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The Independent: Jeremy Warner’s Outlook: Oil majors have bit more life in them yet

Published: 04 July 2007

That old chestnut again. The story that BP is exploring the possibility of a mega-merger with Shell to create the Western world’s largest oil company does at least have the merit of once being partially true. Exploratory talks were indeed held a year or two back when John Browne was chief executive of BP. They were one of the things that convinced the BP board that Lord Browne had been too long in the job and needed to be reined in.

The story should be given even less credence today than it was back then. Not in a month of Sundays are US and European regulators going to allow any such merger – or at least not without disposals so large that they would undermine much of the transaction’s purpose. So why has the rumour come bouncing back? With the City advisory fees on any such deal likely to be almost as humongous as the merger itself, this may be a question more of hope than realistic expectation.

Yet the thinking behind such an apparently monstrous marriage is not entirely without foundation. The world’s reserves of oil and gas are not in any danger of running out any time soon, but we may be quite close to so-called “peak production”. Some of the world’s biggest known sources of hydrocarbons, are, moreover, increasingly closed off to the Western oil majors. To the Middle East must now be added Venezuela, and perhaps Russia too, whose mood has turned distinctly hostile.

This may be as much a function of the high oil price as anything else and is certainly nothing new to the oil industry. Buoyant oil revenues have allowed countries such as Russia to spurn the Western capital and expertise that in more austere times they so desperately needed. Some of this may come back with the next downturn.

Yet the bottom line is that the oil majors are struggling to replace their reserves at anything like the same rate as they are expending them. For the oil majors at least, the oil truly does seem to be running out. The sort of successes in far-off lands being reported by smaller players such as Cairn, though not to be sneezed at, would only amount to a few days’ production for the big boys.

For all the success BP has achieved in Angola, the Gulf of Mexico, and more recently Libya, it is still not enough. What’s more, there has been a marked deterioration in the terms of entry. Libya has extracted a high price for allowing BP back. Both Shell and BP are being forced to agree more onerous terms in Russia.

The question for directors of both companies is whether this is a permanent shift, or just a cyclical one which will abate when the oil price falls back to a level where foreign participation is more appreciated. An added complication is the arrival on the energy scene of some highly aggressive Chinese players with priorities that are much more national and strategic than commercial. They too are distorting the terms of trade.

For the oil majors to answer these pressures by eating each other none the less seems to me to amount to a strategy of despair. It is no kind of a solution to the problem of asset replacement simply to buy your nearest rival. The cost synergies would keep the bottom line growing for a while longer, but eventually the same problem would return in magnified form. If rumours of a merger between BP and Shell seem exaggerated, those of the impending death of the oil majors look equally implausible. They may be past their zenith in terms of profits and influence, but even in run-off they remain mighty powerful beasts.

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