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CANTOS Transcript: National Oil Companies squeeze energy giants

EXTRACT: Shell has been having major problems with cost increases in a number of their projects around the world. For instance, in the Sakhalin LNG project earlier in the year they had to revise their costs from $10bn to $20bn.


Answers by Adrian Jackson, Energy Analyst, Investec 

Why do you think the super majors are facing some rather unfavourable news flow at the present time?

The thing is now with the majors is that obviously with high oil prices it’s very much in the mind of the public. They go to the petrol pump they see very high prices. They have high energy prices, gas and electricity prices at home. So these high prices are very much in their minds and they relate that back to the majors because that’s the public face of these high energy prices. So if you look at any adverse news coming out, immediately the press and the public will look at the super majors.

Obviously, the recent news in Alaska with BP and the incident with the pipeline there, they’re obviously going to get a lot of public attention on that fact. Equally, when we have geopolitical events such as in the Niger Delta where the large majors such as Shell and Chevron are operating, there’s an angle there that the public is interested in. They wonder why are they making, what they perceive to be very large amounts of money and high profits, and yet they still have these problems both on the safety side and also on the operational side.

So the super majors are the public face. They can’t really relate to the National Oil Companies like Saudi Aramco, the Kuwaiti National Oil Company, because they don’t have an immediate interaction with them on a day-to-day basis.

Is it your view that these super major oil companies are facing an unprecedented threat from their smaller competitors? What example would you give of this?

Certainly the smaller companies are providing some competition in certain areas to the super majors, but actually I wouldn’t say they’re the main threat to them. It really is the fact that the National Oil Companies who are the big resource holders are now not allowing access to their reserves. Now a lot of the Middle Eastern countries have held those reserves for themselves for some time now. But what we’re getting is other countries that are beginning to make it harder for the super majors to gain access to their resource base. So in a way they’re the major competitors because they are expanding their production at the expense of allowing the major oil companies to come in.

Now to of give some examples, we’re seeing a sort of creeping nationalisation happening in a number of countries around the world. Russia, we’ve seen what’s been happening there, that the state has gradually been taking control much more into their own hands. They’ve recently had a sub-surface law that doesn’t allow foreign companies to own a majority of the assets. So they are restricting in Russia the access of the majors to those reserves. Also, you’re seeing that the taxation rate, the marginal taxation rate in Russia, is increasing quite considerably.

Other countries, Latin America, obviously there’s been a lot of action in the past year with Venezuela obviously increasing their fiscal terms. A lot of the major oil companies do have operations down in that part of the world and that is eroding their capacity to make money as well as increase their production rates. And then we’ve seen some assets stripped away like Occidental’s assets in Ecuador were taken back by the state and similarly in Bolivia we’ve seen a number of assets of Petrobras being taken back by the state.

So you are seeing the major resource holders and the National Oil Companies actually making it harder for the super majors to get access to the reserves required to grow their production.

Now, also in other areas we’re seeing that you are getting indigenisation of local oil companies. A good example of that is in Nigeria which had been a preserve for the major oil companies. The big companies like Shell, Chevron and ENI have for many years been producing large volumes of oil from Nigeria. We saw earlier in the year they had, in their first public license round, a lot of local companies gaining access to offshore blocks for development. So you’re also seeing some competition there because in Nigeria they want to encourage their own local industry to grow and not just give the reserves to Western majors.

Also I think one of the major reasons for this is that there has been over quite a long period of time a technology transfer from the major oil companies into the service sector. So many years ago when the super majors went out around the world to develop resources on behalf of foreign governments, there was no real alternative. But what you do see now is that foreign governments now can develop their own industry and call on the service sector to get a lot of expertise. So there has been this transfer of technology from the oil majors to the service sectors which is then accessible by any one who contracts their services.

So those, I think, are the major reasons why you are seeing it harder for the super majors.

Now at the margin, the smaller companies do impact on the major companies. They’re taking perhaps the medium sized to smaller assets, but they tend to be less material for the majors.

So you have to see really the NOCs who control the reserves, I think are the major threat and that’s who the major oil companies have to deal with.

So how can the super majors then present themselves as a more attractive option to the National Oil Companies?

I think there is definitely a role for the super majors because we are still dealing with very large complex developments and operations. And if the majors can demonstrate that they are best in class and so they can be the lowest cost, most efficient, safest operator of facilities, then they still have a role there. Similarly, with new developments, these developments are getting larger in scale, more complex as technology improves. So they’re getting more complex so you need a project manager who can manager these complex projects without significant cost overruns.

Now, where we see recently on both of those points where a couple of the majors have stumbled in their public images, obviously, BP’s recent Prudhoe Bay operations were not leading-edge operations because they were having trouble, obviously, with the corrosion in the pipeline. So they weren’t operating those facilities at the best manner. So that’s where they have to keep their profile. They have to demonstrate that they are the best operators. Similarly, we saw with the new developments, Shell has been having major problems with cost increases in a number of their projects around the world. For instance, in the Sakhalin LNG project earlier in the year they had to revise their costs from $10bn to $20bn.

So those are two areas where the majors have to demonstrate that they are the best operator and developer of hydrocarbon assets. Now that’s getting pretty cutthroat in that area because a number of the contractors are moving into that space as well. Not long ago we heard that Dubai were outsourcing the management of their production fields offshore to Petrofac, which is a recently listed company on the UK exchange. And they will operate. They’re an engineering firm and they will operate those facilities. Previously, those fields had been operated by ConocoPhillips. So you’ve beginning to see a migration to the service sector again where the perception is that they have the expertise and they are probably a lower cost, efficient but still safe operator.

Where they have to compete really, in my view, is in the technological aspects of the sub-surface. So where they can squeeze more oil and gas from existing reservoirs and they can demonstrate this sub-surface expertise. There are a number of companies that are actually already doing well in that area. For instance, Occidental has got expertise in heavy oilfields and they’ve developed this in the Permian Basin of the US and in California where there has been heavy oils and they’ve been applying technology to enhance the recovery through steam injection to reduce the viscosity of the oil in the reservoir and enhance the recovery. But also from carbon dioxide floods which also enhance recovery from these oilfields.

So they grew up that technology in those basins in domestic US and then last year they acquired Vintage Petroleum which gave them access to reserves in Argentina which were heavy oil reserves which they could see they could enhance the recovery and gain additional reserves. But more importantly, you are seeing that they were brought in to the Mukhaizna Field in Oman to replace Shell who was the license holder. This is a very heavy oilfield which had only been producing about 10,000 barrels a day. Now, Occidental went to the government and said well we can aggressively increase the production, we can use our technology to enhance the recovery. So that’s an example where perhaps you don’t have the same level of expertise in the service sector; it tends to be more in the engineering and topside and maybe drilling technology, but not in sub-surface reservoir management.

Similarly, we have all the heavy oilfields, the tar sands in Canada and Venezuela. So technology, again, can be a differentiator for these companies.

Then my fourth point on this is where the majors can actually gain is where they provide access to markets and in particular I’m thinking of the LNG market which is growing very fast at the moment. And access to the US market where domestic gas production is declining and they have a very strong growth in gas demand expected for LNG over the next five years – to be in excess of 30 per cent each year. So if a company can offer access to that market through owning regasification terminals that can allow them to gain access to reserves.

So those are really the main areas, but I think to really differentiate, the majors have to work on the sub-surface aspects.

Another example that might be interesting to look at is that recently Chevron was doing a pilot steam flood project for Saudi Arabia. So getting access to these reserves could be through using their technologies. Chevron have the largest steam flood oilfield in the world – onshore Sumatra in the Duri Field which they’ve been operating for decades. So they’ve built up a lot of expertise and that has enhanced the recovery from 2 per cent of the oil in place to nearer 20-25 per cent and that’s the big prize that can be applicable to these major resource holders.

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