Oil industry challenges include chance of OPEC misstep

Challenges for an oil and gas industry that must retool for growth include a chance the Organization of Petroleum Exporting Countries has misread the market.

"OPEC may be underestimating the weakness of demand," said Fereidun Fesharaki, president of FACTS Inc., Honolulu, at the Middle East Petroleum and Gas Conference in Dubai last week.

OPEC crude prices in the middle of the group's target range of $22-28/bbl will hurt demand "and could set the market up for a big fall," Fesharaki warned.

Other speakers outlined a number of industry challenges, including financing growth, responding to pressure for environmental regulation, and organizing companies for work in a rapidly changing business.

Demand weakening

Fesharaki pointed out that last year's global demand growth of 700,000 b/d was the lowest in nearly a decade. Three-fourths of the increase occurred in Asia. Of that increment, China accounted for two-thirds.

The market has become vulnerable to disruption of Chinese demand. Disruption could come from China's entry into the World Trade Organization or from economic restructuring but likely would be short-lived, Fesharaki said.

He projected global demand growth this year at 800,000-900,000 b/d, of which about 650,000 b/d will occur in Asia, where economic recovery "remains fragile." Other Asian economic concerns include the stagnant Japanese economy and Indonesia's economic and political problems.

Fesharaki said refining capacity will remain in surplus in the East-of-Suez region, where China and India have become major product exporters and where improvements to refining margins last year resulted from temporary plant outages (see related story, p. 29).

"The situation looks extremely difficult for 2-3 more years," he said.

Transportation grids developing in Asia and the Middle East, Fesharaki said, will reshape the East-of-Suez natural gas market.

South Korea will be the most important LNG market. An international spot market for gas will develop as long-term LNG contracts expire and as the US increases imports.

Financing growth

Archie Dunham, chairman, president, and CEO of Conoco Inc., Houston, pointed to "structural underinvestment in the energy industry" as a reason for recent price gains. Company shareholders, he said, lack confidence that funds invested in oil and gas projects will produce sufficient returns, and thus [they] treat share buybacks more favorably than investments in operations.

"The irony is that, if this trend continues, we will not attract sufficient investment in our industry to satisfy global energy needs," Dunham said.

He said the industry must make new investments totaling $1 trillion worldwide during the next decade to develop enough petroleum reserves to meet expected need.

In addition to investing amid uncertainty, the Conoco chief said the industry faces challenges in the areas of technology and political and social issues.

Under the latter category, he called for adjustment in the relationships between consuming nations and countries that host hydrocarbon development by international companies.

Host-country governments, he said, must offer stability conducive to investment, respect for the sanctity of contracts, fiscal regimes that encourage investment, and reasonable and consistent regulations and environmental policies.

Consuming nations also must be stable and reliable, with "coherent and consistent energy policies," Dunham said. He singled out two moves by the US as "bad policy": tapping the Strategic Petroleum Reserve "for the sake of domestic political considerations" and unilateral sanctions.

The Phillips view

James J. Mulva, chairman and CEO of Phillips Petroleum Co., Bartlesville, Okla., offered a list of challenges similar to Dunham's-financial, technical, and public policy issues and the possibility of a severe economic downturn or political disruption.

"However," he said, "I believe the overarching challenge we face is to ensure that oil and natural gas remain the world's fuels of choice."

Public confidence in the industry and its products has eroded for the past 20 years, Mulva said.

"We must continue to demonstrate that we can develop and transport energy in a safe and environmentally responsible way and continue to produce the ever-cleaner fuels the public demands."

Mulva explained his company's recent large acquisitions by saying, "It was clear that if we were going to continue to compete as a fully integrated company, we needed to build a larger, stronger corporate structure-one that would enable each of our four business lines to compete against the very largest players in their industries."

Last year, Phillips committed its midstream gas business to a joint venture with Duke Energy Corp., Charlotte, NC, and its chemical business to a joint venture with Chevron Corp.

It then acquired ARCO Alaska for $7 billion and more recently agreed to acquire the independent refiner Tosco Corp., Old Greenwich, Conn., for a similar amount.

Mulva expects that by yearend the company's asset base will have increased to $36 billion from $15 billion last year and its debt-to-capital ratio will have fallen to about 35%.

Further investments will target exploration and production, the Phillips chief said. With the Tosco acquisition, the company's assets will be split about evenly between upstream and downstream. The target is 60-65% upstream.

Middle East view

Executives from two of the Middle East's national oil companies offered lists of challenges slightly different from those voiced by their commercial counterparts.

Abdulaziz F. Al-Khayyal, senior vice-president, international operations, of Saudi Arabian Oil Co. (Saudi Aramco), Dhahran, cited environmental issues, competition from substitute energy sources and technologies, the need for cleaner and improved fuels, the public image of the oil industry, and the pursuit of organizational excellence.

Noting the 95% reduction in emissions from vehicles manufactured at present from those of vehicles made during the 1960s, Al-Khayyal turned his attention to global warming.

"The uncertainties associated with climate change science and long-term predictions are serious enough to warrant caution against sweeping policy measures," he said. "Such caution is also justified because the economic implications of policy measures such as the Kyoto Protocol can be devastating for world economies, particularly the developing nations and the countries whose economies depend almost solely on their hydrocarbon resources."

Nader Sultan, deputy chairman and CEO of Kuwait Petroleum Corp., Safat, Kuwait, focused on the challenges of market volatility and rapid change-including the pressures of environmental issues and ever-sharper shareholder demands.

"The oil business is not for people who want a quiet life," he quipped.

He said business leaders in the current environment exhibit market responsiveness, operational diversity, technological adeptness, and organizational fitness.

Operational diversity, he said, is the ability "to shift shape as markets demand." And organizational fitness is the ability to "maximize competencies rather than physical assets."

Sultan noted that for KPC, revenue growth from oil production is beyond the company's control because of OPEC quotas and price uncertainty. The company therefore seeks growth from upstream projects abroad and from downstream projects, where the potential is "far greater."

Because of its interest in developing a chemical industry, KPC affiliates are discussing imports of natural gas from Qatar and Iran, Sultan said. Domestic gas is mostly associated with oil, volumes of which are limited by OPEC.

And it is in the context of technical adeptness that KPC is discussing participation in Kuwaiti upstream deals by foreign companies.

Fields in the north of the country offer great potential but present difficulties KPC hasn't encountered, especially in the handling of water and management of corrosion.

"To access the right technological and management skills," Sultan said, "we are turning to the offshore expertise of international oil companies."