Oil Industry Enters The New Era Of Austerity

Last week, Chevron (CVX-NYSE), the second largest oil company, held its annual analyst meeting at which time the company’s management laid out its plans for the next five years, including projections for capital spending and oil and gas production growth. The meeting followed on a presentation at the IHS CERA Week conference in Houston by Chevron CEO John Watson in which he proclaimed that today’s $100 a barrel oil is the equivalent of the past’s $20 a barrel oil. By that he meant that the oil industry must now figure its budget outlooks based on the need for oil prices to stay around the $100 a barrel level in order for the company to generate the necessary cash flow to support spending plans and for projects to offer future returns to meet or exceed required investment hurdles. Mr. Watson has talked about the impact on his business of rapidly escalating costs for finding and developing new oil reserves, which is why he says the company now needs that $100 a barrel price. Chevron is the latest major oil company to implicitly declare that the oil industry has entered a new era – one marked by higher costs and more disciplined capital investment programs that will require higher oil prices. Capital discipline forces companies to sacrifice production growth targets on the altar of increased profitability in order to boost returns to shareholders. What does this new era mean for the oil and gas business? Equally important, what does it mean for energy markets?

Chevron now projects it will produce 3.1 million barrels a day of oil equivalent (boe/d) in 2017, down from a target of 3.3 million boe/d that the company established in 2010 and reiterated to the analysts last year. If Chevron attains its target, it will have increased production in the interim by 19%, a not inconsequential gain. Mr. Watson attributed the reduction in the company’s output target to lower spending for shale wells due to the fall in North American natural gas prices, higher volumes of oil going to the host countries where the company operates under production-sharing arrangements, and “project slippage.” Mr. Watson also indicated that the company would raise $10 billion from the sale of assets, up from its previous target of $7 billion. The company plans to sell oil and gas fields and acreage to raise the funds.

The Chevron outlook mirrors that presented earlier by the industry’s largest company, Exxon Mobil (XOM-NYSE), at its annual analyst meeting. There, not only did ExxonMobil CEO Rex Tillerson announce a reduced production target, but he also said that the company would cut back its capital investment program. While neither the world’s number one nor number two oil companies signaled that the changes in their targets were the result of the industry entering a new era, their actions and similar ones by several of its smaller sisters do suggest that reality.

BP Ltd. (BP-NYSE) announced it was going to split off its shale operations into a separate company, still wholly-owned by BP, in an attempt to transform the operation into a more nimble explorer and developer of shale properties. If mimicking the organizational structure of larger independent oil and gas operators was BP’s goal, one has to wonder what structural impediments necessitated the total separation of the unit. Maybe the move made it easier for BP’s
senior management to highlight the drag of its shale business and establish the entity as a stand-alone business. It may also be advertising the unit’s potential in order to attract a joint venture partner or another energy company’s investment.

The strategic moves by ExxonMobil, Chevron and BP fit with the efforts that Shell (RDS.A-NYSE) is making to improve its financial performance. The company is constraining its capital spending and reassessing the economic attractiveness of every exploration and development project. Another large oil company that recently made a strategic move was Occidental Petroleum (OXY-NYSE). The company is planning to spin off its California oil and gas assets and operations into a new company for its shareholders, while the remaining corporation is picking up stakes and moving its headquarters from Los Angeles to Houston where it maintains significant operations. While this move may say more about the desire of OXY’s management to exit the unfriendly confines of California’s regulations and costs, it also says something about the future direction of the company’s exploration and development focus.

We have seen similar statements about revisions to strategic plans by the large, European-based oil and gas companies – ENI (ENI-NYSE), Total (TOT-NYSE) and Statoil (STA-NYSE). These moves are being undertaken by the management teams in response to flagging performance from their huge shale investments and other challenges similar to those outlined by Mr. Watson.

We were intrigued by the decision by Chevron to boost its oil price outlook from $79 a barrel for Brent crude oil to $110 per barrel. This move is designed to help the financial outlook for the company’s earnings and to offset the reduction in the production target. The oil price assumption is consistent with the average Brent price for the past three years, but it is at odds with the trajectory for prices derived from the futures market, which call for lower levels in the future. We wonder whether this price-target revision will rank with their statement about the future course for natural gas prices a few years ago when the major oil companies jumped on the shale gas bandwagon. Their timing essentially marked the top for gas prices as North American gas prices collapsed due to the surge in gas output. This would not be the first time major oil company planning departments incorrectly projected the course of global oil prices.

Strategy adjustments by major oil companies are seldom quickly reversed even when near-term industry trends suggest an adjustment should be made. If the newly defined financial discipline mantra demanded by investors is followed and industry capital spending is restrained, and possibly falls, there will be ramifications in the energy market. If Mr. Watson’s declaration, as echoed by other oil company CEOs, is true, then the cost of finding and developing new reserves is too high and the pressure to drive down oilfield service costs will grow more intense. We may now be witnessing the fallout from that discipline in the offshore drilling business where the expansion of the global rig fleet with more sophisticated and expensive rigs, necessitating higher day rates, is leading to near-term “producer indigestion.” Could the offshore drilling industry be on the precipice of a significant wave of older rig retirements in order to sustain demand for its new, expensive drilling rigs currently being delivered without contracts?

Another question for the industry is who will supply the risk capital for exploratory drilling, both on and offshore, if the majors pull back their spending? Onshore, for the past few years, a chunk of that capital has been supplied by private equity investors who have supported exploration and production teams in start-up ventures. They have also provided additional capital to existing companies allowing them to purchase acreage or companies to improve their prospect inventory. Unfortunately, the results of the shale revolution have been disappointing, leading to significant asset impairment charges and negative cash flows as the spending to drill new wells in order to gain and hold leases has exceeded production revenues, given the drop in domestic natural gas prices. Will that capital continue to be available, or will it, too, begin demanding profits rather than reserve additions and production growth?

The amount of capital flowing into the oil and gas business is extremely important for the future growth of the nation’s oil and gas output since shale wells experience sharp production declines in the early years of their production. A series of questions flow from that production profile: What will happen to oil and gas prices in the medium-term if drilling slows and production rapidly declines? Will manufacturers who currently are building billions of dollars-worth of new plants designed to capitalize on cheap American energy find their investment returns not what they anticipated? How will they react? Will first-mover advantages in this manufacturing renaissance become a disadvantage? What about the billions of dollars targeting new liquefied natural gas (LNG) export terminals? Will we actually have the volumes of natural gas to export, and especially at the low prices projected that are anticipated to give American gas a competitive advantage in European and Pacific gas markets?

These questions should be raised at the same time the national debate about exporting domestic crude oil is commencing. There are various subtleties in that debate that are often lost in the broad debate themes. For example, how quickly can the U.S. refining industry build new refineries or expand existing ones in order to use more of the light, sweet crude oil coming from the tight shale oil formations? If the refining expansion doesn’t keep pace with the growth of light oil, then there could be a cutback in drilling for shale oil that will certainly result in a sharp reduction in the current bullish outlook for U.S. oil production as shown by the significant increase in future output estimated by the Energy Information Administration in its 2014 outlook versus its 2013 projection. (Exhibit 2, next page)

A cutback in oil drilling would also reduce the volume of associated natural gas being produced, which could result in an unexpected spike in gas prices. For some time, U.S. oil producers have been able to secure export licenses to send oil out of the country, primarily to Canada, but will that avenue continue to exist and can it be expanded to prevent a shutdown in shale oil drilling? The political debate over exporting domestic crude oil is being described as 310 million American consumers versus a handful of oil company CEOs with fat pay packages. We doubt the industry can win that battle.

Those are only some of the critical questions that must be asked and answered as the oil and gas industry transitions into the next era of its existence. Much like the performance of the United States economy, the oil and gas business has internal momentum that will keep it going as managements reassess its future. We have been watching the industry over the past couple of years with one historical perspective in mind – the generational change underway in the executive suites of energy companies. While we are not denigrating the experience levels or intellect of the new CEOs, we are merely reflecting on the past periods when industry leadership changes occurred. Those transitions often resulted in the new leaders having to make their own “learning mistakes” like their predecessors did. That may be an important aspect of the industry transition currently underway.

– See more at: http://www.rigzone.com/news/oil_gas/a/132190/Musings_Its_Official_Oil_Industry_Enters_The_New_Era_Of_Austerity/?all=HG2#sthash.bCmLQNSF.dpuf

23 Comments on "Oil Industry Enters The New Era Of Austerity"

Pops on Thu, 20th Mar 2014 10:15 pm 



“Those transitions often resulted in the new leaders having to make their own “learning mistakes” ”

Yeah, that’s what PO is, snotnosed kids’ (read that: IOC CEOs’) learning the ropes –

says an advisor to a “boutique oilfield service investment banking firm”

LOL

shortonoil on Thu, 20th Mar 2014 11:10 pm 



“The company plans to sell oil and gas fields and acreage to raise the funds.”

In five years the value of these shale fields will be what ever moose pasture is selling for in their vicinity. The majors are aware of this, and they will, are; going to dump it. Shale can not make money at $100/barrel, and oil will stay at $100/barrel as long as shale is expanding. Everyone was heralding the wonders of technology in oil, but they forgot to ask what it was going to cost! Now they know; more than they can afford.

Technological advancement always results in a huge increase in energy input, and that is what petroleum now longer has to offer. The energy cost of producing petroleum is going up, and its energy return is going down. Expect more draconian cuts from the petroleum industry worldwide over the next few years.

http://www.thehillsgroup.org/

Davy, Hermann, MO on Fri, 21st Mar 2014 1:05 am 



As usual I have seen no mention of the financial variable. One of the most important variables I see is the cost of money. Interest rates are at historic lows. A whole range of activities is no possible because of these low rates. Oil production is very rate sensitive from demand to supply to higher rates. Production cost increase lowering supply. When rates go up less discretionary spending is available lowering demand. It will be hard to keep oil prices in the goldilocks range with volatility from higher rates. I would like someone to tell me where interest rates can go if they are at historic lows, exactly, they can go up. Interest rates cannot go down anymore. A normal rate used to be around 5%. Add that into the cost of these oil firms and tell me what that does to their budget outlooks. Sooner or later rates will go up. They could go way up but most likely the global central banks will restrain rates as much as they are capable. A big reason for this is the sovereign debt problems. The US government will default if rates go too high. This is a very serious issues that is being ignored by many lately. We have not ended business cycles just because we can print money and manipulate markets.

Northwest Resident on Fri, 21st Mar 2014 1:29 am 



“The energy cost of producing petroleum is going up, and its energy return is going down.”

Try explaining that to a reasonably intelligent person who has no interest in the subject and who just stares at you with a glazed-over look if you try to explain how that is very bad news, coming on fast. I have, several times. No luck. The lights are on, but nobody is home. They just, don’t, get it.

Makati1 on Fri, 21st Mar 2014 2:06 am 



If you see articles like this, even in RIGPORN, you know it is getting real out there in Petro Land. They have discovered that they cannot sell oil that costs much over $80/bbl to recover and process or there will be no profits.

But, as you said NWR, few want to hear it.

Plantagenet on Fri, 21st Mar 2014 2:22 am 



Its peak oil, baby. Of course the cost of oil is going waaaaaaay up.

rockman on Fri, 21st Mar 2014 2:40 am 



“By that he meant that the oil industry must now figure its budget outlooks based on the need for oil prices to stay around the $100 a barrel level in order for the company to generate the necessary cash flow to support spending plans”. OK let me explain what he means even though he’s trying to avoid saying it: there are a very limited number of wells that can be drilled if oil prices were much under $100/bbl. And it doesn’t mean there are a lot of those wells out there.

““The energy cost of producing petroleum is going up”. I’m not saying this concept is wrong but the cost of drilling a well onshore or offshore hasn’t gone up per se. But we are spending a lot more per well. That’s sounds contradictory but follow this Eagle Ford example. When the play started you could drill and franc the typical well for $4 – $5 million. Now $10+ million isn’t uncommon. But the cost per foot drilled or per franc stage has gone up much. In fact some of this costs have dropped a bit do to falling competition. But the cost increased because we went from 3000’+ laterals with 2 or 3 franc stages to 8,000’+ laterals with 20+ frac stages. So while recent wells appear to be as good or better then early wells it has come at a cost. But companies are spending more money because the have run out of wells that could be drilled cheaper that made an acceptable return.

So that beings us back to the point made many times before: the increased monies spent to drill hasn’t caused the price of oil to rise. It’s the increased oil price that has made the more expensive wells capable of creating an acceptable return. Which is exactly what Mr. Chevron is saying in his own stealthy way.

Kenz300 on Fri, 21st Mar 2014 4:58 am 



Alternatives look better and cheaper as the price of oil continues to rise.

paulo1 on Fri, 21st Mar 2014 12:42 pm 



Oil Sands in Alberta and Sask looks secure as what there is is exactly what you see. It is an ore deposit as opposed to some hidden pot of ‘black gold’ thousands of feet down under the surface. If the price remains stable it will certainly be a supply niche.

Paulo

Aaron on Fri, 21st Mar 2014 1:00 pm 



They are trying so hard not to say it aren’t they? It’s excruciating to watch them squirm. Just say it. Peak oil! Peak oil! Peak oil!

rockman on Fri, 21st Mar 2014 1:34 pm 



Paulo – along those lines: Reuters – The 180,000 barrel per day Grand Rapids oil sands project planned by Cenovus Energy received Alberta government approval on Thursday, the province said in an email. Located 186 miles north of Edmonton, the project will use solvent-assisted and thermal technology to produce heavy crude. Steam and a solvent are pumped down a well to liquefy the bitumen which is then pumped to the surface through a second well. Cenovus plans to build the project in phases over the next decade, beginning with 100 well pairs and rising to 2,500 when construction is complete.

shortonoil on Fri, 21st Mar 2014 1:44 pm 



When Ghawar was in its heyday, about 1970, the cost of drilling a well was $250,000 and the well produced 50,000 barrels/day. The cost of the average Bakken well is now $8.5 million, and produces 85 barrels/day. Using graph# 12 at our site, those $ values can be converted into energy terms. $ units are constantly changing, so to really see what’s happening it is necessary to convert them into units that don’t change with time.

When Ghawar was being developed the upfront energy cost per barrel was 293,000 BTU/barrel. The Bakken now requires 687 million BTU/barrel in upfront energy costs. The cost per barrel to drill a well (in $, or energy terms) is increasing, and it is increasing exponentially. In the “Commentaries” section at our site, “The Energy Factor Part I” we explain how this affects the general economy. The impact of increased energy costs to extract petroleum has a 5 to 1 effect on the economy. A one BTU increase to extract petroleum reduces the energy delivered to the general economy by almost 5 BTU. Since $ and BTU can be expressed in equivalent terms, the monetary impact is the same if the time variable is factored in.

The EIA has, had a graph on the cost of drilling a well over the last 50 years. We have a hard copy of it here in our files, but I don’t have time to find the new link to it. But what it shows is that the cost of drilling a well has been increasing exponentially over time. How much longer we can bare this increasing cost of production is what our report is all about.

http://www.thehillsgroup.org/

Davy, Hermann, MO on Fri, 21st Mar 2014 2:18 pm 



Short excellent data, thanks

Northwest Resident on Fri, 21st Mar 2014 2:29 pm 



“How much longer we can bare this increasing cost of production is what our report is all about.”

And it seems to me, THAT is the most compelling question of the day.

Davy, Hermann, MO on Fri, 21st Mar 2014 2:45 pm 



N/R, converging storm of increased imputes, equipment, cost of money, regulations, water, energy, and labor. This is being counterbalanced by better technology and still adequate prices. Watch out if a financial correction comes and demand falls and maybe prices!!

Aaron on Fri, 21st Mar 2014 2:51 pm 



From my meagre knowledge of the oil industry I know there is a lag between investing in a new field and when that field begins supplying oil. I think the lag is about 5 years. Therefore, if companies are starting to restrict investment this year, which is what appears to be happening, we have around 5 years until the crunch. Am I wrong in this assumption?

Northwest Resident on Fri, 21st Mar 2014 3:15 pm 



Aaron — Based on what I think I know, your assumption is generally correct, but your timeline of five years is a little on the long side. Conventional oil is already past peak, that is a given. It is only the shale and other nonconventional fuels that are making it appear as if the oil industry is able to increase production to meet growing world demand. Some very good and believable fact-based articles seem to be pointing at late this year, sometime next year or perhaps the year after (2016) when due to rapid declines in unconventionals, we will begin to see our first worldwide “shortfalls” in oil. When that happens, it will be nearly impossible to hide, and it will be a major shock to whatever investors haven’t already figured out that unconventional oil production stocks are wildly inflated. I think if everything goes like clockwork, we might make it to 2016, but I’m thinking that by 2015 we’ll be hitting a brick wall with oil production, and from there things will start unraveling rather quickly.

bobinget on Fri, 21st Mar 2014 4:13 pm 



Statoil: Attractive Valuations Coupled With Reduced Government Stake To Provide Shareholder Value

As costs have increased and margins are expecting to decrease, oil and gas including Statoil ASA (STO) are feeling the squeeze. As this period of weakness is underway, these companies are reassessing their assets and presenting the long-term investor some excellent opportunities.

Setting the Tone

Back in January, Royal Dutch Shell (RDS.A)(RDS.B) “set the tone” for the majors, warning that their fourth-quarter earnings would be “significantly lower” than 2012. Some of their reasons for this are:

profit margins on products from Shell’s refineries continued to be under pressure in Asia, Europe and Australia.
maintenance expenses in gas-to-liquids plants in Qatar.
security issues in Nigeria causing pipelines to shutdown.
Even though Statoil did not issue a “profit warning” like Shell, the company did warn that changes must be made as costs are deteriorating margins.

“When profitability is falling and costs are rising this much in the oil industry as a whole and risk is increasing, the industry must take measures,” Statoil Chief Executive Officer Helge Lund said in an interview in Stavanger, Norway, where the company based. For suppliers “change is hard, but the fact is that the alternative is much worse.”

shortonoil on Fri, 21st Mar 2014 4:22 pm 



“And it seems to me, THAT is the most compelling question of the day.”

Theoretically our analysis puts the end date at about 20 years from the present. That will be the point in time when it must stop, or the laws of physics have changed. In actuality there are many other factors that could change during that period. Natural disasters, broad based war, large scale civil unrest, collapse of a major economic power, or the unwinding of the debt based, over indebted, monetary system. Anything that would disrupt the flow of credit to the petroleum sector, at this point in time, would precipitate a catastrophic decline in production.

Pick your poison!

http://www.thehillsgroup.org

Northwest Resident on Fri, 21st Mar 2014 5:05 pm 



Doom and gloom, guys. If you’re not feeling it, then you aren’t facing reality. Fear and terror combined with utter despair are lurking in the shadows of the not-too distant future. If you aren’t digging your foxholes and keeping your powder dry right now, then you better get started.

Northwest Resident on Fri, 21st Mar 2014 5:08 pm 



The above post was a public service announcement. Have a nice day.

paulo1 on Fri, 21st Mar 2014 5:33 pm 



@ Rockman re: Cenovus plans, etc

I know at CNRL they have had a mess with a resulting imposed moratorium on in the (steam) situ process that caused oil leaks into the surrounding environment. I did not know they are also using solvents in future projects.

It is my hope that this possible steady production with reliable reserves will help provide a stable source going forward for NA. Obviously, this will never be enough to retain present consumption rates, but it may allow for time to transition to other energy sources as well as be available as product when nothing else will do. You just can’t beat that old portability factor of liquid fuels.

As a Canadian my wish is that such production would remain within our borders, however, I am not naive enough to believe that this would happen nor do I think it is the right thing to do. I could forsee, as globilization is no longer feasible, real and proper trading blocks of opportunities on a more localized scale. For example, NAFTA is now cast as an ‘evil job killer’, but it doesn’t have to be that way. A real pooling of NA resources, talents, and markets could be a strong foundation for a decent standard of living under different political realities and roles. In short, Canada would have to stop being a simple ‘resource bitch’ for multi-nationals, USA would have to stop trying to control and police the world, and Mexico need not be a source of exploted and cheap labour. With our shared resources, talents, markets, and growing climates we could retain a damn good life as future FF production declines. It would surely beat mass migrations, increasing crime, violence, and hardships.

It could be done, imho.

Paulo

Nony on Sat, 22nd Mar 2014 12:59 am 



Maybe Chevron is worried about a price crash and doesn’t want to go after any more high priced projects or buy a bunch of leases that won’t make money if OPEC loses discipline. (A girl can dream.)

Rock, you’ve probably seen more booms shut down from global price falling than from the oil running out.