CERA: CEOs say IOCs have room to grow in expanding world markets

Sam Fletcher
Senior Writer

HOUSTON, Feb. 11 -- Despite huge challenges, major oil companies still have room to grow in a more competitive international markets, said top executives of such firms at Cambridge Energy Research Associates' annual energy conference that opened Tuesday in Houston.

Corporate growth "is not an end unto itself. Our industry is here to serve the world's energy needs, and our efforts will only be sustainable if we deliver both growing returns and value in conjunction with growing energy supplies," said James J. Mulva, president and CEO of ConocoPhillips, in a luncheon speech Tuesday.

Major international oil companies (IOCs) have to deliver growth for investors without harming profitability "in a tough competitive environment where they are facing a whole range of challenges: steep production declines in mature basins, technological challenges in frontier areas, geopolitical risk in non-[Organization for Economic Cooperation and Development] countries, tough new competitors in the shape of national (or ex-national) oil companies, and so on," said Thierry Desmarest, chairman and CEO of Total SA, in the opening address at the conference.

However, some question whether major oil companies can keep growing, Desmarest noted. "When you look at the size of the five supermajors today, producing between 2.5-4 million boe/d, you think: Can these giants grow? And there are, of course, a few examples of supermajors, which, on a pro forma basis, have not grown their production at all in the last 10 years," he said.

The five largest major oil companies together command "only 15% market share of the world oil and gas production, so they should have scope to increase market share. And even if demand growth in our industry is relatively modest, we need, because of natural declines, to replace about half of today's production in the next 10 years, so there should be no shortage of projects for a well-placed company," Desmarest said.

Signs of growth
Like many at the CERA conference, Mulva sees optimistic signs for industry growth. "The global economy seems to be gaining some traction, and expanding economies obviously need more energy" he said. "It seems that the US economy is on the move, and some European economies likewise seem to starting to pick up some speed. Worldwide [gross domestic product] growth for 2004 is projected to be 2.7%, the second highest rate since 1990. The total growth rate in 2005-09 is forecast to average about 3%, which exceeds the average in the last 5 years."

Moreover, Mulva said, "Worldwide oil consumption is predicted to rise more rapidly in the next 30 years than it has in the past 30 [years]. By 2030, overall demand is predicted to be 60% greater than it is today, and gas demand will more than double."

He said, "Boosting [oil and gas] production to meet increased demand will be a challenge in itself. But on top of that, our industry faces significant progressive declines in fields already in production."

Natural production declines range from around 11% in Europe, 9% in the US, 4-6% in the Middle East, he said. As a result, said Mulva, "The International Energy Agency forecast that our industry is going to have to develop about 200 million b/d of new production over the next 30 years. And about 85% of that new capacity is going to be required to simply offset the natural production declines that we currently have in the field."

Over the next 30 years, consumers will be looking to the oil and gas industry "for most of their energy supplies," said Mulva. "And they want it when they want it and at a price they can afford. In short, consumers are demanding that we not only provide more supplies, but that we find and deliver them more economically and thereby constrain the growth of energy prices," he said.

Profitable growth "is going to require two things, which are more important than ever in our industry," said Desmarest. "The first is capital discipline. We need to be sure in our project selection that the rewards we can expect from our investment projects, based on a prudent estimate of future hydrocarbon prices, justify the risks we are prepared to take.

"And second, we need to control our costs," he said. "There is always a risk when the oil price is high, as it is today, that we lower our guard and let out costs spiral out of control. We already see this happening in some companies' recently published results, and we really need to be vigilant about this."

New supplies, infrastructure
Mulva sees "three issues that I think will challenge industry as it ramps up for growth—access, infrastructure, execution."

He said, "The industry can't do the job expected of us if we do not have adequate opportunities to search for and develop new reserves. This is especially obvious for [IOCs], which as a group controls only about 6% of the world's oil reserves, and most of those are located in the more mature traditional regions of the world."

The search for new energy supplies has taken major international companies into regions "that are rich in resources but also associated with significant risks—technical risks, commercial risks, geopolitical risks," said Mulva. "Over the years, oil companies have become quite skilled at mitigating risks and managing around uncertainties. But what is changing now is the magnitude of the projects being planned and developed against the backdrop of these ongoing uncertainties."

Building adequate infrastructure for commercial development of international energy projects "is not just a question of know-how," said Mulva. IEA has forecast that the industry will have to spend nearly $2 trillion on oil and gas infrastructure over the next 30 years.

"My concern is how much larger and more complex the supply chain will become and whether that supply chain can be assembled fast enough to meet anticipated consumer demand," said Mulva. That's particularly vital in the burgeoning international market for liquefied natural gas, he said.

"Close to half of all investment in worldwide gas development will be directed toward infrastructure improvement and expansion," said Mulva. "Global gas trade is expected to double by 2020. By then nearly a third of natural gas use worldwide will be traded internationally." That will require "the largest, most complex supply chain in history," he said.

Companies' future success will depend on their ability to execute those future large projects, he said. "Consumers, shareholders, and other stakeholders really have no mercy for poor performance. They expect us to deliver regardless of the technology that is required, the infrastructure needed, or the risks and labors of the operating environment," Mulva said.

Capital spending, reserves replacement
Latest industry surveys indicate worldwide exploration and production expenditures will increase about 4% this year, with international spending to rise about 6%. "Upstream spending may attain record highs for some of the companies in the industry. However, I think the drive to reduce costs will continue in order that we get mileage out of every dollar that we spend upstream," Mulva said.

ConocoPhillips plans to hold its 2004 capital budget to about the same level as last year. "But that capital discipline should not suggest that we are slowing down or postponing projects that we believe will deliver attractive returns," said Mulva. "Through the end of the 2006 planning period, we intend to more than replace 100% of our production and to grow our production at around 3%/year."

To continue growing at its present rate, Total must replace its production by 140-150%/year. "If you take our annual exploration spend of around $750 million and our finding cost since the merger of around 75¢/bbl, which is among the best in the industry, you can see that, through the drillbit, we have been generating about a billion bbl of reserves a year, which is roughly what we produce today. That means we get a 100% reserve replacement rate through exploration and revision of past discoveries," said Desmarest.

However, he said, "I do not think we can go materially beyond 100% replacement either by spending more or by driving finding costs even lower, and I doubt if many of our major competitors can either." Desmarest said, "It is clear the other 40-50% [of production growth] is going to have to come from areas other than exploration."

He said, "One thing we are paying a lot of attention to now is getting the absolute maximum out of our existing acreage. I think this is something [US producers] are very good at here in the mature basins of the Lower 48. For Total, growing fast in new frontier zones, it is something we have historically paid less attention to, but it has now clearly become a major focus for our efforts."

Another source of growth "that has been very important for Total in the past is deal-making to help producer countries get the best out of already identified fields. This involves having the imagination and experience to devise innovative contracts, which make sense both from a host country and an oil company standpoint and being able to demonstrate to host governments and national oil companies that we can really add value through our technology, finance, and project management capabilities," he said.

Key growth areas
One key area for the future will be the Middle East, even if "some countries are not opening up to major oil company investment as fast as was hoped at one time," he said. Total currently is active in all Middle East oil and gas producing countries, except Iraq. "It is our intention to be active there as soon as the safety and legal frameworks are in place," said Desmarest.

The former Soviet Union is another important area for the major oil companies, with multibillion dollar investments needed "around the Caspian Sea" to "develop super-giant fields and build the necessary logistics to bring these landlocked barrels to market," Desmarest said.

"Inside Russia itself, things are a bit more complicated," he said. "The reserve potential is clearly there, but different companies have different ideas how best to proceed in what is a complex and fast-changing regulatory environment, either by forming alliances with existing Russian oil companies or by developing major grassroots projects such as Vankor and Shtockmanovskoye, two giant oil and gas fields on which we are conducting preliminary work."

He said, "Given the size of the financial commitments involved and the cocktail of risks that these interesting opportunities present, this seems a play where the majors have a significant competitive advantage."

Desmarest sees natural gas, particularly LNG, as another growth area. "Because of its ecofriendly qualities, gas demand is expected to grow strongly in most geographic areas, and with declining indigenous supply in both North America and Europe, imports will grow even more strongly," he said.

"LNG is a classic activity for the majors, requiring the development of large-scale projects marrying the development of reserves, liquefaction facilities, transportation, and marketing through regasification plants, all very capital-intensive requiring the level of skills and financial resources the majors can mobilize," Desmarest said.

Nonconventional oil is another promising growth area for the majors "if hydrocarbon prices remain high," he said. That would include both extra heavy oil deposits in Venezuela and Canada, "and the various uses of methane gas to produce liquids for motor fuels or chemical feedstock."

Mergers and acquisitions
Desmarest is less sure about growth through acquisitions, however, "either by smaller, targeted acquisitions or by going further along the mega-merger route." He said, "for a company of our size, acquiring a small company, unless it gives us access to some new opportunities [that] we would otherwise be cut off from, is unlikely to be a material and may therefore be a diversion of management resource."

Total merged with Petrofina SA in 1999 and later with Elf Aquitaine SA to create "the world's fourth largest publicly quoted oil company," said Desmarest.

"Clearly, one major focus of the mergers was cost-cutting synergies, particularly in labor-intensive areas such as refining and marketing and in overhead burden. In Total, these synergies have allowed us to create a European downstream leader out of three more-or-less subcritical players and have contributed to a total self-help program of around $5 billion/year in extra pretax profit since the two mergers of Total with Fina and TotalFina with Elf, so clearly that has not been bad for profitability and value," he said.

But another driver behind those mergers was creation of a major E&P company "with the technological know-how and the financial muscle to take big shares in very large-scale projects, with a cocktail of exploration risk, technical risk, geopolitical risk, and (in the case of gas particularly) market risk, which may well put them out of the reach of smaller players," Desmarest said.

The combination of the companies' technological and geographic areas of expertise also gave Total "an unrivaled exposure to new industry hot spots," he said. As a result, said Desmarest, "Our 2003 production is up 23% on our 1999 premerger pro forma numbers, and we expect in the next 5 years to deliver about the same amount of growth again."

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