When the recession hit, the major companies streamlined, cut costs and became more efficient, giving them a shot at a profit comeback

By BRETT CLANTON
HOUSTON CHRONICLE

Feb. 21, 2010, 4:32PM

Big Oil has had a little less swagger in its step of late, humbled by a global recession that halted a multi-year run of soaring profits and exposed weaknesses that had been less acute when times were good.

International giants like Exxon Mobil and BP have suffered the effects of the economic downturn, which brought the first significant decrease in global energy demand in nearly three decades, created wild gyrations in oil and natural gas prices and wreaked particular havoc on the oil refining business.

But they responded in different ways. Some took a hard look at organizational structures and cut thousands of jobs. Others pared portfolios to pay debts and refocus on core businesses, while at least one took advantage of the depressed climate to boost spending and make a major acquisition, even as profits tumbled.

“The majors weathered the storm in 2009, but I would also say it made them more efficient, more focused,” said Gary Adams, vice chairman of Deloitte’s oil and gas practice in Houston.

The biggest international oil companies will likely continue to face tough conditions in oil refining this year, amid still-weak demand for gasoline and other fuels, rising crude prices and surplus plant capacity.

The natural gas business also remains challenging in the short term, as does the task of trying to lure back investors who recently have been more enamored of shares in smaller, faster-growing oil and gas firms.

Add broader concerns about the slow pace of economic recovery, the increasing difficulty in accessing new oil and gas resources and the possibility of new, costly regulations on the industry, and the outlook grows cloudier still.

Majors have advantage

Yet, the oil majors — with their diverse integrated business models, big balance sheets and cautious approach to investing — still may be among the best equipped in the industry to ride out what’s ahead.

“That’s partly why they’ve gotten to be as big as they are,” said Ken Medlock, a fellow in energy studies at Rice University’s Baker Institute.

Or, as Kenneth Cohen, Exxon Mobil’s vice president for public and government affairs, put it recently, “It’s really these times that our company and our business model are designed to handle.”

In recent years, rising oil and gas prices drove profits of the five biggest Western oil companies — Exxon Mobil, Royal Dutch Shell, BP, Chevron Corp. and ConocoPhillips — to new heights.

In 2008, when crude oil reached nearly $150 a barrel and retail gasoline topped $4 a gallon nationwide, the companies made a combined profit of $100 billion. That’s the second-highest on record from the group, exceeded only by the 2007 combined total of $123 billion. But the global economic crisis changed all that and in 2009 slashed the group’s combined haul to $61 billion.

In response, the majors have taken steps to cut costs and streamline operations.

• • Shell, under a sweeping reorganization launched in July by new CEO Peter Voser, cut 5,000 jobs last year, including hundreds in Houston, and aims to eliminate an additional 1,000 positions this year. It’s also reviewing 15 percent of its non-U.S. refining capacity for possible sale.

• • BP has shed 7,500 employees since late December 2007 under an ongoing turnaround program led by CEO Tony Hayward, who said this month the British oil giant still has a way to go in becoming more competitive.

• • ConocoPhillips, Houston’s largest public company, plans to sell $10 billion in assets over the next two years to help pay debts and improve financial flexibility. Separately, the company recently said it may consider closing refineries that can’t cover their costs.

• • Exxon Mobil, the biggest U.S. oil company, has shed global refining assets in recent years, and officials said it will continue to “optimize” its downstream portfolio, but it doesn’t see any need for a major restructuring.

• • Chevron Corp., after cutting expenses 15 percent in 2009, is planning a reorganization of its global refining business, which will result in an unspecified number of job losses. It has also cut its 2010 capital spending budget by 5 percent.

‘Becoming leaner’

Many of the moves were tied directly to the global collapse in refining, but the poor economic environment also gave some companies cover to take an ax to organizations that had grown too big or complex.

“A lot of this is eliminating redundancy, becoming leaner, and that’s important, particularly in an environment where costs are as high as they are,” Medlock said.

Recently, however, stabilizing global economic conditions and higher oil prices have helped stoke investment and are buoying hope of a recovery.

Spending on exploration and production, excluding acquisitions, is expected to rise by 7 percent to $326 billion in 2010 among more than 65 of the largest publicly traded oil and gas companies, according to a recent report by Norwalk, Conn.-based energy research firm IHS Herold. That compares with a 23 percent decline in upstream spending in 2009.

Also this year, majors likely will be on the hunt for acquisitions, particularly those that expand their holdings in North American natural gas shale plays, like Exxon Mobil’s recent deal to purchase Fort Worth’s XTO Energy for $41 billion.

“Unconventional gas is still where a lot of the action is going to be,” said Daniel Yergin, chairman of IHS Cambridge Energy Research Associates in Cambridge, Mass.

Not only are such deals a strategic bet the world will move toward cleaner fuels, they could help majors regain the attention of investors who have recently rewarded independent oil and gas producers for leading the way in shale and other unconventional gas plays.

In 2009, Standard & Poor’s Oil and Gas Exploration index — a basket of stocks that includes names such as Anadarko Petroleum, Apache Corp. Devon Energy and Southwestern Energy — grew 41 percent. By contrast, a Standard & Poor’s index that tracks the majors fell 4 percent.

But there is another possible explanation for the majors’ renewed interest in North American gas plays. With access increasingly limited to new oil and gas reserves around the globe, they’re simply running out of places to invest.

“All of the sudden, North America looks very attractive relative to other opportunities out there,” said Fadel Gheit, industry analyst with Oppenheimer & Co. in New York.

“It’s the devil you know versus the devil you don’t know,” Gheit said, “and they know this devil pretty well.”

brett.clanton@chron.com

SOURCE ARTICLE

February 21, 2010, 07:10 PM EST

By Eduard Gismatullin and Marianne Stigset

Feb. 22 (Bloomberg) — BP Plc and Royal Dutch Shell Plc may falter in their campaigns to save billions in oil and gas project costs as a resurgence in drilling and demand for engineers threaten to revive inflation in the industry.

Crude prices doubled in the past year, prompting producers to resume projects put on hold during the recession. Oil and gas industry spending will rise 11 percent this year to $439 billion, according to Barclays Capital.

“Oil price inflation and cost inflation are highly correlated, albeit with some delay,” said Paul Wheeler, a London-based managing director in the oil and gas group at investment bank Jefferies International Ltd. “The oil industry is always people constrained. It’s one of the biggest challenges: a lack of young engineers and geologists.”

BP Chief Executive Officer Tony Hayward said Europe’s largest oil company will try to cut costs further this year after saving $4 billion in 2009. Shell’s Peter Voser aims to trim expenses by $1 billion. The respite the economic crisis brought on costs may prove temporary as producers are forced to spend more to recover oil from deepwater reserves, tar sands and gas-bearing rocks.

While the major oil companies may face difficulty holding costs down, the beneficiaries of increased drilling will be oil services companies like Schlumberger Ltd., Baker Hughes Inc. and Petrofac Ltd., hired to work on production projects.

Investor Outlook

Investors prefer the outlook for service companies to oil producers. Shares of Schlumberger, which yesterday agreed to buy drilling lubricants provider Smith International Inc. for about $11.3 billion, have gained 82 percent in the last year. Petrofac has more than doubled. In the same period BP has gained 28 percent and Shell is up 11 percent.

“All the service sector is going to be busy again,” Ayman Asfari, CEO of Petrofac, the U.K.’s biggest oil contractor by market value, said in an interview in London. “All the majors now are realizing they cannot stop investing and they are all coming back.”

Aside from salaries, prices for raw materials such as steel, are the biggest contributor to project costs. World steel prices have recovered 19 percent since reaching a three- year low in May as the global economy returns to growth, according to a tracker index from Steel Business Briefing. That will push up the prices of piping and sheet metal needed to build rigs and processing plants.

‘Log Jam’

“Cost pressures on oil services are bottoming out and the next move is up,” Keith Morris, an analyst at London-based Evolution Securities Ltd., said in a note earlier this month. A “log-jam of projects postponed from 2009 will lead to a scramble for oil services. Spare capacity will get booked up, quickly leading to return of cost inflation.”

London-based BP will invest $20 billion this year, little changed from 2009, as it works on projects in Alaska, Trinidad & Tobago and the Gulf of Mexico. Shell, based in The Hague, expects to spend $28 billion this year and Paris-based Total plans $18 billion.

“We are definitely seeing costs recover slightly,” Total CEO Christophe de Margerie told reporters in London this month.

The trend toward deepwater drilling, liquefied natural gas plants and other high-technology projects is adding to pressure on contractor capacity, de Margerie said.

“The costs of developing assets today are significantly higher than they were five years ago and there is no way we are going back to those levels,” Petrofac’s Asfari said in London. “There is nothing you can do about the underlying costs, like human resources.”

Skilled Workers

In Australia, where San Ramon, California-based Chevron Corp.’s $40 billion Gorgon project is among more than a dozen LNG ventures under development, cost pressures are already starting to show in salaries for skilled workers. Woodside Petroleum Ltd. said in November the cost of its $12 billion Pluto project may surge as much as $1 billion, partly because of labor expenses.

Pressure on skilled oil industry professionals may increase in other parts of the world as projects get up to speed, recruitment consultants said.

“We’re still far away from the pre-financial crisis levels, but there has been an increase in demand for engineers,” said Geir Doelvik, managing director of Manpower Professional Engineering AS, an Oslo-based recruiter for the oil industry. “We haven’t seen salaries increase yet, but we’re going into wage negotiations, so we’ll see what happens then.”

Charges for hiring drilling rigs may rebound after more units were pressed into service in recent months. The number of rigs in use worldwide has risen 40 percent from May’s six- year low, according to data from Baker Hughes.

Talks with producers to cut prices “are behind us,” Andrew Gould, CEO of Schlumberger, the world’s largest oilfield-services provider, said in an interview in Oslo this month. “The danger is that if oil prices accelerate then in the supply industry, certain shortages will appear quite quickly.”

–With additional reporting by Brian Swint in London. Editors: Will Kennedy, Amanda Jordan.

To contact the reporter on this story: Eduard Gismatullin in London at +44-20-7673-2268 or egismatullin@bloomberg.net; Marianne Stigset in Oslo at +47-22-99-6109 or mstigset@bloomberg.net.

To contact the editor responsible for this story: Will Kennedy at +44-20-7073-3603 or wkennedy3@bloomberg.net.

BLOOMBERG/BUSINESS WEEK ARTICLE

THE NEW YORK TIMES

Energy companies are on the prowl again.

After a two-year slowdown in mergers and acquisitions in the industry, companies are once again looking for ways to use their checkbooks to expand their reserves, buy new technology or snap up promising oil and gas fields.

Unlike the round of mergers that created today’s behemoths in the late 1990s, the current round is not expected to form new giant companies like Exxon Mobil or ConocoPhillips. This time, companies are focused on buying fast-growing small companies, or on acquisitions that expand their reserves in an era when it is hard for them to find new places to drill.

The targets include companies that own new fields in nations like Ghana and Sierra Leone, independent gas producers in the United States, and companies that control fields in the deep waters of the Gulf of Mexico.

“In this industry, where you’re in the business of increasing your reserves, there are two ways to do so — to drill or to acquire,” said Christopher W. Sheehan, director for mergers and acquisitions research at IHS Herold. “There is an intense competition for access to resources through mergers.”

This latest wave of consolidation comes amid fresh enthusiasm for natural gas production, especially in the United States, where new technology has significantly expanded the nation’s reserves. The huge potential of new gas fields has driven most mergers in the North American energy sector in recent months, with more to come this year, according to bankers and analysts.

Buying interest is particularly strong among the international oil majors, which had sold off many of their onshore assets in the United States over the last decade and are now eager to come back. Anthony B. Hayward, the chief executive of BP, said last month at the World Economic Forum in Davos, Switzerland, that the gas being extracted from beds of shale was “a complete game-changer. It probably transforms the U.S. energy outlook for the next 100 years.”

The biggest deal in that sector was announced in December, when Exxon Mobil said it would buy XTO Energy for $31 billion. Shortly after, Total of France said it would pay $800 million for a minority share in Chesapeake Energy’s Barnett shale gas portfolio. Chesapeake has raised about $11 billion from joint ventures for its shale gas assets in the last two years; BP and Royal Dutch Shell have struck similar agreements in recent months.

In a humorous note to investors, Bernstein Research analysts quipped recently: “Frankly, you can virtually plan your gym sessions around these deals, they are becoming so regular. Thinking about it, isn’t it about time for another Statoil deal?”

Statoil, the Norwegian national oil company, recently struck a deal with ConocoPhillips to trade some of its assets in the Gulf of Mexico for acreage that Conoco holds in the Chukchi Sea of Alaska; in November, Statoil agreed to pay $3.4 billion for a 32.5 percent stake in Chesapeake’s assets in the Marcellus shale formation in the Appalachian region.

“The growth opportunities from shale gas are something we haven’t seen in the United States for decades,” said Roger D. Read, managing director and senior energy analyst at Natixis Bleichroeder in Houston. “The United States, which had been a static market, now has the chance to grow its production.”

Bankers and energy consultants expect deals to pick up this year after a two-year lull. There were 244 deals in the global oil and gas industry last year, down from 285 in 2008, and 336 at the peak in 2007, according to data from IHS Herold, a consulting and advisory firm.

While the number of transactions was down, the size of the Exxon-XTO transaction helped raise the total value of last year’s mergers to $144 billion, up from $104 billion in 2008. (Merger values peaked at $200 billion in 1998, a year when many of today’s giant companies were created.)

Analysts point to a wide range of companies that are potentially on the market, including EOG Resources, Southwestern Energy, PetroHawk Energy, the Encana Corporation, Chesapeake Energy, Devon Energy and Anadarko Petroleum.

“There will be a shakeout there. It will be eat, or be eaten,” said James Bogues, who leads Accenture’s North America energy mergers and acquisition unit. “Given Exxon’s reputation as a very deliberate, cautious company, the fact they made such a bold move with XTO will no doubt inspire others that a price has been set for shale gas assets and technology.”

Outside of the United States, the pace of mergers has also picked up. Suncor Energy of Canada bought Petro-Canada in a deal valued at $18 billion at the time to form a national giant and stave off possible bids from foreign buyers, particularly Chinese companies. In West Africa, Exxon has offered $4 billion for a stake in an offshore field in Ghana, though that deal could fall through given the government’s threat to block the transaction; international firms, including Eni of Italy, are battling over some prospective fields in Uganda.

Chinese companies have also been particularly active. In August, Sinopec, one of China’s biggest oil companies, closed a $9 billion acquisition, buying Addax Petroleum, a Geneva-based oil explorer that is most active in Nigeria, Gabon and the Kurdistan region of Iraq.

Sinopec, formally known as the China Petroleum and Chemical Corporation, said the deal “represents the largest successful acquisition of overseas oil and gas assets by a Chinese company.”

The interest of national oil companies, like Sinopec, could prove a powerful and lasting driver for merger deals in the energy sector.

“The mandate of national oil companies is to go and find reserves around the world,” said Jon McCarter, the oil and gas transactions leader for the Americas at Ernst & Young. “They have been very active and very aggressive.”

NYT ARTICLE

Heath Aston, Daily Mail
5 February 2010, 9:51am

Oil giant Royal Dutch Shell will cut jobs and refine capacity as it enters an ‘uncertain’ 2010 faced with weak gas prices and depressed refining margins for oil products.

Under pressure from better performing rivals such as BP, Shell chief executive Peter Voser conceded that the Anglo-Dutch company had become bloated during the good times of sky-high oil prices before the financial crisis.

He said: ‘We’ve had four years of record profits. You know yourself when you have a good time you eat a little too much and you get a bit fat.’

In a bid to trim the company down, Voser will axe 1,000 staff, mainly executives, and sell about 15% of Shell’s oil refineries dotted across the globe, raising up to £1.9bn.

The deeper cuts come after Shell got rid of 5,000 staff last year and reduced its refining capacity, especially in established western markets where fuel consumption has dwindled since the recession. Last week the company closed a refinery in Montreal, Canada.

The need to strip back and kickstart Shell’s operating performance was illustrated by earnings figures showing annual profits in 2009 at $9.8bn were just a third of the $31bn bagged in 2008.

By comparison, BP’s annual profits halved.

n what one analyst described as a ‘truly awful set of figures’, Shell’s fourth quarter earnings on a current cost of supplies basis wilted to $1.2bn from $4.8bn in the same quarter of 2008.

Excluding one-off items – mainly the $900m cost of redundancies – earnings fell to $2.8bn from $3.9bn, below what the City had anticipated.

Oriel Securities analyst Andrew Whittock described the result as ‘disappointing’.

Voser warned there could be no quick fix, with refining capacity in the market outweighing demand and refining margins at their lowest point in 15 years.

Shell’s move to increase its exposure to the lower carbon natural gas market has backfired in the short term, with prices falling much harder than oil since their peaks.

Echoing statements from BP, Voser said the rebound in the global economy would take longer than many people expected.

He said: ‘On the outlook, I wouldn’t call it a rosy one. I would be quite cautious.’

Voser said Shell’s $28bn capital expenditure programme would be directed more at expanding Asian markets although building new refineries was not on the agenda after India and China opened refineries that have added two million barrels a day of oil supply in that region.

Royal Dutch Shell’s A shares ended the day in the doldrums and down 43p at 1732p.

DAILY MAIL ARTICLE

LONDON (Reuters) – Royal Dutch Shell Plc posted a 75 percent fall in fourth-quarter profits to $1.18 billion, as the oil major was punished for falling output and its strong position in the depressed refining and natural gas businesses.

Oil prices recovered in the quarter but gas prices were much lower than in the same period a year earlier, while refining margins collapsed to their lowest level in almost 15 years.

Europe’s second largest oil company by market value said it made a $1.76 billion loss in its refining unit and Chief Executive Peter Voser said he was mulling the sale or closure of 15 percent of Shell’s refining portfolio, even after saying it planned to close its Montreal facility last month. “These results confirmed the very negative trends affecting the downstream business,” Colin Smith, oil analyst at ICAP, said.

Excluding one-off items, which amounted to a charge of $1.6 billion, the result was $2.77 billion, short of an average forecast of $2.87 billion from a Reuters poll of 10 analysts.

Oil and gas production fell 2.4 percent to 3.3 million barrels of oil equivalent per day in the quarter compared to the same period last year. Full year output was down 3 percent.

Shell’s results compare with a 23 percent drop in fourth-quarter net income at the largest western oil company by market value, Exxon Mobil, and a 37 percent drop at the second-largest U.S. oil company, Chevron.

However, UK rival BP managed to report a 33 percent rise in profits in the quarter thanks to its low reliance on refining and natural gas.

Finnish refiner Neste Oil lagged consensus with Q4 sales of 2.5 billion euros compared with 2.66 billion in a Reuters poll while Europe’s largest independent refiner Petroplus beat forecasts but swung to a clean net loss of $150 million in the fourth quarter.

(Reporting by Tom Bergin; Editing by Victoria Bryan, Mike Nesbit)

SOURCE ARTICLE

• Oil company hit by cheaper energy prices and lower refining margins in 2009
• BP chief executive sees ’slow and gradual’ economic recovery in US and Europe

Katie Allen
Tuesday 2 February 2010 08.10 GMT

BP’s Thunder Horse platform before it was towed to the US Gulf of Mexico. The platform came online this year Photograph: Michelle Christenson/AP

BP has reported a sharp drop in profits in 2009 as it grappled with cheaper energy prices and squeezed margins on refining.

The oil company said underlying profits in the fourth quarter rose 70% on a year earlier to $4.4bn (£2.75bn), but that missed the City’s forecasts. The year as a whole suffered a 45% fall in profits to $14bn.

Still, BP sought to flag up a stronger-than-expected 4% rise in oil and gas production in 2009 thanks to the start-up of new projects, including the first full year of production from the Thunder Horse field in the US Gulf of Mexico.

In a statement, Tony Hayward, the chief executive, said that BP had still exceeded many of the aims he had set out at the start of 2009 and described it as a “very good” year overall.

He said BP expects recovery in the major economies of the US and Europe to be “slow and gradual”. While oil markets look well supported by Opec, BP expects gas markets to remain volatile and refining margins to remain depressed for the foreseeable future.

“2009 has been one of the best years for BP and its shareholders since the merger with Amoco [in 1998]. But we are not resting on our laurels. There’s a lot more to be done,” said Hayward.

BP’s results echo news on Monday from ExxonMobil, the world’s largest publicly traded oil company, that profits slumped to $19bn in 2009 from $45bn as it too battled against declining margins at its refineries and weaker demand for fuel in recession-battered economies.

SOURCE ARTICLE

Feb. 1, 2010, 10:49 a.m. EST: NEW YORK (MarketWatch) — Crude futures rose on Monday after declining last week, as a round of upbeat global economic reports lifted demand expectations, while an oil pipeline in Nigeria was damaged by an attack and rekindled concerns over supply.

Sunday Telegraph

BP expected to exend gap with Shell in the battle of oil giants

The British oil major, now the biggest in Europe, is currently winning the race against its Anglo-Dutch rival

By Rowena Mason
Published: 8:12PM GMT 30 Jan 2010

Royal Dutch Shell is likely to endure more humiliation at the hands of BP this week, when it posts profits an estimated $1.7bn lower than its rival.

BP, which recently stole Shell’s crown as Europe’s largest oil company by market value, is likely to report profits of $4.6bn (£2.9bn). This 80pc up from $2.6bn in the last quarter of 2008 on a “replacement cost basis – a measure used by oil companies to strip out the effect of changing inventories.

BP is reaping the harvest of an aggressive $4bn cost-cutting drive that began before the recession and doubled in pace last year.

Meanwhile, analysts have been downgrading the forecasts for Shell’s profits over concern that its refining business has been performing below expectations.

According to consensus estimates, it is likely to report that profits have fallen to $2.9bn from $4.8bn in same quarter of the 2008, when it reports on Thursday.

Shell started cutting costs much later than its rival, resulting in 5,000 job losses during the downturn.

Its chief executive Peter Voser warned last week at the Davos economic summit that there were likely to be more redundancies this year.

“It’s normal in any business that you have to go further and you have to operate your operating expenditure in a very tough way,” he said, sounding a cautious note on global recovery. “As part of that, it may also mean that some more people have to go.”

Both the companies’ profits are expected be down sharply for the year – in the case of BP, 40pc lower at $15bn, and more than 60pc down at $11.4bn for Shell.

The first US oil company to report, Chevron, showed on Friday the difficulty of maintaining healthy profits when refining margins remain low, with hefty losses in that division.

The corporation posted a 37pc fall in quarterly profits, as the cost of producing petrol and diesel prices failed to keep up with a big rise in the cost of crude oil.

The second-largest oil company in the US made a net profit of $3bn between October and December, down 37pc from in 2008.

Data from BP shows that companies are now making just $1.49 per barrel of petrol product, compared with $5.19 a year ago.

Downstream divisions – responsible for refining, marketing and selling petrol-based products – are expected to suffer at all the majors, owing to lower demand in the recession. Many oil companies are frantically trying to offload their refineries, concerned about overcapacity in the industry.

Shell is in the process of selling its UK-based Stanlow refinery in Cheshire to Indian company Essar and three others in Europe.

A higher oil price of $76.13 in the fourth quarter – almost a third above last year – will have supported profits in the exploration and production arms.

But BG Group, the oil and gas producer, is still likely to report pre-tax profit of £1.05bn on Friday – down 10pc from £1.16bn a year earlier, with annual profits 23pc below last year’s £4.1bn.

Analysts often see discrepancies between BP and Shell’s performance as merely part of the cycle of rivalry between the two companies.

BP rose by 19pc on the stock market this year and boosted production to 3.9m barrels, while Shell fell by 3pc and saw its output drop below 3m barrels.

“Shell began restructuring last year, so is lagging BP, and furthermore its massive capex expenditure in recent years does not see new volumes start to kick in until 2011-2012,” said Richard Griffith, an analyst for Evolution Securities. “On balance, earnings won’t look great when they’re announced but we see more scope for positive surprises at BP and less dividend risk.”

Most industry experts are more concerned with the expected dash for new production assets in the aftermath of the recession than any temporary drop in profitability.

Citi analyst Mark Bloomfield said: “We expect the focus to shift from a defensive cost-saving mode towards pursuit of opportunities for expansion.”

This shift in emphasis towards new projects has led some City investors to favour Shell over BP.

Mr Voser has promised that Shell would commit to record capital expenditure. It is forecast to see a boost in output from European gas and Nigeria this year and, looking to 2013 and beyond, it will see new prospects at its Qatar gas-to-liquids project, and the Canadian oil sands come on stream. The company has staked its future on a number of technically difficult fields, including unconventional reserves in Canada and deepwater projects in the Gulf of Mexico and Brazil.

BP will also increase production over the next couple of years and is exploring deep drill sites in the Gulf of Mexico and under the Arctic ice.

However, it lacks its competitor’s big flagship projects to lift future output.

Sunday Telegraph Article

Created: 27 January 2010

Written by: Daniel O’Sullivan

Royal Dutch Shell chief executive Peter Voser cannily chose the safe ground of an exclusive interview with the Financial Times to finally admit the all-too-obvious – the Canadian oil sands development Shell has touted as a major growth driver is instead a costly distraction, on which time is now being called. Mr Voser said the massive expansion the company had previously planned for its Athabasca Oil Sands Project (AOSP) – envisioning growth from the current 155,000 barrels per day (bpd) capacity to an eventual 770,000bpd – was now ‘”clearly scaled down” and would be “very much slower”.

Over the past few years Shell has emphasised heavy investment in so-called ‘unconventional’ hydrocarbon sources, both Canadian oil sands and gas-to-liquids projects elsewhere, as a substitute for the new conventional oil and gas resources the company has been notably lacking since its reserves-booking scandal of 2004. But the relatively high costs of new oil sands developments in particular mean scant profits with oil prices anchored stubbornly in a $70-$80 a barrel trading range. As recently as November, Shell oil sands head John Abbott indicated the in-construction $14bn (£8.69bn) AOSP Expansion 1 project, coming onstream later this year to boost total AOSP output to 255,000bpd, needs oil prices around $60 per barrel just to break even. And new investments would require higher prices.

Two previously-slated medium-term expansions of 100,000bpd each are on ice indefinitely, and any serious AOSP growth beyond de-bottlenecking, which could add perhaps some 100,000bpd in small increments by 2020, seems moot. Mr Voser was not questioned on what this strategic U-turn means for Shell’s resource base, defined as its portfolio of hydrocarbon exploitation opportunities not yet migrated into developed reserves. But the effective scrapping of further large-scale AOSP growth will presumably have a material impact – while oil sands currently account for 8.4 per cent of proved Shell reserves, totalling 11.9bn barrels-of-oil-equivalent (boe), they were previously thought to account for perhaps a third of Shell’s total resource base, estimated at 66bn boe.

IC VIEW

We have been saying for years that the unconventionals strategy would come a cropper. Mr Voser said Shell would now concentrate again on conventional hydrocarbon development. But he played down the need for acquisitions to bolster the new direction, saying they were hard to justify ‘if you don’t have a strategic hole somewhere you want to fill’. But we think this is exactly Shell’s problem. High enough at 1714p.

INVESTORS CHRONICLE ARTICLE

THE WALL STREET JOURNAL

JANUARY 25, 2010, 9.32 A.M. ET

By MATTHEW CURTIN

These days, you have to corral an army of engineers in the desert to build an enormous factory to transform natural gas into a liquid to be used like oil. The capital cost of Royal Dutch Shell’s Pearl gas-to-liquids plant in Qatar is a cool $18 billion or more—10% of its market capitalization. Like Chevron’s Gorgon liquefied-natural-gas project offshore Australia, it shows what big integrated oil companies are capable of.

Associated PressShell has bumped up its exploration budget to $3 billion.

But have they neglected bread-and-butter exploration for lower-risk, lower-return engineering projects? Certainly, investors are unimpressed. A decade ago, the international oil companies, or IOCs, accounted for 79% of energy-sector market capitalization and nearly all its net income. Today the figures are 53% and 62%, according to Sanford C. Bernstein. Shell trades at a discount of 13% and 36% respectively to the 2010 forward price-to-earnings multiples at Petroleo Brasileiro and BG Group. But their estimated five-year average output growth is 5% and 9% compared with Shell’s 3%, around the IOC average.

If there is a premium on growth, why haven’t the IOCs spent more on exploration? The question is a little unfair. The majors are so big they spend billions simply replacing the barrels they produce. Geopolitics and resource nationalism have narrowed growth options.

It takes a big discovery to move the needle. Shell more than doubled its exploration budget to $1.4 billion between 2004 and 2008 when it represented 3% of net cash from operations. But contrast that with the 16% of net cash from operations spent by the smaller BG, which has made exciting finds offshore Brazil, alongside Petrobras, and in West Africa. That is why Bernstein analyst Neil McMahon questions whether IOC executives have sufficiently examined the merits of exploration over one-off engineering marvels. Facilities like Pearl have to be built on giant, long-life gas fields, which are rare.

Intriguingly, Shell, scaling back development of its high-cost Canadian tar-sands operation, has bumped up its exploration budget to $3 billion, around 10% of capital spending. But could it spend even more? With their huge upfront cost sunk in 2011, Shell’s two Qatar projects will generate $4 billion a year in cash flow. They will be nicely geared to any rise in oil prices at a modest unit cost of $6 per barrel of oil equivalent. Few IOCs may be as well placed as Shell to take on more exploration risk.

Write to Matthew Curtin at matthew.curtin@dowjones.com

WSJ ARTICLE