At this time last year, the price of West Texas Intermediate was $34/bbl and the Henry Hub daily index for US natural gas was $6/Mcf. Suppliers were exclaiming that the recent rise in oil and gas prices had not translated into respective increases in the prices of their products and services. Now, the shoe is on the other foot.
Many service companies recorded record earnings for the third quarter of 2001, while oil and gas producers listed a fall in prices as the main reason for their decline in earnings in the third quarter. I suggested last year that the number one root cause of inefficiency in our industry, especially in drilling, was price cycles. Such cycles lead to decisions made because of cash flow considerations, which lead to single-year budgeting and further issues surrounding joint operating agreements, among the more obvious. Two years ago, at the annual International Association of Drilling Contractors (IADC) conference, I made several comparisons:
- The prediction of rig utilization (and oil & gas prices) can be compared to weather prediction. You know what the situation is now, and a good idea of what it will be tomorrow, but the only thing you know long-term is that it will change.
- Industry cycles can be compared to hurricanes, tornados, droughts, and times of surplus. As an industry, we should be able to anticipate these cycles and be prepared to react quickly to each in different ways.
When decisions are made
For the past 50 years, oil sold at US$17-23/bbl (in 1995 dollars) for 73% of the time, but the majority of our critical decisions in the industry were made in the 16% of time that the price was less (cutting projects, reducing workforce), or the 11% of the time it was higher (contracting a whole new generation of rigs, sanctioning marginal projects).
The reactions at either end of this price cycle exacerbate the problem at the other end, and the lag in the price of product and cost of production introduces other issues for us to manage. At either extreme of the price cycles, our collective efficiencies are adversely impacted:
- At high product cost, our development costs are high due to new people in the work force (consider drilling rigs coming out of mothballs) and because the unit price of products and services are high.
- At the lower price scenario, focus is lost due to cutbacks and uncertainty, leading to poor performance as well as poor practices, such as lack of equipment maintenance.
On the subject of price cycles and inability to predict, we have not only supply and demand, global economy, OPEC, the vagaries of weather, and the influences of national policies, but now we are dealing with trader speculation, which makes prediction truly impossible.
One year ago, I observed that there were opportunities to control costs in any environment, such as people, project management, technology, supply-chain management, and continuity of operations. But all of these factors look much more promising and easier to influence when the price of products is on the way up, rather than on the way down (as it is today). It is especially daunting when you consider the demographics of our work force, the basic conflict in goals between operators and suppliers, and the shift in funding and timing of technology development and implementation.
Today, we must find a way to combat these difficulties. For example, Apache's strategy of cutting back on high operating-cost environments and taking advantage of opportunities in low-operating-cost environments has served industry well.
The industry needs to find solutions to the conflicts between the goals of operators and that of suppliers, to improve the competency of the industry's work force, and to find more efficient ways to deliver the appropriate technologies to the field. The prize of industry leadership will go to companies that bring the most intelligent responses to these issues. As an example of a commitment to pursue these goals, Apache is preparing to spud a late-year well in 3,400-ft water depths in the Mediterranean Sea offshore Egypt. This well - Apache's first in deepwater - is a commitment to growth and the application of technology.
The firm is planning and operating the well with the help and expertise of our partner (BP) and service companies, most notably Halliburton Solutions Group. At this juncture, the project is on track and appears to be efficiently making the best use of people, technology, and supply chain management. If all goes well, I should be able to write in the future about our success in this venture.
Mike Harris is the Director of Wordwide Drilling for Apache Corporation. He began his career with Exxon's engineering research, in the area of chemicals, followed by drilling fluids and systems. Also, he held drilling management positions with Amoco, including Drilling Manager of the Netherlands, UK and US, and was Regional Drilling Manager for BP Amoco prior to joining Apache. He holds a BS in Chemical Engineering from the University of Arkansas.