Future of hydrocarbons secure, but supply, demand remain erratic
Super-majors, Y2K, de-nationalization driving business
The future of oil and gas in the next cen tury is tied directly to the demand for energy, which is tied more or less directly to popu lation growth. In October 1999, the UN hailed the 6 billionth human being to join the planet's living population. While the poster-child was in Kosovo, the actual new addition was likely in India, China, or another developing nation.
Population growth will continue upward far into the new millenium, even though the rate of growth is slowing. While reductions in energy demand in developed nations will continue as a result of efficiency gains and relatively flat population growth, energy demand growth in under-developed nations will continue to overwhelm these reductions. There are two forces at work here:
- Environmental pressures: Pressured by environmentalists in developed nations, under-developed countries are giving up one energy form (wood, coal) for others (crude oil, natural gas). The trend is toward lower carbon numbers.
- Aspirations: Global communications have encouraged consumption in under-developed countries, pushing up energy needs per capita.
But, these two trends are not the only forces at work preserving the future for hydrocarbons. There are others taking place right now in developed nations dealing with existing energy forms.
Not so benign
Nuclear and hydro power, long considered to be low-impact environmentally friendly power sources, are proving to be not so friendly, and downright dangerous in the case of nuclear power.
- Nuclear: As nuclear power plants age, they are proving to be so problematic and difficult to maintain and manage that most countries have stopped building the units and others are voluntarily ceasing the operation of such facilities. In addition, the costs and difficulty associated with the disposition of spend nuclear materials is finally beginning to stimulate broad concern.
- Hydro: In the case of hydro power, Three Gorges Dam in China may be the last major dam built. The huge displacement of people and loss of agricultural lands and mineral capacity is becoming uncomfortable politically. Also, environmentalists are pushing hard to dismantle many smaller dams around the world, including many in developed nations. Few new dams are contemplated, even in the under-developed world, because of the new tougher environmental standards being applied.
The advent of environmentally friendly transportation power sources has taken on a significantly different appearance than originally expected. The overall objective now is simply a low carbon fuel, not necessarily a non-carbon one.
While the overall fuels goal appears to be hydrogen (no carbon), obtaining a moderate supply of the element is not without significant energy inputs, and containing it on mobile vehicles is proving to be difficult and possibly dangerous.
Thus, scientists and application engineers are having to settle for energy forms that have lower mass than conventional fuels, but with modest carbon content. Most of the "green" engines for vehicles being developed for the next 10-20 years will be powered by methanol and natural gas fuels.
Electricity, also considered a front runner in the race to develop low-environmental-impact vehicles, is falling far short of expectations. Electrically powered vehi cles are seen now as
simply transferring emissions upstream to the power plant. Futher more, researchers are having great difficulty coming up with battery or electrical storage devices that are light enough and powerful enough to meet power and distance needs for vehicles, let alone providing for the new accessory loads imposed on vehicular electrical systems. Fuel cell powered cars will still require a source of hydrogen to operate with hydrocarbons as the likely source.
Thus, the future of demand for oil and gas appears relatively secure. The future of supply then becomes the point of concern, along with the regulation of that supply. Despite the fact that there are adequate reserves of discovered oil and gas for the foreseeable future, no new reserves have been found to fully offset the concentration of oil and gas in the Middle East.
De-nationalization of country resources continued this year as a significant trend. Brazil is an example of the political drive to open up licensing of offshore acreage with distinct national goals.
The Brazilian national oil company, Petrobras, is an efficient producer, but it lacks something Brazil needs badly - investment. The addition of outside expertise won't hurt either. Brazil hopes to expand the resource base. Major new seismic surveys are underway now; to be followed by rigs and drill bits in a year or two. The trend will likely continue among other countries.
Norway is considering a more open approach, which includes either a reduced state share or royalty only without a state working interest. Even Saudi Arabia is openly discussing foreign participation, although the form is still in question, and the discussion could go on for a lengthy period.
The Middle East is hungry for investment capital. Iraq, Iran and Saudi Arabia are discussing ways to open their lands to greater development, yet still retain control of the massive resources under their lands. To meet the growing demands of the developing countries new Middle Eastern oil fields will have to come on production quickly. The nations do not have the internal capacity to meet the longer-term growth targets. They will be forced to reach an accommodation with foreign companies for their money and technical skills.
One of the more immediate challenges for oil and gas operators and service companies is year 2000 conversion of microcomputer and related time-driven devices. Rollover problems associated with the much-feared computer bug could hit second-tier economies hard.
The oil industry infrastructure in developing countries is suspect and problems may restrain production and cash flows for a time until the glitches are overcome. Ill-prepared national companies could be damaged by the bug to the point that more countries open to international oil investment.
Politicians and environmentalists will find it expedient to blame foreign sources for domestic problems, which could set back oil and gas development. It will be important for in-country management to be proactive in addressing problems, if they occur. Compensation of some kind may be needed to assuage local frustration. All of these issues are being assessed and contingency plans prepared by in-country management.
- Consolidation: Company combinations have changed the competitive landscape. The majors have transmuted into super-majors, rivaling nations in their financial power and global reach. Just how these larger entities will compete against one another and against the nations that control access to oil resources is an open question. In most of 1999, ongoing and threatened mergers have sharply subdued exploration and development activity, conveniently so, since crude will remain in over-supply beyond the end of 1999.
- Personnel: The return of oil and gas exploration and development growth in 2000, in response to dwindling supplies, should see a return of most of the available work force. Personnel training and replacement will become more important as strong cash flows allow companies to begin the rebuilding process. Ironically, at the moment of least financial flexibility, companies should begin now to promote careers in the sciences and support university programs, if they expect to have sufficient minds to solve new complicated offshore problems in 3-4 years.
- OPEC: In the future, the Organization of the Petroleum Exporting Countries (OPEC) will have to recognize the expanded power and role of the oil super-majors. As the global oil companies expand and control more reserves, they create a counter-balance to the nation-states in OPEC.
OPEC did not constrain its production policies until Saudi Arabia went outside the group to create a production counter-balance that could force restraint. Saudi is determined not to be the swing producer in the future.
If the super-majors are brought into the equation, their market power (financial, refining, distribution, and retailing) could be incorporated to moderate excesses on either side. This would provide the world with a stable flow of resources at stable reasonable prices, until the world transitions into new energy sources.
- South America: This continent is a significant destination for major investments. Venezuela's political climate has chilled investment temporarily, but that should improve in 2000 as world oil demand increases. The major worry is a possible rewriting of licensing contracts.
Brazil's economy is expected to grow GDP at a 3% rate in 2000. Any new reserves discovered from the enhanced effort exploration will take several years to come to market. Argentina will see little additional offshore exploration in 2000. The country's shelf is still lightly explored and the deeper areas of the Malvinas Shelf that were tested in 1999 must be reviewed before a new consortium campaign will be organized. Once the initial seismic activity off Brazil is complete, vessels may move south to explore the southern shelf, if the economic conditions are right.
- Gulf of Mexico: Deepwater areas will be equally active in 2000 as in recent years. Expir ing deepwater leases, new semisubmersibles and drillships with ultra-deepwater capability, and excellent 1999 deepwater drilling results assure an active year. The Subsalt Trend will continue to be tested both on and off the shelf as the result of extensive 3D surveys, pre-stack depth migration processing, and gravity modeling.
The time horizon for deepwater projects is long and the new rigs have three year and five year contracts, which should assure reasonably steady drilling. It is likely that many slim holes will be drilled to test and prove acreage ahead of release dates. Discovered reserves can be developed at a later time.
- Eastern Canada: Terra Nova field is slated for development in 2000. The success of tie-ins to Hibernia will prove the value of the massive structure and encourage additional satellite development. The developing oil industry in Canada's east will likely begin to seek new opportunities. As world demand builds in 2000 watch for a renewed interest in Arctic projects.
- North Atlantic/North Sea: Low oil prices killed this area in 1998-1999. With stable oil prices and a return to growing demand these areas will get a second look in mid-2000. Major drilling will likely wait until the future of oil prices is clearer.
- West Africa: Deepwater will continue to be developed in 2000. Angola is planning to shoot its new deeper-water blocks. The discoveries of 1999 will move into the development phase keeping equipment busy through out the year.
- Russia: Russia's opening in the early 1990's has turned into a rout. Most companies that invested significant money have found that it has vanished with little or no way to recover the principal, much less generate a profit. Russia will see a continuing drop in foreign oil investment until the political and contractual problems are resolved. The problems are difficult and will take many years to reach stability.
- Caspian Sea: The Caspian Sea is a special case, but it is not free from political turmoil. New pipelines are being constructed to carry both oil and gas. The eastern European markets are receiving small quantities of this oil now with more to come. Major new oil flows must wait until the pipelines are in place in another few years. Exploration and drilling in 2000 will be minimal. Russia remains a long-term play.
- Asia/Pacific: Asia's recovery from recession will gain momentum in 2000 and will permit the national oil companies to spend more supporting exploration and development plans. The major question mark is Indonesia, which continues to have political turmoil and is suffering a slow recovery. The nation still has not acted on necessary financial reforms to encourage market stability and increased foreign investment. Oil exploration in Indonesia should remain steady, and may grow in deepwater and frontier areas.
Long-term demand growing at 2.6%/year
Matthew Simmons and his team at Simmons & Co International presented the significant challenges confronting the oil & gas industry at the firm's annual Oil & Gas Outlook Seminar. The long-term demand for oil is solid and growing at around 2.6%/yr (excluding the former USSR). Supply is the sticking point with non-OPEC supply growth stalled and experiencing 16%/yr depletion rate.
The short message is that the industry needs more drilling. The longer message is that because of incorrect supply demand numbers from the International Energy Agency (IEA) "paper barrels" were traded that dropped the price of oil. This removed capital from the industry preventing it from addressing the long-term growth in world oil demand. The industry now faces a significant challenge in meeting world oil demand over the next ten years.
For the oil service sector a significant period of expansion is immediately ahead. Strong oil & gas fundamentals are driving increases in E&P cash flows with renewed spending to follow soon. Simmons' updated hydrocarbon demand model projects a total demand growth rate of 2.5%/yr on a boe basis. This yields a world demand total of 119,390 MMboe for 2000; 134,560 MMboe for 2005; and 152,500 MMboe for 2010.
The November 1999 through March 2000 time period will be critical for world oil supply. OPEC will maintain price discipline because it fears the $10/bbl oil price experienced last year. Higher prices and growing demand will continue into the next year and drive activity.
For the domestic US market, natural gas will be an increasingly important portion of demand. Growing electricity demand and the need for "clean" fuels to generate power will drive natural gas drilling.
Assumptions underlying the 1990's oil industry were false. Technology has increased the depletion rate and produced a "treadmill" effect as companies more quickly extract oil and gas from reservoirs. Depletion continues to remove supplies faster than the industry can replace them.
Opportunities in 2000
Trend: For public companies, higher price/ earnings multiples await those that can gain size. In a commodity business, the public will not pay or reward companies for secure oil resources, and a diverse market reinforces that position.
Impact: More majors will merge, but the stronger action in 2000 will be with the inde pendents. Larger companies will mean eco no mies of scale and collapse of redundancy. Portfolio high grading will place many proper ties on the market, and there will be opportuni ties to grow through acquisition. New technologies will open new reserves in old fields.
Trend: National oil companies will be forced to justify their reason for being, and those that survive will have to greatly improve efficiency and productivity to compete in a world com modity market in oil.
Impact: More national oil companies will either privatize or open their territories for outside participation. The process that began after the Soviet collapse in 1991 will continue into the century's last year.
Lower unit productivity
Trend: For merging entities, significant productivity drops will continue, resulting in another six months of internal "craziness" and one to two years before new momentum can begin building.
Impact: Merging companies will have to pro vide assurances to motivate employees and develop clear plans to focus worker efforts. For non-merging companies, an opportunity to advance will develop as merging companies stabilize.
Production and cash flow
Trend: Commodity markets demand high volume, ready availability, and low unit price. The return to supply/demand balance in the first half of 2000 will reinvigorate producer efforts to be the high volume supplier.
Impact: Efficient operations and the applica tion of appropriate technology will be employed to reduce time lags and further minimize frictions between different segments of the business. Greater control over the processes of the value chain will allow greater value extraction at each node.
Change and technology
Trend: The pace of change will increase, forcing people and systems to adapt, but line and field workers will not be able to see the direction of change because of the need to add value today.
Impact: Technology will remain a primary driver and advances in business systems will allow more operations to be monitored, controlled, and regulated. Networked communications systems will continue to expand, minimizing frictions and expanding the group mind to smooth the flow of raw, processed, and final products.
Trend: Employees at all levels are becoming stressed. Tools, the lack of ergonomics, and relent less goals/targets are burning out profes sionals, even as a compressing industry makes it difficult to attract talent.
Impact: Along with clearer goals, manage ment will have to set timeframes for system upgrades and support for workers as they adjust to new tools. This may require a longer upgrade cycle.
Employees must see the value in learning the new systems and have a useful stake in the change process. Management must begin developing the next generation of professionals.