The oil industry between hopes and fears

by Karel Beckman | 15 October, 2010

This week’s Oil & Money Conference in London, a meeting place for the oil industry, identified four “game changers in global energy”: Iraq, China, Macondo and shale gas. Game-changers these may be – but none of them bodes particularly well for “Big Oil”. And they don’t even include climate change, nationa...

The Oil & Money Conference – whose 31st edition was held earlier this week in London – is one of the best known annual gatherings of the oil industry. It brings together representatives from the “western” oil majors (ExxonMobil, Shell, Chevron Total, ENI, Statoil, etcetera – there was no one from BP this year) as well as their financiers, consultants and service companies. As such, the conference provides a good indication of the prevailing mood in the industry. That mood can best be characterized as: between hopes and fears.

The conference focused on what the organizers described as ‘new game changers in global energy’. The organizers – the Energy Intelligence Group and the International Herald Tribune – identified four of these:

the Macondo (BP) oil spill in the Gulf of Mexico
Iraq’s upstream potential
the shale gas revolution
the power shift from the west to Asia

At first glance, these four earth-shaking developments seem to have very little connection to each other. Yet it is no coincidence that the conference organizers happened to select them as major catalysts of change. Each in its own way connects to the deepest hopes and fears that are currently gripping the western oil industry.

Declining figures

To understand what such seemingly disparate issues as Macondo, Iraq, China and shale gas have in common, we have to take a step back and look at where “Big Oil” is coming from and what the

Oppenheimer notes that the oil majors were unable to grow their oil and gas production, despite all the promises they made to investors

challenges are that it is facing. Earlier this month, a report came out from the Wall Street investment fund Oppenheimer & Co that takes a look at the development of the oil industry since the “megamergers” in the late 1990s and early 2000s that gave birth to the oil giants of today – Chevron (with Texaco), Exxon (with Mobil), BP (with Amoco) and Total (with FinaElf). Shell was the only company that did not participate in this consolidation, but it was then the biggest to begin with.

As reported by the journal Energy Intelligence Finance, Oppenheimer comes to the conclusion that the stocks of the oil majors gained just 39% in the period 1999-2009, compared with 133% for smaller integrated oilcompanies, 529% for independent refiners, 663% for large specialised exploration and production firms and 269% for small exploration and production firms. Even more tellingly, Oppenheimer notes that over this same period the oil majors were unable to grow their oil and gas production, despite all the promises they made (and continue to make) to investors. ExxonMobil, the industry leader, saw its oil production decline 5% and its gas production 10% over the last ten years. Shell recorded similar results, as I have reported in another story.

The main reason for the declining production figures of the oil majors is well known: they have been increasingly barred from the “easy” oil and gas fields in the big producing countries and have been forced to find new reserves in ever more difficult surroundings. It was the reason why they went for their big mergers in the first place: to pull their remaining reserves together and to be able to take on the huge investments that are required to produce oil and gas in the deepsea, the Arctic and other hard-to-reach places. This strategy obviously has not (yet) delivered the hoped-for results.

So what can the oil companies do to finally deliver the growth that they have been promising for so long – to become once more an industry on the rise rather than a “sunset” industry? From the various strategic reviews they have produced – and from their actions – we may infer that they have identified four main possibilities to turn their fortunes around:

- they can grow in “unconventional oil”, in particular in the deepsea
- they can try to get access to the last remaining “easy oil” reserves in the world, in particular in Iraq
- they can switch from oil to gas
- they can hitch onto the growth of the Asian (Chinese) market

So now you can see where those four “game-changers” are coming from: each relates directly to the growth options the oil companies have pinned their hopes on. Unfortunately for the industry, however, their expectations may not be fulfilled so easily, as the discussions at the Oil & Money Conference made clear.

Game-changer 1 – Macondo

The BP oil spill in the Gulf of Mexico is of course a negative game-changer for the oil industry. It is a fear rather than a hope. The fear that the one area in which the industry has scored its greatest successes in the recent past – oil exploration and production in the deepsea – will be wrecked by political interference.

The importance of the deepsea to the oil industry should not be underestimated. Ivan Sandrea, Vice-President International E&P Strategy of Statoil, said at the conference that deepsea production is already good for 5 million barrels per day out of the total global production of 80 million barrels. Andrew Gould, CEO of oil service company Schlumberger, noted that in 2030 one-third of global oil production is expected to come from offshore drilling. Any kind of regulation that hampered offshore oil production would seriously impact on the oil industry.

As investigations into the accident are still ongoing in the US, nobody is quite sure as yet what the fallout will be of Macondo. The experts at the Oil & Money Conference all agreed, however, that regulations will no doubt be tightened, although they voiced hopes that new regulations might not be too restrictive, especially as the power of the Republican Party is growing again in the US. David Williams, CEO of the offshore drilling contractor Noble Corporation, said that there is reason to believe that new regulations will be ‘fairly reasonable’. Still, he noted that production costs could go up by 20 to 25% and the disaster could lead to a 12% production decrease in the Gulf of Mexico in the period up to 2020. That would amount to 950 million barrels less production for the oil companies in the Gulf – and that was not, Williams said, the worst-case scenario.

Bernard Duroc-Danner, CEO of service company Weatherford International said that Macondo would lead to ‘more regulations, more liability, more costs, more time’. He also expected a ‘big ownership-shift’ as the smaller companies would not be able to handle the extra costs and liabilities and would be forced to sell their possessions to bigger companies.

The possible consequences of the Gulf of Mexico disaster for deepsea drilling activities elsewhere in the world are even less clear. Most experts expected no great changes in Norway and Brazil, though that is of little comfort to the oil majors, as they hardly have access to fields in those countries anyway. In this respect the effect of Macondo on future drilling opportunities in the Arctic region may be much more damaging. The BP disaster will surely be a big boost to environmentalists who oppose drilling in the Arctic.

Game-changer 2 – Iraq

‘There is nothing like Iraq’. Peter Wells, non-executive director of Neftex Petroleum Consultants, said it several times in his presentation at the Oil & Money Conference. ‘It is the last place on the planet where you can find so much unproduced reserves.’ What is more, said Wells, we need Iraq, to make up for the production that will be lost due to natural oilfield decline. ‘If we don’t get Iraq, we will have a problem.’

Among oil analysts there is a general awareness that, as Chief Economist of the International Energy Agency (IEA) Fatih Birol once famously put it, the world needs to find ‘four Saudi Arabias’ in the coming decades to make up for natural production decline – even if demand stays flat all this time. Peter Voser, CEO of Shell, made the same point in his presentation in London. He even talked about ‘four Saudi Arabias in ten years’.

Iraq, potentially, could be one or even two of those Saudi Arabias. The Iraqi government has said it wants to raise production from the current 2.5 million barrels per day (mbpd) to 12 or even 16 mbpd – which would be 1.5 Saudi Arabias. No one doubts that the country has enough reserves – and western oil companies have been getting at least some access to them, even if only in the form of service contracts.

However, as the speakers at the conference made clear, anyone who thinks that Iraq could even remotely approach a production of 12 mbpd in the next 10 to 20 years, is living in fantasyland. Iraq has no money, virtually no infrastructure, it does not have a legal and regulatory system in place (the contracts that have been signed have not been approved by Parliament). Worst of all, its security situation is, as former Oil Minister Issam A.R. Al-Chalabi put it, ‘very bad’ – and getting worse rather than better.

According to Sadad Al-Husseini, President of Husseini Energy Co and former Member of the Board of Saudi Aramco, in a best-case scenario it will cost 7 or 8 years for Iraq to reach a maximum production of 6.3 mbpd. This would be the “plateau” for another 12 to 14 years, he said, after which production would likely go down again. Even at 6.3 mbpd, Iraq’s ‘value chain will have major gaps and capacity issues’, Al-Husseini pointed out. Wells and Al-Husseini also noted that Iraq, as the birthplace of OPEC, would never undermine the oil cartel – thus severely restricting opportunities for western oil majors to ever achieve significant production growth in that country. Alas, if the American-British invasion of Iraq was all about oil, as many people have claimed, it has been for nothing.

Game changer 3 – shale gas

If not oil, then gas. That currently seems to be the dominant thinking among many “oil” executives. Shell in particular uses every opportunity to make its case for gas. At the Oil & Money Conference, CEO Peter Voser repeated what has become a Shell mantra in recent times: gas is (should be) the fuel of choice, as it is abundantly available, relatively cheap, has a relatively low CO2-content, and when used for power production provides the necessary flexibility to accommodate intermittent renewable energy sources such as solar and wind power. The only thing that bothers Voser and his colleagues is that politicians and the public seem to be insufficiently aware of the blessings of natural gas. ‘It is time that gas gets a more positive press’, he said.

Voser did get some support for this plea, as Lord Howell, UK Minister of State in the Foreign Office (and former Minister for Energy under Margaret Thatcher), enthusiastically endorsed gas at the opening session of the conference. ‘Gas is the name of the game’, he said. That is to say: temporarily – until

In 2030 one-third of global oil production is expected to come from offshore drilling

nuclear power and renewables can take over, Howell added. Voser has a rather more defnite role for gas in mind. In this context he stressed the importance of carbon capture and storage (CCS) several times. In combination with CCS, Voser said, gas can play a large role in energy supply ‘well into the future’.

When it comes to gas, the main worry of policymakers is the security of supply issue (i.e. the danger of overdependence on Russia), but this was brushed away by Voser. The Shell chief pointed to the ‘supply revolution’ taking place in the gas industry: the revolution in the production of shale gas and other forms of “unconventional gas”.

How revolutionary is shale gas really? Enough has been said lately about the shale gas developments in the US and the enormous impact they have had on global gas supplies. Less clear at this point is to what extent Europe can duplicate the American success. Paul Stevens, Senior Research Fellow at Chatham House, has recently published a fairly critical report in which he expresses ‘serious doubts’ as to whether Europe can copy the American shale gas revolution. Wolf Regener, President and CEO of the independent oil company BNK Petroleum, presented a much more optimistic view. Wegener, whose company has acquired six shale gas concessions in Poland and Germany and intends to be a leading player in Europe, said that ‘shale gas should work in Europe’. The obstacles that are frequently mentioned – a lack of water, high population density, a lack of drilling rigs and ownership issues – are ‘not insurmountable’, Wegener said.

Still, even if the American shale gas revolution should spread to Europe and China, which does not seem unlikely, this is not necessarily good news for “big oil”. In fact, the oil majors seem not particularly well equipped to handle the relatively small shale gas plays. In this sense, the megamergers of the past work against the companies. The fact that the oil majors did not play any role in developing the shale market is highly significant in itself.

A successful global unconventional gas revolution would probably lead to both a fragmentation of the market and depressed prices. (We might even see a repeat of the early days of the American oil industry, in which case the industry would need a new John D. Rockefeller to make shale gas profitable for them!) In the US spot market we are already seeing this to some extent. Prices are so low that new investments in shale gas are already being threatened. In Europe and Asia, a massive supply of unconventional gas would give a boost to spot gas markets, undermining the oil-indexed long-term

‘It is time that gas gets a more positive press’

contracts that now form the backbone of the profits the oil companies make in the gas trade. Just think about the huge LNG projects developed by Shell and ExxonMobil in places like Qatar and Sakhalin. Gas from these fields is sold under long-term contracts to mostly Asian buyers. If these buyers could produce their own shale gas, it could hurt the oil companies considerably. In short, a gas supply revolution might be good from the perspective of security of supply – it might not necessarily be beneficial to the oil majors.

Game changer 4 – the power shift to Asia

No one doubts that the rise of China is the game changer par excellence – not just in the energy market, but in the world as a whole. And no doubt the oil industry can profit from the Asian growth to some extent (for instance, through the gas contracts just mentioned). The problem is, though, that the western oil majors are … well, western. They are not Chinese. The Chinese have their own oil majors, which are, as everyone knows by now, ruthless competitors to the western companies.

The rise of China is bad news for the Exxons, Shells and BPs in a more fundamental geopolitical sense as well. As Ghassan Salamé, Professor of International Relations at Sciences-Po and Columbia

University, and Scott Ritter, Energy Security Consultant at Energy Intelligence, pointed out at the conference, no longer are the countries of the Middle East and Africa oil provinces of Great Britain or the US. The British and American oil companies have always operated to a significant extent under the protective umbrella of their powerful governments. Now that this power is shifting, the umbrella is getting full of holes.

The final countdown

The future, then, looks more uncertain than ever for the oil industry. (Not coincidentally, the uncertainty plaguing the energy sector will also be a major theme of the upcoming World Energy Outlook of the IEA.) The more so because fossil fuels are also under threat from another direction: from climate policies. This - climate change – is another “game changer” the oil companies have a hard time dealing with. Just a few years ago, the oil majors (with the exception of ExxonMobil), all ventured into renewables (BP even billed itself as “Beyond Petroleum”), but they quickly discovered that these markets are very different (and not nearly as lucrative) as the oil and gas market. By now, they have sold many of their renewables activities again. BP and Total are still active in solar power, but they are far

‘I think this energy revolution is happening. A historic transition is starting.’

from turning into solar companies. The oil companies seem to see the most opportunities in biofuels. Shell, after saying for years that it would not invest in “first-generation” biofuels (that compete with the food chain), just signed a $12 billion joint-venture (still to be approved) with Brasilian ethanol producer Cosan. Even ExxonMobil is conducting research into the possibilities of algae. But whether biofuels will provide the oil companies with a viable alternative for their trusted oil, remains to be seen.

In the meantime, another threat is looming on the horizon for the oil companies: the slow but sure advent of the electric car. Indeed, Nabuo Tanaka, Ececutive Director of the International Energy Agency, said at the Oil & Money Conference that he considered the electric car to be one of the main game changers of the energy market. ‘I think this energy revolution is happening’, he said. ‘A historic transition is starting.’

If all else fails, the western international oil companies (IOC’s) always have one option to fall back on: they can swallow their pride and become sophisticated service-companies, working for Saudi Aramco, Gazprom and the other national oil companies (NOC’s) that lord it over most of the earth’s oil and gas resources. For some years the IOC’s have been working hard at forming “partnerships” with the NOC’s. And, as Jay Prior, Vice-President Business Development of Chevron, and Claudio Descalzi, Chief Operating Officer of Eni, made clear, they have every intention to broaden and deepen these relationships.

But the question in the end is, who will eat whom? Shokri Ghanem, the Former Libyan Prime Minister and Chairman of the National Oil Corporation of Libya, noted that the NOC’s are becoming more like IOC’s, for example through partial privatisations and international expansion. He also warned that the IOC’s, if they wanted to continue operating in producing countries, should open the door to executives and managers from the NOC’s. It all added to the feeling that was hanging in the air at the Oil & Money Conference – that the days of the oil industry as we know it are numbered.