Petroleum industry opportunities persist despite downturn

Anne Rhodes
Associate Managing Editor-News

Contrary to the opinion of some observers outside the industry, petroleum does have a future, and that future is full of opportunities and challenges.

So said several speakers at Cambridge Energy Research Associates' annual CERAWeek conference, held last month in Houston.

Despite the current downturn, many in the industry remain optimistic about opportunities for growth and profit in oil and gas. One reason for this optimism is increasing access to reserves in areas that were formerly off-limits to private firms. Another is technology.

Nevertheless, it is a universally accepted fact of life in the increasingly global petroleum industry that companies must make adjustments in order to thrive in a future that promises to hold myriad economic and political challenges.

Globalization

Exxon Corp., the International Energy Agency, and the Energy Information Administration all expect oil's share of energy demand to remain essentially constant, at 1996 levels, through 2020, says Jon Thompson, president of Exxon Exploration Co. And all three predict increases in gas's share of demand.

The potential for future growth in oil and gas demand lies in developing countries. However, said Adri n Lajous Vargas, director general and CEO of Petroleos Mexicanos, "Recent economic conditions in emerging economies have limited the growth in oil demand and frustrated the expectations of industry.

"Unfortunately, the prospects for economic growth in some of these countries are being affected by the deterioration of the terms of trade and other serious structural obstacles. International and national, and privately and state-owned, oil companies will have to prepare themselves in order to serve these emerging markets."

Thompson says he is excited about the petroleum industry's future because private companies have ever-increasing access to energy resources, particularly in these emerging markets. Before 1990, he says, the private sector's access to remaining undiscovered potential oil and gas resources was about 35% of the total. By 1998, that access had risen to about 80%, according to Exxon's estimates.

"The fall of the Iron Curtain opened new opportunities," said Thompson. "Other centrally planned economies, like China and India, have opened their petroleum sectors. Other countries, such as Venezuela, Bolivia, and Brazil, decided that opening resource development to private capital would bring added impetus to their economies.

"And there could be more good news on the horizon, with Kuwait and Saudi Arabia considering private industry participation in their upstream sectors."

Exxon hopes it will eventually have the opportunity to consider participating in Mexico's upstream as well, says Thompson, in addition to countries currently subject to U.S. or U.N. sanctions.

Lajous also sees increased access to these oil resources as reason for optimism: "Despiteellipseshort-term conditions, there is a deep-rooted certainty regarding the large magnitude of undeveloped hydrocarbon resources that can be produced more efficiently in the mid-term. The extraordinary potential of (Persian) Gulf countries-the low-cost, low-risk potential of Iraq, Saudi Arabia, and Iran, among other countries-and the opportunities in the Caspian all point in this direction.

"Many other producing areas in the world have not had adequate access to capital, technology, and modern managerial skills during the last 20 years, inhibiting a more rapid development of their resourcesellipseLower prices and revenues are tempting some large producers to open their oil industry to outside investment under various contractual schemes.

"In some cases, mounting economic pressures impose themselves on a weak industry infrastructure in need of maintenance and rehabilitation. Access to capital and technology has been impaired for a long period of time," said Lajous. "Under these circumstances, foreign participation is seen as the only way to maintain and increase output, and thus revenuesellipse.

"Contractual negotiations are taking place over the whole range: new concessionary agreements, joint ventures, production-sharing agreements, buy-back and risk service contracts. Elements of rent are necessarily redistributed through these mechanisms. But, more importantly, economic rent is lost to the weakening of supply management that these contractual schemes imply.

"It is not yet clear which of these arrangements will prove successful in large producing countries. Many, many restrictions prevail: sanctions, hard economic realities, and political risk."

Technology's role

While Thompson sees these new opportunities as reason for excitement, he doesn't expect the path to be easy.

"The new opportunities we face are often located in hostile physical environments such as the arctic and deepwater. Many are in remote locations, far from existing infrastructure. They often present new, difficult challenges that drive us to try to extend the limits of our technologies," he said.

"Many of these projects are huge and capital-intensiveellipseAnd, finally, because of these factors and others, they involve a greater degree of technical risk and more cost uncertainty.

"Under these conditions," said Thompson, "there is greater risk that prices prevailing in the market will not be sufficient to sustain the commercial success of these projects." This is why it is imperative that the industry maintain its research and development and technical expertise, even during the down times, says Thompson.

"We need to always keep in mind the long-term nature of this industry and the difficult and complex nature of the challenges we face. While we cannot count on technology to cure all our future ills, it is still the lifeblood of the industry.

"Moreover, we also need to ensure that the industry maintains a sufficient supply of technical expertise, both in terms of experienced personnel and a steady supply of new talent to train and develop. Technology alone never found any oil or gas. It's successful application of technology that counts."

Simon Kukes, president and CEO of Tyumen Oil Co., also sees technology, and its application, as integral to success in the future. "Oil is heading for an era of cost-based pricing and is possibly already there," he said. "Cost and price are chasing after each other on a downward slope, and, as they do, we'll be driven to cut our costs further to remain competitive."

This is done on three fronts, he says: people, technology, and goods.

"I acknowledge the important role technology has played in lowering costs, but I also think this role may be more limited in the future. The fact is thatellipsefinding and production costs have fallen dramatically." In only 15 years, he says, they have been reduced to $6/bbl from $25/bbl.

"But how much further can they fall?," he asks.

Kukes sees limited potential for further technological breakthroughs that will dramatically change how and where we explore, produce, and refine oil and gas: "It is not technology that will count in the future as much as managing technology."

While technology and increased access to reserves are reasons for excitement about the industry's future, some serious concerns remain for Thompson.

"I'm most concerned about governments over-reaching, with respect to the legal, contractual, and fiscal terms they're trying to impose," he said. "As great as the advances in technology have been, there is a limit to how much further they can reduce costs to help industry cope with an environment of low prices and high total government take."

For this reason, Thompson says he is worried about whether all the opportunities becoming available will fully deliver their potential benefits to both the host countries and the private operators.

Despite the opening to new areas, the fiscal terms offered by many countries-including Russia, Venezuela, Brazil, and the U.S.-are not adequate, he says. He affirmed that Exxon would walk away from deals that provide inadequate incentives for E&P.

Industry's resiliency

Phillip Carroll, chairman and CEO of Fluor Corp. and former CEO of Shell Oil Co., put a different spin on the challenges that increased opening to new markets brings. While he agrees that this opening delivers new opportunities, and that those opportunities are exciting, he says the current slump can be viewed as a warning to be careful what you wish for.

"Welcome to 'Marketworld,'" said Carroll. "Markets are less predictable and sometimes crueler than regulatory agencies."

CERA Pres. Joseph A. Stanislaw agrees. "The market is relentless," he said.

But Carroll believes the industry is already learning to adjust to changing market conditions. "I think that the industry is already moving aggressively to restructure itself and to cope with the current but temporary difficulties," he said.

"The new entities being createdellipseare going to produce great new institutions that are more capable of serving the world and providing energy than in the past. They will be richer not only in financial resources and strengthellipsebut there will be great synergies in combinations of technology and know-how, and in human resources, that they can bring to bear on what will be increasingly challenging technical problems of finding, producing, and delivering the oil and gas products to the world.

"I also am very upbeat about the future of this industry," said Carroll. "Sure, it's going to be tough for a while, but in the long run, the industry will configure itself, structure itself so that it is flexible, resilient, and able to move quickly in what will always be, now, a volatile and changing environment that markets represent."