge spikes in previous years, including a record 11% in 2003.

Analysts expect oil output growth to recover in the next decade after a number of new major deposits are launched in Eastern Siberia, which is rich in resources but lacks infrastructure. Eastern Siberia is expected to compensate for falling output from mature fields in the traditional oil-producing region of Western Siberia.

Like PDVsa, Pemex of Mexico has experienced a crude oil production shortfall, down to significantly less than 3m barrels per day from almost 4m barrels per day four years ago, rooted in the long-term estrangement between Mexico and the Majors. In fact Juan Carlos Zepeda, director general of exploration and exploitation at Mexico’s ministry of energy has recently argued that reform is crucial if Mexico is to reverse the trend of falling production that the nation has been seen in recent years, notably from the giant Cantarell field where production had declined by as much as 1 million barrels per day since it hit its peak in 2004, and is down 35% in the last year.

If current trends continue, Mexico’s production is set to fall 1.1 million bpd from today’s levels below 3 million bpd to at little as 1.8 million bpd, he warned. On the bright side Zepeda noted that Mexico’s remaining resource potential is high. However, reserves are located in fields that are smaller and more difficult to develop than the giants on which Pemex initially relied. Also, inadequate investment in refining capacity has left the country with a significant products shortage – recently Mexico was importing more than 380,000 barrels per day of gasoline – about half the country’s demand. A major problem for Pemex is funding – the company’s debt amounts to $55bn.

Zepeda reiterated the government’s insistence that a proposed reform bill will keep Pemex solidly at the centre of Mexico’s E&P sector, emphasizing that “we are not bringing other companies to the country” as owners of reserves. Nevertheless, he highlighted the view that Pemex needs to be given flexibility in the deals it reaches with service companies to boost reserves and production, including deals with oil companies. The government wants Pemex to be able to move to contracts with companies that “reward for success,” he said.

And somewhat against expectations, Iran and its NIOC can point to the fact that crude production has reached 4.2m barrels per day, way down from the 6m barrels per day peak of 1974 but the highest level since the 1979 revolution. New fields have come into production, for example Azadegan onshore and a clutch of fields offshore. Clearly, enough western and regional entities are willing to defy US pressure and UN sanctions to help NIOC although a return to former heights would clearly demand access to capital, “Know How” and project management expertise which is currently unavailable as many IOCs continue to avoid the country. For example, StatoilHydro has recently withdrawn.

What the production history of Venezuala, Russia, Mexico and Iran tells us is that they have many older fields that are in depletion. For any one field, it is possible to mitigate the production decline resulting from depletion by good oilfield practice and the use of technology; typically this means that the decline rate will be lessened but not reversed. For production from a basin or a whole country to begin to increase, new developments of existing discoveries are necessary, followed in turn by new discoveries.

Of course, all four of these countries might be entirely happy with the fact that the Majors are spooked enough that they have either left or never entered, and think that they have a couple of choices of much more acceptable partners, namely global oilfield service contractors and other, resource hungry, NOCs.

However, oilfield service contractors do not in general have the “Know How” to explore for and develop oil and gas fields: they have never done it. Nor do they have experience of, nor are they either willing to begin, investing risk capital in exploration and development – what they bring is simply technology. Of course, in combination with a smart NOC this may be sufficient: the NOC itself can over time, although usually quite a long time, build its own “Know How”, attract the best staff and so on.

This is what Saudi Aramco has done – but it is apolitical at least in comparison with PdVsa, Pemex, Gazprom, Rosneft and NIOC. By resource hungry NOCs, I mean the Chinese and the Indians – however, it seems to me that where they choose to compete, the former blow the latter out of the water, so let’s focus just on China and CNPC.

Now we could talk about CNPC and its associated companies in various ways – their lack of transparency, their approaches to HSE, the government-to-government deals, the support for undemocratic regimes etc. However, there’s something much simpler and less emotive to talk about – the fact that CNPC’s urgent, not to say desperate, global scramble for oil & gas is driven by a failure to expand the country’s domestic resource base adequately, in other words a failure of domestic exploration to deliver reserves at the rate required.

So, whilst the governments and people of actually or potentially resource-rich countries may worry about accepting the embrace of CNPC for one or more of the reasons outlined above, the host NOCs should perhaps concern themselves with a more basic question – can CNPC and its associates explore their way out of the proverbial paper bag………..?

In contrast to the above examples, Angola and Sonangol have profited by their relationship with the Majors to the point at which Angola has just over-taken Nigeria as the biggest producer in sub-Saharan Africa (and has recently joined OPEC). Yes, Sonangol has become more powerful over the last ten years and, No, the relationship hasn’t always been easy but the Majors are still doing what they do best, bringing their financial muscle and “Know How” to bear.

Equally, political rapprochement between Libya and the west has enabled the NOC to partner with Majors such as ExxonMobil and BP to re-invigorate the country’s offshore and onshore exploration.

Notwithstanding these latter examples, it has become somewhat fashionable to berate the Majors for lack of investment. However, another way to look at this is to say that Government and NOCs are deliberately in some cases, and inadvertently in others, raising the level of ‘above ground’ risk perceived by the Majors and making other ways of spending their money, for example on share buy-backs, seem more attractive, at least for a while. However, on the respective journeys of discovery, these ‘other ways’ have turned out not to be as fruitful for the Majors as might have been first thought, and NOCs have discovered that service companies cannot help with exploration, and so in the meantime everybody stands a chance of losing out as Supply problems hove into view!

Indeed, it can be said that, apart from the host governments who have clearly benefited, the high oil price has most benefited oilfield service companies as vast amounts of other peoples’ money flows into their coffers – consider the share price behaviour for the 3 years to 22nd August 2008 shown in Exhibit 1 for example; there’s one clear winner!

How might IOCs respond to the transformed competitive landscape that now lies in front of them?

Perhaps the starting point is to remind ourselves what IOCs bring to the Game. Of course, some of them are not without political support from their own governments but, in my humble opinion, the two main IOC ‘resources’ are:

1. Financial ‘muscle’…….Capital
2. “Know How”.

Let’s consider each of these in turn:

Capital

The point is often made that host governments and NOCs find IOCs to be attractive partners because of the latter’s ‘deep pockets’ and that this has given IOCs considerable leverage as they are free to switch their capital investments away from countries with less-generous terms and/or less-benign conditions in which to operate.

And there’s no doubt that this flexibility is still being exercised today.

Thus as IHS has reported, it’s no accident that, globally, countries such as Canada, UK, Brasil, Australia and US (Gulf of Mexico) are ranked highly as investment locations, and that within South America, investment seems to be moving away from Venezuela and Ecuador and towards Brasil, Colombia, Peru, and Argentina.

However, this flexibility may be less powerful at a time when NOCs around the globe are generally cash rich.

Thus, financial ‘muscle’ is necessary for an IOC but not sufficient.

“Know How”

My definition of “Know How” runs something like this:

First of all, it is about knowing how to take investment decisions in the face of extreme risk – of all sorts – and uncertainty. This is needed throughout the E & P value chain whether buying ‘tail’ production, or investing in a new field development, or constructing a new pipe-line but nowhere is it more important than in exploration.

Second, it is about knowing how to apply technology. Again this is needed throughout the E & P value chain whether identifying sub-surface resources, accessing them with the drill-bit, extracting them successfully or designing, building and operating surface facilities.

Such “Know How” is acquired by having explored for, developed and produced hydrocarbons around the globe and thus is the preserve of IOCs. It is not generally available from contractors who may well own some technologies but do not know how as defined above. Those NOCs who have attempted to internationalise via exploration – Petrobras, Statoil, CNPC, Petronas, ONGC etc – failed largely because they did not know how: no number of government-to-government deals can wish away this rather fundamental problem.

Another way of saying this is that the oil & gas industry is knowledge-based, that is, dependent on people. And all the signs are that in the short to medium term there will be a shortage of appropriately educated and trained or trainable staff. Thus a “scramble” for this resource will ensue.

Why has this happened?

Well, we sit at a moment in the history of the oil & gas industry when four or five different factors are in play to promote this
“scramble”:
• Over the last 25 years or so, there has been a large, absolute, decline in the number of people working in, or available to, the oil & gas industry, driven largely by the major consolidations that have taken place amongst the Majors, the larger Independents and the bigger contractors.
• Demographics for professional technical staff from the USA and Europe show a strong, relative, peak in the late ‘40’s age range, with many professionals seemingly planning to retire early in a few years’ time.
• In the USA and the UK, low graduate hiring levels of certainly the early ‘90’s – and arguably the whole of the ‘90’s –
have led to a shortage of “mid-career” seasoned, knowledgeable professionals.
• Increasingly weak science and engineering bases in the US and the UK, with overall drastically less folk studying “hard” sciences and mathematics, both in school and at University.
• A relative rise in the number of suitably qualified but as yet untrained graduates in China, India, Indonesia etc.

It should be anticipated that some companies will “miss out” in this particular “scramble for resources”.

In the short term, there will be an intense competition for experienced, knowledgeable staff, for example with the oil & gas companies with the ‘big battalions’ actively seeking to reduce “attrition”, deter staff from taking ‘early retirement’, poach the best staff from the contractors, and use their global operations to attract new recruits from areas where they are available e.g. Asia. Considering the combinations of “Reward”, “Opportunity” and “Risk” offered by oil & gas companies of various types, it seems likely that the Majors, the bigger Independents and the bigger service contractors will succeed in accessing the staff they need. The same cannot be said of smaller companies.

The Era of ‘New Eyes’

So, my summary of the opening of the next era of the global oil & gas industry is something like this:

1. The last several years have seen a rush for global exploration assets, with very high prices being paid for some very poor opportunities, in a market where costs are rising at least as rapidly as commodity prices; capital is scarce for the smaller explorers. The Majors and bigger Independents are cash-rich and are ‘as I write’ no doubt thinking “where do we go from here?”
2. I believe this will trigger:
 a) Further Consolidation amongst the Majors and bigger Independents, continuing the renewed process started and exemplified by Chevron/Unocal, ConocoPhillips/Burlington, Statoil/Hydro and so on.
 b) Atrophy of the small explorers.
3. A shortage of sub-surface resources is the least threatening dynamic facing the E&P industry. Much larger risks lie in finding technical solutions for difficult reserves, accessing staff with “Know How”, and solving geopolitical problems.
4. The consolidated survivors with enhanced resources - financial ‘muscle’ and “Know How” and, above all, the best people – will look for new ways of engaging the ‘host’ NOCs who control ~80% of global oil & gas resources. They will seek relationships of “mutual advantage” – beyond the Production Sharing Agreements and Contracts that have been demonstrated to have key weaknesses as oil & gas prices and costs rise – for example weaknesses for IOCs in the volatility of reserve bookings and for ‘host’ governments in delays in receiving the returns they expect.

Put another way, the survivors will fill in some of the craters on the Oil Supply Road, and drive on!

Author: David Bamford

Monday, September 22, 2008 20:03