A Pessimistic View On Big Oil

‘Big Oil’ is described as the Supermajors of the oil companies that operate around the world. This list includes: Exxon Mobil XOM, BP, Royal Dutch Shell RDS.A, Chevron CVX, Total TOT, Saudi Aramco, Eni and sometimes ConocoPhillips COP. This article will provide a pessimistic outlook for the macroeconomic conditions that are becoming evident for the future of Big Oil as exploitable reserves decrease and global pressures push for a shift to a greater use of renewable energy to secure energy security.

According to a study by BP, total proved oil reserved totaled 1700.1b barrels at the end of 2014. Although this might seem like a huge amount, this only equates to 52.5 years of global production. This figure is of course subject to a number of variables in the future such as: future investment in exploration and development, future global oil demand and the extent to which renewable energy usage plays a part of global consumption.

It should also be noted that global energy consumption is decreasing. Bob Dudley (CEO of BP) stated in 2015,

Global primary energy consumption increased by just 0.9% in 2014, its slowest rate of growth since the 1990s, other than immediately after the financial crisis.

Effects of declining reserves

To focus on the effects on Supermajors in an area of declining production, look no further than what is happening in the North Sea. The North Sea was once one of the most prominent oil producing areas in the world. Production started in the 1970s, producing several millions of barrels of oil per day to reach its peak in 1999, from where it has declined ever since. This has declined down to 1.42 barrels being produced per day in 2014, a decline of approximately 70% from the 1999 peak. This is shown from the graph below.

(click to enlarge)

Although it has been exemplified by the lower price of oil, investment in the North Sea has declined dramatically, and this is set to continue. Capital investments in the North Sea this year were £14.8b and are set to fall by £2-4b over the next four years.

In addition to this, as the oil fields have been maturing further, Supermajors have been selling off assets to smaller niche firms that have special technical expertise to exploit reserves that are harder and more expensive to reach. Instead, Supermajors are being offered licenses for exploration and production in ‘frontier’ areas of the UK, where harsher conditions and deeper waters require higher financial capabilities. The frontier areas also carry higher risk and costs as less proven reserves have been discovered and little infrastructure exists to support the transportation of hydrocarbons.

This format is expected to be followed in other maturing provinces around the world as some argue that we may be seeing ‘peak global oil’ with proven reserves having only increased 0.4% from 2013-2014. This is expected to fall even further this year as investments in further production has decreased dramatically as the price of oil has plummeted from $100+ per barrel to under $50.

These factors are expected to create a harsh long term outlook for the Supermajors as their ability to create enough cash flow to cover costs and dividend payments with declining global production is diminishing.

The Arctic

The Arctic is seen to be the next major source of hydrocarbons over the next few decades. According to the U.S Geological Survey (USGS), the estimated total amount of undiscovered hydrocarbon resources in the Arctic is 413b boe (about 22% of global undiscovered conventional oil and gas resources). These estimates equate to the Arctic’s share of non-OPEC supply is increasing from a rise of 16% in 2010 to 31% by 2050.

Although this large amount of undiscovered reserves may seem a huge positive for oil majors, it comes with many qualifications.

Firstly, there is no international treaty on the Arctic at present as what is considered ‘the Arctic’ can be disputed as it is not a single land mass such as Antarctica. This creates many uncertainties in determining which countries can drill where. As oil majors are very reluctant to invest heavily when their legal positions are very much in doubt, progress in further production may be very slow.

Secondly, the Arctic has some of the most technically challenging conditions to explore and produce hydrocarbons. While the oil price remains low, it is not commercially viable to exploit the reserves when there is plentiful supply from cheaper middle eastern countries.

Evidence of the Arctic’s problems has been recently proven by Shell’s retraction from exploring and drilling this month after allegedly only finding traces that were not commercially viable.

In addition to this, the US has pulled the plug on exploring and developing hydrocarbons in the foreseeable future. It has cancelled plans to sell more drilling leases in the Alaskan regions and has refused to extend leases given to Shell and Statoil.

The above reasons should result in a lowered global guidance of oil and gas production.

Political Pressures to increase percentage of energy consumption to renewable energy

As climate change becomes an ever increasing issue that needs attention, countries around the globe are creating new regulations to combat green house gas emissions and move towards higher consumption of renewable energy.

An example of this come from the European Union. In 2007, the European Council agreed to adopt an overall binding target of 20% renewable energy consumption within total energy consumption in the EU by 2020. This was implemented in the Directive 2009/28/EC. These targets are expected to increase beyond 2020. The overall effect of this will be increased spending initiatives on renewable energy projects and a reduced reliance on oil and gas for energy security.

Similar regulations are being put in place across the globe, which is having the effect of a rapid increase in renewable energy consumption as a percentage of total energy consumption.

For the long term investor

For these reasons, I think it would be prudent for very long term investors to realise how energy consumption is changing in this century and should realise that holding dividend aristocrats such as Exxon and Chevron, with an exemplary history of increasing dividends might not be able to continue this over the next few decades.

Conclusion

The playing field is changing in the oil and gas sector. Many more reserves in the world are maturing leading to production being taken over by smaller niche oil and gas production companies rather than Supermajors. In addition, the low oil price and global regulatory reform on climate change is hampering the outlook for Supermajors to invest in commercially viable projects to increase production. The only way for Supermajors to secure financial security for shareholders over the next few decades is for both the oil price to increase over time and to increase their share of revenues from non green house gas emitting hydrocarbons.

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