Geopolitics, unconventional fuels to reshape industry

April 25, 2005
Current forces having potential to shape the future of the oil and gas industry-consistently higher oil and gas prices feeding on mushrooming energy demand, conventional oil supply limits, shrinking rig availability, continuing geopolitical concerns, and the need to retain critical industry knowledge-were the focus of speakers at an RMI-sponsored oil field forum in Houston Apr.

Current forces having potential to shape the future of the oil and gas industry-consistently higher oil and gas prices feeding on mushrooming energy demand, conventional oil supply limits, shrinking rig availability, continuing geopolitical concerns, and the need to retain critical industry knowledge-were the focus of speakers at an RMI-sponsored oil field forum in Houston Apr. 1.

“It is definitely a good time to be in the energy business, and especially the oil field service industry,” said Allen Brooks, managing director of Parks Paton Hoepfl & Brown.

“Since the start of this decade, the OSX [Philadelphia Oil Service Index] is up 62.1%, while the [Standard and Poors] 500 is down 19.6% [through Mar. 31].” He said oil field service company earnings and their stock prices would rise even further, provided there are no major global economic or geopolitical upheavals.

Geopolitical concerns, however, continue to color the industry outlook, said Brooks, noting that many of today’s hot spots “are ‘Middle East-centric.’ The issue confronting the industry is that the Middle East, with its high promise for more oil and gas, remains the most politically unstable region in the world.”

Demand vs. supply

The steadily rising demand for energy seems irreversible, with worldwide population in 2030 projected to be a third again as large as it is today, said Oil & Gas Journal editor Bob Tippee. Most of this demand growth will occur in poor countries, which will need to develop economically but will do so less efficiently than in developed countries, he said.

However, demand could “undershoot expectations,” moderated in part by rising prices and conservation, “which will happen,” Tippee said. To meet increasing demand, technological progress and growing knowledge about the subsurface will result in “nice surprises” in conventional supply, which currently is approaching its natural limits, he said.

In addition, the industry is introducing technologies to produce unconventional supplies economically, Tippee added.

“Elevated prices will improve the economics of energy forms previously too expensive to develop and produce,” he said. “We’re seeing this now” in the development of extra-heavy oil and synthetic crude from tar sands, commercial-scale plants that will produce high-quality liquid products from natural gas, and increases in the production of renewable sources such as biodiesel, wind, and solar.

“Deconventionalization means that an expanding portion of total energy supply will be a mosaic of many increments, many of them relatively small,” Tippee said. “We’re not used to that.”

Pricing power shifts

Brooks said the current era also is marked by a pricing power shift and new market conditions, which require more adjustments by the industry. He noted that the shift of oil pricing power in the 1970s from the Texas Railroad Commission to the Organization of Petroleum Exporting Countries is now shifting away from OPEC to large consuming countries such as China and India that are aggressively seeking new energy resources worldwide.

“Importantly, these countries are seeking these resources with their checkbooks and geopolitical agreements in hand,” Brooks said. For these countries, oil availability is more important than price, he said. “This is the most important new industry dynamic-the rapid economic and living standard improvement of 2 billion people.”

Tippee said China’s aggressive acquisition of foreign exploration-and-development rights under apparently extravagant terms are part of a trend he calls “renationalization.” It is manifest partly in the diminishing welcome to foreign exploration-and-development capital by major producers that, thanks to high oil prices, no longer think they need the money. “Russia and Venezuela leap to mind,” he said.

“So the competitive landscape for international petroleum investments is changing-and not for the best,” Tippee said, although he added that there is still a fast-growing industry for natural gas liquids outside of OPEC and Russia, and tremendous opportunities exist in that area.

Capex down

The industry’s upstream reinvestment rate currently is 15-25% below the historical average, said Paul Bragg, president and CEO of Pride International. Exploration and development capital expenditures to cash flow are averaging 53% in the 2000s, compared with 75% in the 1990s, he said.

Brooks said aging oil fields are requiring a shift in industry spending patterns and will demand more capital investment and new technology to fight accelerating production declines. “This will cause a spending shift away from exploration,” he ventured.

“Oil company capex spending increases this decade have been muted in the face of extraordinarily high commodity prices, keeping the ‘euphoria genie’ in the bottle,” said Brooks. This has resulted in uneven activity across the oil field service industry. He said this decade’s “wimpy” 5-7% increase forecast for 2005, averaging about a third of the increase experienced in the 1970s, is puzzling.

“Either the industry doesn’t believe prices will stay up, or they have few attractive new oil and gas investment opportunities-or possibly they are more concerned about Wall Street’s treatment of their share prices,” Brooks postulated. He said it is probably a combination of all three.

“The greater use of equity-based compensation for executives in recent years may be the biggest inhibitor of capital spending, something that is not likely to change anytime soon,” he concluded.

Brooks said that capital today claims to be smarter than in the 1970s. “It appears to be focused on cash returns and less-risky business strategies rather than ‘investment home runs,’ and that causes managements to alter their capital allocation thinking.”

Downstream prosperity

Another industry sector that, surprisingly, is prospering in the face of high oil prices, is the refining business, said Tippee. Among the reasons for this is a capacity squeeze born of steadily rising consumption; the recent shedding of old, inefficient capacity; and the high costs of adding capacity, largely related to environmental regulation.

“An oil market that requires growing amounts of light, low-sulfur products is rewarding past investments in conversion capacity-the ability to upgrade the distillation residues for which demand is falling and to process heavy, sour crude,” he said. This is important to the upstream sector because “profitable refiners can pay more for crude oil.”

Rig constraints, rates

The international land rig count-at 2,745 rigs working-is “pretty much at full utilization,” said Bragg. In the Gulf of Mexico the number of jack ups available for operation is reduced by about 50 rigs or so, he said. Many deepwater discoveries are now moving toward the development stage, and the demand for drilling rigs in water more than 3,000 ft “is exceeding supply for at least the next 3 years,” he said.

“Today about 26 new orders are confirmed, mostly for 2006-07 delivery,” Bragg said.

The high rig utilization rate is putting pressure on rates, he added.

“Deepwater rig rates have moved up dramatically over the last year. With substantially higher operating costs today and really higher production costs, I expect to see these rates continue to push upwards,” Bragg said.

Brooks said the industry is not adding enough new rigs. “Although new drilling techniques are making existing rigs more productive, drilling contractors remain hesitant about adding significant additional rigs to the market for fear of driving down rig day rates, and hence their profits,” observed Brooks.

Developing technology

Every year exploration results improve, said Mike Bahorich, Apache Corp. executive vice-president for E&P Technology. Bahorich credited technology with stimulating that success.

Casing drilling and underbalanced drilling technology have been particularly instrumental in Apache’s successes, he said. After implementing casing drilling technology in 2003 Apache increased natural gas production to 750 MMcfd from 250 MMcfd.

“Apache has seen three times the IP using this technology,” he said.

“For the deepwater players, a very interesting technology is Controlled Source Electromagnetics,” which he said also has improved exploration success.

Bahorich said Apache boosted its own reserves to 9.6 bcf in 2004 from 1.8 bcf in 2000, and its North Sea production increased 80% in 2004 over 2003.

Bahorich said that oil service companies have assumed the lead in technology development that, 8 years ago was held by oil companies. He said the industry needs a new model in technology development. “We’ve done some good things, but I think we can do better.”

Loss of knowledge, workers

Brooks said one looming problem for the industry is a shortage of labor, including technical talent. The industry’s geologists, geophysicists, and petroleum engineers are reaching retirement age, and many of today’s graduates are foreign nationals who will head home to local jobs after graduation, he said. “Employing technology to maximize available technical talent has become critical.”

Peter Bernard, president of Landmark Graphics Corp., said that current petroleum engineer enrollment in the US will turn out fewer than 435 graduates.

Bahorich said, “We work in the world’s largest industry, an industry that has done more to bring up the standards of people around the world than any other industry. We’ve got a lot to be proud of.” He said the industry “needs to work with the universities to get our message out.”

Much work also is needed to capture and document knowledge that will otherwise be lost when experienced personnel retire, Bernard said. The average age of E&P personnel in 2007 is projected to be 55 years of age, and many of them now have the financial wherewithal to retire at earlier ages, he said.

“As a result of practices in the last few decades, upstream oil and gas companies will likely lose more than 50% of their employees by 2010.... That is only 5 years away,” Bernard cautioned.

Bernard urged companies to begin capturing and documenting the knowledge and expertise of their experienced employees and to initiate training within the organization. Firms need to involve IT and human resources personnel to identify what knowledge is at risk, prioritize the most critical expertise, and create manuals containing those processes, techniques, and actions needed to keep the company running. Landmark, he said, has 35 employees devoted full-time to this pursuit.

“We believe you should treat this as a strategic business initiative,” Bernard said. “We should have done this years ago.”