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A car passes in front of Imperial Oil’s Dartmouth refinery on Feb. 20, 2008. 
Despite masses of cash pumped into search for new sources, Big Oil can’t replenish its reserves

Mar 15, 2008 04:30 AM
Tyler Hamilton
Energy Reporter

Investors in energy stocks are understandably excited. Record profits, strong demand and healthy share prices offer plenty of reason to celebrate.

With oil surging past $110 (U.S.) a barrel this week, and with increased talk of consolidation in the oil sands, there’s also a sense that the good times will last.

“In the short term, the oil and gas companies are still on an uptrend,” said Michael Wang, a mergers and acquisition analyst with energy research firm John S. Herold. He said the equity returns from oil and gas companies have beaten the overall market for the past seven years. “There’s no reason they can’t continue to do that for another six or seven years.”

But behind the stock-market gains lies a festering problem that Big Oil is more reluctant to discuss. The large, publicly traded oil giants are pedalling harder to keep up with demand, and paying dearly for it. Many are also failing to replenish their proven reserves, a major indicator of long-term health.

“If you don’t replenish your reserves, you are riding on the back of high oil prices,” said Wayne Chodzicki, who leads the Canadian energy practice for consultancy KPMG.

The question is how long that strategy is sustainable. Last week, Chevron Corp., the second-largest U.S. oil company, revealed that its oil and gas reserves are expected to rise 5 per cent over the coming three years. But analysts were quick to point out that this growth isn’t enough to offset an expected 7 per cent depletion of reserves between 2007 and 2010.

It’s a trend not isolated to Chevron. A study last year out of Rice University’s James A. Baker III Institute for Public Policy found the Big Five oil companies – Chevron, BP, ExxonMobil, ConocoPhillips and Royal Dutch Shell – have been struggling to replenish their reserves for much of the past decade.

“The Big Five are gradually depleting their reserves with an average replacement ratio of only 82 per cent in the period since 1999,” the study found.

And many continue to shun the drill bit, according to a report released earlier this month by Herold. Based on a survey of 125 companies, global spending on exploration and production will only grow by about 10 per cent in 2008 compared with last year. The report called this a “relatively marginal increase” when coupled with an assumed 10 per cent rise in costs.

It’s true that energy stocks have been spectacular investments this decade, but there are signs of rising concern about future production levels. The Toronto Stock Exchange’s energy index sits a little lower than where it was at the start of 2006, even as the per-barrel price of oil has jumped more than 60 per cent. Currency fluctuations account for much of the discrepancy.

Herold analyst Aliza Fan forecasts significant challenges ahead. “We found that the industry is spending barely enough to maintain the current level of drilling activity, and has limited, if any, leftover capital to flow through to drill bit growth.”

Chevron, Shell and Total SA of France are among those that seem willing to invest more, but it could prove too little, too late given the substantial lag between exploration, development and production. Squeezing a barrel of oil out of the Alberta tar sands or deep-water reservoirs in the Gulf of Mexico comes with a hefty premium and loads of risk.

“If we know about anything with the Canadian oil sands, it’s that, as a general rule, it costs twice as much and takes twice as long,” said Jeff Rubin, chief economist with CIBC World Markets. Most major oil projects around the world are after “problematic reserves” and have been plagued with delays, he added.

Chevron, for example, has seen at least five of its exploration projects delayed. Despite boosting spending on exploration by 21 per cent last year, the company is still struggling to replenish reserves.

And while oil at $110 motivates the hunt for new reserves, rising labour and equipment costs associated with projects have deflated expectations. That’s excluding the likelihood of a price on carbon emissions, or geopolitical challenges that add to financial risk.

Oil prices above $100 have even failed to jump-start growth in oil production, at least among companies that aren’t part of the Organization for Petroleum Exporting Countries. “For the first time in our 16 years covering oil markets, we no longer believe continuous increases in non-OPEC supply are a certainty,” analysts at Goldman Sachs reported last week.

No one, they argued, would have believed in the 1990s that oil prices could average over $25 a barrel each year starting in 2000 and that the oil companies wouldn’t increase supply in response. “Yet here we are with a $100-a-barrel oil price during what most now believe to be a U.S. recession (and still) no appreciable supply response.”

Goldman’s analysts suggest that these “long-term structural supply” issues are largely responsible for the higher cost of oil, rather than speculative trading and the weakening U.S. dollar – as many analysts and industry officials have claimed. If the U.S. economy begins to recover – driving up demand – or if there is a major disruption in global oil supply, they argue the per-barrel price could even skyrocket to $200.

It’s why industry experts say consolidation, particularly in the oil sands, is a certainty as Big Oil looks for a quick way to increase reserves and annual output.

“These large oil companies are looking around the world, and there are very few places in the world open for business,” said Wang, pointing to the lack of access to the Middle East, Venezuela and an increasingly hostile Russia.

That makes Canada, a friendly country with 40 to 50 years of proven reserves, a logical target.

The big oil companies have no choice, said Wang, calling it a matter of survival. BP, for example, has long considered the oil sands a dirty and expensive business that it was determined to avoid. That position changed abruptly last December when the company struck a joint venture with Husky Oil.

Even so, high construction and labour costs, environmental restrictions such as mandatory carbon capture, and rising taxes could slow down consolidation – at least in the short term, according to another Herold study released last week.

Timing aside, Rubin sees major oil-sands players such as Suncor, Nexen and Canadian Natural Resources as obvious targets that are likely to attract 40 per cent premiums as the Canadian-owned patch morphs into a UN of oil activity.

The larger question is whether buying into the oil sands as a way for Big Oil to beef up reserves will merely delay, rather than address, the underlying problem. “With four or five billion barrels a day coming out of the place, I don’t think it’s going to offset what the rest of the world is going to lose in production,” Rubin said.

Still, he said shareholders of oil-sands plays have much to gain. “I’m not saying they should necessarily stick around after those acquisitions, but they should certainly stick around for them.” and its also non-profit sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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