Third quarter earnings reports for the oil and gas majors were somewhat mixed: while profits were up, driven principally by high crude oil prices, production declined significantly. BP for example announced 3Q ’11 profits of US$5.1 billion, while the values for Shell and ExxonMobil were US$7 billion and US$10.3 billion respectively. Production at BP declined by 12% year-on-year (y-o-y) to 3.32 million barrels of oil equivalent per day (boe/d), the highest in more than a decade; even after exclusion of effects such as assets divestment and Production Sharing Contracts (PSCs), the decline was 8%. In the United States, the company’s production decline was an unsavory 25%, due in the main, to the Macondo well incident. Similarly, for ConocoPhillips, the decline was 10%, Chevron 5% and Shell 2%. For some of these companies, output decline was more than could be attributed to divestment. In comparison, net output for Norway’s state-controlled oil company Statoil, grew by 14% y-o-y.
There are three fundamental issues which challenge the very viability of these majors. While these issues are not new, they are accentuated by the latest quarterly earnings reports.
Reserves are fundamental to the viability of any oil and gas company. In the late 1960s, the oil and gas majors held about 85% of global crude oil reserves. At present, an estimated 80% of global crude oil reserves is domiciled with state-controlled companies or National oil Companies (NOCs). Most oil-exporting countries have domiciled their national resources in these NOCs while the majors have to go through costly bidding and acquisition processes for access to acreages.
Figure 1 shows a comparison between the largest NOCs and super majors by proved reserves.
In terms of barrels of oil equivalent, the top three NOCs hold more than ten times as much oil and gas reserves as the top three majors and there are no majors among the top ten rankings. Among the top twenty rankings, there are only three majors, two of which barely figure. In 2010, Saudi Aramco alone produced more crude oil than the four largest super majors put together.
Cost of Production
For many of these majors, access to state-controlled reserves is via Production Sharing Contracts (PSCs) or Service Contracts (SCs). Most PSCs provide for the majors to bear discovery and development costs while proceeds from sales are shared in agreed proportions. Quite often, these proceeds come under very steep royalty and tax regimes that eat deep into the majors’ take. ExxonMobil and BP, in their latest quarterly reports for example, cited the effect on their books, of increased government take from PSCs.
Service Contracts provide for fixed payments — often far less than the producers would like — for each barrel of production above pre-determined baselines. In the West Qurna 1 fields of Iraq for example, ExxonMobil is set to receive US$1.90 per barrel of new production after deduction for costs.
The majors, in their quest to enhance their viability have also been plumbing and scouring for petroleum reserves in increasingly complex geological formations; and with enhanced technologies to match. This conduces inevitably to higher production costs. According to RIGZONE, cost of discovery and development for the majors more than doubled from US$9 per barrel of oil equivalent (boe) during the period 2000 – 2005 to US$19 per boe during 2008 – 2010. In addition, the International Energy Agency reports that these costs are set to increase significantly over the next two decades compared with crude oil prices, further squeezing profit margins.
NOCs have fast been encroaching on an industrial turf previously controlled by the majors. Now independents are setting their stakes on that same turf: over the past few years, niche-focused, independent oil and gas companies have proved more efficient in their respective niches than the majors. The majors which had hitherto leveraged on the industry’s complete value chain, have become quite unwieldy. Independent Exploration and Production (E&P) as well as Refining and Marketing (R&M) companies recorded overwhelmingly higher share price gains year-on-year in 2010 than the majors.
In their bid to bolster profitability, the majors have embarked on a series of assets divestments. BP recently increased its divestment target by 50% to US$45billion by 2013 while for ConocoPhillips the value is US$10billion by the same year. Such divestments however, substantially curtail the production capacities of these majors. For example, BP’s divestments are expected to reduce the company’s production from about 4 million boe/d to between 2.3 and 2.4 million boe/d according to its chief executive officer. Such output decline would also impact profits, as again in the case of BP, where Q3 upstream profits dipped despite higher crude oil prices.
The independents have been some of the beneficiaries of such assets divested by the majors and as such have been enhancing their portfolios. In addition, the potential alliance between these independents and NOCs bears winning synergies at further expense of the majors — technical expertise and efficiency marrying vast oil and gas reserves as well as state funds which carry less stringent terms.
All said, the majors’ viability will depend on their ability to navigate these issues.