OilVoice

If you want to succeed, you should strike out on new paths rather than travel the worn paths of accepted success.
John D Rockefeller (1839-1937)

Occasionally, the press reports some oil & gas stories that are…well, bizarre. A current one is the story that the descendants of John D Rockefeller are loud voices in a campaign to get his main legacy, now rejoicing in the name ExxonMobil, to separate the roles of Chairman and Chief Executive. Apparently they see this as a route to re-establishing the principles which John D espoused; I wonder if they’ve ever read Ron Chernow’s book “Titan” which describes how John D actually pulled together and ran what was then Standard Oil? Or perhaps they now have the same benevolent view of him as I do of my great-grandfather, Samuel Bamford, who owned a cotton mill in Lancashire around a hundred years ago and covered all the angles by being mill-owner, Methodist preacher, Justice of the Peace and shop-owner in his small town!

Or then there’s the article in the Financial Times on 23rd April 2008. Under the headline “Oil’s quest to find tomorrow’s fuel”, we are treated to the view that the Majors are soon to be so bereft of resources that they are “being forced to turn to the once unimaginable raw materials of chicken fat, tar and algae to make fuels and sustain their businesses into the next century.” And it does indeed seem that ConocoPhillips are working with Tyson Chicken to produce diesel from animal fat!
Putting to one side both the thought as to what exactly John D would have made of that and images of CEO’s (without a non-executive chairman to guide them) running around like head-less chickens, one finds that the main thrust of the article is actually to plough a now familiar furrow to the effect that the Majors and IOCs have had their day and the resource-rich and cash-rich NOCs are in the driving seat.

Sliding NOCs
So, the Majors have had their day - the big NOCs own nearly all the reserves, have all the money they need and can access the technology they need from the global contractors such as Schlumberger, Baker Hughes, Weatherford et al?

A great story, and for some such as Saudi Aramco it may be close to the truth. However, let’s consider a few others, with the help of recent articles (March and April 2008) in the Petroleum Economist, and as the FT specifically mentions Venezuela and Russia as exemplars of its thesis, let’s start with them:

In Venezuela, President Hugo Chavez has pursued an aggressive policy towards the Majors (for a 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.

And what can we say about Russia? Before 2003, production was rising at around 9%; since then only at about 1% and is almost certainly declining this year. 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.

Likewise, Pemex of Mexico has experienced a crude oil production shortfall, down to less than 3.5m barrels per day from almost 4m barrels per day four years ago, rooted in the long-term estrangement between Mexico and the Majors. 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.

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.

In contrast, 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.

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 are they either willing to begin, or have experience of, 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………..?

W(h)ither the Majors?
One thing the Majors and IOCs are not struggling with is cash flow – the higher oil prices mean large inflows into their coffers. However, they are struggling with Reserves Replacement: Exhibit 1 shows the decline, more or less continuously since 1998, in the average Reserves Replacement Ratio (RRR) for a basket of 25 leading Majors and Independents.

Many commentators state that the solution to this declining performance is for the Majors and IOCs to spend more of their cash mountain on exploration; this view is echoed by most oilfield service contractors who of course would like even more cash to flow in their direction! I do not believe this is a sound recommendation.
Looking back at the strong rise in the average RRR over the period 1994-1998, this can be attributed directly to the opening in the early 1990’s of “New Geography” and subsequent exploration success – for example in the Deep Waters of Angola, the Gulf of Mexico, Nigeria, in the Caspian and so on – from which many companies benefited. Exhibit 2 shows four measures of exploration activity and success, including RRR and total discovered resources, all normalised to the very best year for discovery volumes which happened to be 2000: the reason that average RRR does not peak in 2000 is because that year there was a huge discovery at Kashagan in the North Caspian but its volumes benefited only a small number of companies. Exhibit 2 also shows a couple of measures of Exploration Spend – it’s pretty clear that there is no substantive causality between increased overall Spend and increased overall success.

The main driver of increased exploration success has always been the opening of new hydrocarbon provinces, as with the North Sea and Alaska in the late 1960’s/early 1970’s, Deep Water Gulf of Mexico in the 1980’s, Deep Water Angola and Nigeria and the Caspian in the 1990’s and perhaps the Santos sub-salt province today. In a very recent OilVoice article (Global Exploration “Hotspots”), I have argued that a significant number of exploration Frontier provinces remain, for example in Iraq – especially in Kurdistan, in the Arctic – with Greenland perhaps first in the queue, in onshore rift systems, sub-salt and so on but that many IOCs, but especially the Majors, seem much more comfortable investing in North America, whether offshore in the Gulf of Mexico or the Chukchi Sea or onshore in non-conventional gas, extra-heavy oil etc.

Lest anyone should think this is simply an unsupported assertion by me, I’ve been digging around to see what sort of opportunities the Majors talked about in their recent presentations to analysts and investors:
ExxonMobil chose to focus on Tight Gas and Heavy Oil in North America, LNG and Integration Across the Upstream and Technology Investments.
Shell talked about Exploration Technology, Deep Water Technology, Smart Fields and Smart Wells and majored on Heavy Oil in North America (EOR; In-situ Upgrading).
BP talked about recent access to Canada Oil Sands, Technology Focus areas, Alaska, North American Gas, Gulf of Mexico, Trinidad & Tobago, Angola, Azerbaijan, Egypt and of course had a whole section on TNK-BP.
Chevron has the clearest articulation of an exploration strategy, describing New Entries (Alaska, Canada, West Greenland and Libya), Test Areas (Brazil Deepwater, East Coast Canada, West of Shetlands and Norway) and Focus Areas (Gulf of Mexico Deepwater, West Africa Deepwater, Gulf of Thailand and Northwest Australia); Global Leadership in Thermal Recovery Processes and Sour Oil & Gas Processing is equally emphasised.
ConocoPhillips emphasises its OECD Platform for Growth (North America and North Sea), with an exploration portfolio in the Arctic (i.e. the Chukchi Sea), North American Gas, Gulf of Mexico Deepwater, the North Sea and Australia.

Perhaps analysts and investors simply do not want to hear about tough places such as Russia and its Arctic, the Middle East, onshore Africa and so on; or perhaps executive management do not want to talk about them…….or perhaps they simply don’t want to think about them!

There do seem to be some well ‘worn paths of accepted success’ out there. To the list of countries and plays that were accessed in the 1990’s – Nigeria, Angola, Azerbaijan, Kazakhstan, Gulf of Mexico Deepwater, West of Shetlands and so on– are added Tight Gas and Heavy Oil in North America and a return/bold step-out to Alaska and the Chukchi Sea! And the US Bureau of Land Management is doing its bit by releasing a report showing that there may be around 31 billion barrels of oil and 231 Tcf of natural gas available onshore in the US but that circa 60% of the corresponding lands are closed to drilling.

One has to ask whether, despite high oil prices, the Majors regard exploration as
irrational in today’s highly competitive and restricted business environment, perceiving unacceptable risks and/or costs of international opportunity capture because of increased competition, tougher production-sharing terms by host governments, and the rising cost of products and services, or simply unacceptable political risks?

There seem to be three or four additional, consistent, signals coming from the Majors and many of the bigger US Independents:

1. Somewhat of a retreat to behind the walls of “Fortress North America”.
2. A rash of share buy-backs, perhaps a signal of perceiving limited opportunities to spend cash flows on accessing new opportunities.
3. A failure to replace reserves over pretty much the last ten years.
4. It is difficult to spot more than one or two companies who, given their singular and hard-earned advantages of financial ‘muscle’ and “Know How”, are contemplating relationships of “mutual advantage” with resource-rich NOCs.

In my humble opinion, this all presages another period of industry consolidation, a return to “Exploring on Wall Street” in which small-medium size resource-rich companies are acquired by their cash-rich, opportunity-poor bigger brethren. It may be however that some cash-rich NOCs attempt to strike first in order to capture the financial ‘muscle’ and “Know How” of their prey – perhaps Gazprom will buy Centrica and with it BG!

Author: David Bamford

Saturday, May 24, 2008 14:15