Financial Times: Western majors feel the squeeze: ‘businesses in terminal decline’

By Ed Crooks and Dino Mahtani
Published: February 1 2008 02:00 | Last updated: February 1 2008 02:00

Daniel Yergin, the chairman of Cambridge Energy Re-search Associates and author of The Prize, a history of the oil industry, argues that this is one of the toughest times for oil companies since the wave of nationalisations in the 1970s.

“The irony is that the other challenging times were when the oil price was low,” he says. “Now it is because oil has gone to $100 [a barrel].”

Results yesterday from Royal Dutch Shell, kicking off the reporting season for the world’s biggest oil companies, offered support for the argument that they are businesses in terminal decline.

Shell’s production fell 4 per cent in 2007, and if conditions including the oil price and the weather remain the same, it will fall again this year, making six successive years of decline.

ExxonMobil and Chevron, the two largest US oil companies, report today and are expected to show only modest growth in production, and BP will show a drop when it reports next Tuesday, according to Neil McMahon of Sanford Bernstein.

Yet Jeroen van der Veer, Shell’s chief executive, mounted a vigorous defence of the oil majors’ business model yesterday, arguing that in the future, conditions will favour the big western companies.

The industry’s production figures have been disappointing in part because of the high oil price in countries where companies operate under production-sharing contracts. As the price rises, the contracts generally give the country a greater share of any oil produced.

This has exacerbated the fundamental problem: that the oil and gas resources in the international companies’ traditional bases in the US and Europe are running out, while getting access to the still-abundant resources of the Middle East, Africa, and South America has become more difficult.

There are few parts of the world that are definitively closed to international companies. Even Saudi Arabia, which keeps them out of its upstream oil business, allows them into its refining industry and to look for gas.

But many resource-rich countries have taken advantage of a tight balance of supply and demand for oil to grab a bigger share of the proceeds.

Shell’s postponement of a statement on its reserves until March has highlighted fears that it and other companies are not getting access to enough new sources of oil and gas.

Another challenge to the western oil companies comes from increasingly assertive emerging market companies, such as Petrobras of Brazil and PetroChina, which, helped by its thin float in China, is notionally the world’s biggest company by market capitalisation. Their share price performance has far outstripped US and European companies recently.

Meanwhile, the boom in activity caused by strong demand and shortages of skilled staff and equipment have created rampant cost inflation in the industry, squeezing the companies’ profitability.

Mr McMahon estimates that the aggregate return on capital employed for the US and European oil majors was no higher in 2007 than in 2005, even though the average price of oil rose from $55 to $72.

The result has been that at a time of lavish cash flows oil companies have been unable to find anything better to do with tens of billions of dollars of income than return it to shareholders through share buy-backs.

Shell bought back about $4.4bn of its shares last year.

In the view of some analysts, the buy-backs are a sign the big oil companies are facing up to a future of inevitable decline, in which the next step could be further consolidation through mergers.

Yet that is far from the way the companies see it. Shell said yesterday that it expected to raise its capital spending by 10-14 per cent this year to $28bn-$29bn; at least keeping pace with the increase in costs.

Chevron also expects to increase its capital spending, by 15 per cent this year to $22.9bn. Christophe de Margerie, chief of Total, said recently he expected a sharp increase in capital spending this year, “and probably in 2009 and 2010”.

Only Exxon is an exception: it said last year it expected capital spending to remain at about $20bn a year.

This strategy of expansion in unfavourable conditions is risky. James Neale of Citigroup said of Shell yesterday: “You need $80 per barrel to make the business break even.”

However, Mr van der Veer argues that by 2015, the world’s output of “easy” oil and gas, which is cheap to extract and to sell, will no longer be able to meet rising demand, meaning more demand for the difficult resources: oil sands – where Shell is investing heavily – very deep water, and so on.

That means, Mr van der Veer says, that there will be plenty of opportunities for big oil companies.

“We have to shift to the difficult end of the barrel. And if you are good at that you can make a lot of money.”

Copyright The Financial Times Limited 2008

 

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