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Oil companies are hitting the pause button

By KRISTEN HAYS Copyright 2008 Houston Chronicle

Dec. 13, 2008, 11:49AM

Renee Schoof MCT

Some companies are delaying decisions to move forward with projects in Canada’s challenging oil sands as lower oil prices threaten the profitability of high-cost production there.

When crude hit $70 a barrel, Canada’s oil sands became alluring. At $80, wind energy was profitable. And at $100-plus, even pricey plans to turn coal into gasoline came within reach.

Now it’s retrench time.

So far, companies aren’t cutting major ongoing projects with oil under $50 amid a growing global recession and sharply shrunken demand. But increasingly they’re postponing final investment decisions — the point at which contracts get signed, contractors are hired, and money is committed — at least until the lofty costs of doing business mirror crude’s fall.

“It’s been a little easier when prices have been so high,” said George Kirkland, Chevron’s executive vice president of global upstream and gas, in a recent interview at the company’s San Ramon, Calif. headquarters. “For a period, oil prices went up faster than the costs of goods and services.

“But that’s turned, it’s definitely turned,” he said. “And it’s got to turn back.”

Analysts say it will, perhaps by the middle of 2009. Once companies stop signing new contracts for steel, labor, drilling rigs, seabed equipment and all else that go into finding oil and gas, those things will be easier to get and their costs will fall.

But for now, the industry is focusing on ongoing projects while holding off on expansions and new projects.

Among recent examples:

• Royal Dutch Shell indefinitely postponed a decision on expanding its operations in Canada’s oil sands.

• Canada’s Suncor delayed completion of an upgrader that processes hard, thick bitumen so it can be refined, while Nexen and Petro-Canada put off decisions on whether to build upgraders.

•Norway’s Statoil withdrew an application to build an upgrader in Canada, citing “prohibitive” construction costs, the state of the global economy and an uncertain outlook for oil prices.

•Saudi Aramco and ConocoPhillips delayed a final decision to move ahead on their $12 billion refinery in Yanbu, Saudi Arabia, and are seeking new bids.

•BG Group postponed a decision on whether to launch the third phase of developing a natural gas field in Kazakhstan.

•Brigham Exploration suspended drilling by two rigs in the Bakken Shale, which stretches from Montana to the Dakotas and into Canada, for several months until costs of drilling and getting a well ready to produce come down.

“If you’re looking at a go/no-go decision now, and steel prices are going down, a typical deep-water project gets a quarter of its cost from steel,” said Candida Scott, an analyst with IHS Energy. “If in six months you’re going to see that cost come down, it gives pause to the amount of money you’re about to spend.”

Kirkland echoed that view, saying delays in final decisions make sense now. Reversing course midstream is a “bad move,” he said, because contracts have been signed, firms have been hired, and the ripple effect is costly.

Spending bottom lines

According to Simmons & Company International, total exploration and production spending this year will exceed $380 billion, including available figures from government-run oil companies as well as publicly traded producers.

When oil averaged $40 a barrel in 2004, such spending reached about $200 billion, Simmons said. That rose to $260 billion in 2006, when oil prices averaged $65 to $70 a barrel.

“Moreover, these capital spending results took place in environments of liberal credit, accommodating capital markets and benign if not buoyant macroeconomic conditions,” Simmons said.

In today’s starkly darker economic environment, “paralysis is setting in” as companies justifiably hold off on big-money decisions and steer clear of adding leverage to their balance sheets, Simmons said.

That means expansions or new ventures into expensive operations like Canada’s oil sands, deep-water exploration or alternatives and renewables take a back seat to what companies already have on the table.

“If we see oil sustained at $50 or $60, you will see more new projects delayed, especially in high-risk environments like deep water and unconventionals like oil sands,” said Gary Adams, vice chairman of consulting group Deloitte’s oil and gas group.

“And for the renewable energy supply, this has got to be really pushing back on investment,” Adams said. “We’ll see an issue in looking at renewables until prices come back up.”

Oil price a moving target

Scott and other analysts said identifying an oil price at which certain operations become profitable is tough because the costs of goods and services fluctuate just like crude.

“It’s very much a moving target,” she said.

But generally, analysts say oil prices need to be above $70 to launch a new oil sands operation; $60 for deep water; and $80 for alternatives even with tax incentives and subsidies.

After dropping to around $40 earlier this month, the price per barrel strengthened toward $50 late last week ahead of a meeting Wednesday at which the Organization of the Petroleum Exporting Countries likely will slash production. Light, sweet crude for January delivery settled down $1.70 at $46.28 Friday on the New York Mercantile Exchange.

Last week the federal government again trimmed its forecast for the 2009 average oil price to $51 from last month’s $63.50—and that had been cut from a forecast of $101.45.

“But remember, projects take years to come to fruition,” said Joseph Stanislaw, a former economist at the International Energy Agency and founder of the Boston-based energy advisory firm JA Stanislaw Group. “Unconventionals can take four to five years. Deep water can take seven or more. Conventional onshore production is a lot faster. But high prices could be back.”

Chevron moves ahead

Chevron, for example, is moving forward with the rollout of new projects in the coming months — including two oil and gas platforms in the Gulf of Mexico. Final decisions to move forward with those projects were made at least five years ago, before crude began its unprecedented rise into triple digits.

But Kirkland said Chevron, Shell’s partner in its Canadian oil sands operations, supported Shell in holding off on its final decision to expand there.

That “internal price view” is a major factor upon which companies base plans for multimillion- and multibillion-dollar projects.

Those thresholds — which companies generally don’t reveal publicly — are the oil price at which they believe they can recover their costs and get an acceptable return on massive investments. They reflect a company’s long-term view of oil prices, rather than the daily or yearly cycles.

“We need to look at our business as a long-term business. We need to make significant money to reinvest and make profits that we can give to our shareholders and get a return that recognizes our risk and meets shareholder needs,” Kirkland said.

Near a pullback point

But at $40, analysts say crude is getting close to a point which, if sustained, could prompt companies to pull back on established yet expensive operations.

“On our estimates, almost 800,000 barrels of Canadian output could go off line if oil prices dipped below $38 a barrel,” Merrill Lynch analyst Francisco Blanch said in a recent report.

However, pullbacks in exploration set the stage for a supply crunch — and significantly higher oil prices — once the economy rebounds and demand returns.

Investment bank Barclays Capital said recently: “We suspect that even in a much slower growth environment for oil demand over the next one or two years, the stresses and strains afflicting the supply side of the business suggest that the global economy could transition quickly from credit to energy crunch.”

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