Oil’s quest to find tomorrow’s fuels

Financial Times: Oil’s quest to find tomorrow’s fuels

By Sheila McNulty
Published: April 24 2008 03:00 | Last updated: April 24 2008 03:00

The world’s major oil companies are being forced to turn to the once unimaginable raw materials of chicken fat, tar and algae to make fuels and sustain their businesses into the next century.

For, in spite of massive legacy positions in oil and gas built over 100 years, gone are the days of the 1970s, when the majors controlled 85 per cent of the world’s oil reserves – the raw materials on which they built their businesses.

Instead, state-owned oil companies in countries ranging from Russia to Venezuela now control more than 80 per cent of reserves, and heightened nationalism from the owner governments often blocks the majors from exploiting res-ources. When the majors are permitted in, they are frequently subjected to high royalties and taxes. This is forcing them to look beyond fossil fuels for their raw materials.

“The IOC (international oil company) model that has proven very successful for the last century – it does need to transform itself,” says Jim Mulva, Conoco chief executive. “We don’t have the availability of new exploration acreage that, historically, we used to get. We, as producers of energy, have to look for newer, exotic types of energy.”

Conoco has developed technology to turn coal into a synthetic natural gas, is turning solid bitumen into synthetic fuel in Canada’s vast oil sands, and is working with Tyson Chicken to produce diesel from animal fat. Now it is trying to decide whether to develop the coal technology with partner Peabody Energy, or simply to sell it, so diversifying to include the business of developing technology for third-party use. “This is how we are working to transform ourselves,” Mr Mulva says.

A large part of that transformation is to come from technology, which Conoco hopes to use not only to help fully develop its 50bn barrel oil and gas resource base but to enable it to move beyond conventional fuels. To that end, Mr Mulva has increased the portion of Conoco’s technology budget aimed at developing unconventional and new energy sources by 50 per cent over the past two to three years to more than $150m(£75m)in 2008.

Conoco is not alone in its quest to find the right model for the future. Royal Dutch Shell is committed to finding at least one renewable fuel to invest in as a big part of its business. It is experimenting with everything from wind to biofuels to solar to hydrogen, says Jeroen van der Veer, chief executive, noting: “It’s too early to make a choice.”

But Mr van der Veer does not exhibit the sense of urgency of Conoco’s chief executive. He notes Shell has a resource base big enough to provide 55 years of production at current levels and is clearly satisfied with that as a source of future income.

That is not to say Shell’s model is not changing. Mr van der Veer says production from unconventional sources of oil and gas, such as Canada’s oil sands, might well comprise 15 per cent of Shell’s portfolio by 2015, up from less than 10 per cent today. In addition, he says, Shell will get more involved in trading liquefied natural gas.

Yet some experts believe the oil majors will find it difficult to adapt to the new environment. Jeff Rubin, chief economist and chief strategist at CIBC world markets, the Canadian investment bank, says developing unconventional fuel projects, such as the oil sands and coal to liquid energy sources that the majors are gravitating toward, “is not a layup”. These fuels are very expensive to dev-elop, require a substantial amount of energy, and emit more carbon dioxide than conventional fuels at a time when the world is keen to curb global warming.

On top of that, he says, unconventional projects, ranging from developing oil sands to drilling in ever deeper waters thousands of feet under the ocean for resources, have been suffering huge delays and cost overruns.

He is convinced, long term, that these changes will not be enough and that the majors are fighting a losing battle to remain big players in the oil game.

“If you look at who, in five to 10 years, is going to dominate the global oil industry, it’s not going to be Chevron, ExxonMobil or Shell,” Mr Rubin says. “It’s going to be the national oil companies.”

He points to the billions of dollars that the majors spend each year buying back their shares as evidence that they do not have the opportunities to properly reinvest in their business. “From a longer-term perspective, they’re in the eighth or ninth inning,” Mr Rubin says. “It’s going to end.”

But PFC Energy, the consultancy, is confident there will be some winners in the drive to exploit new fuel sources. It says that as the situation stands the capital markets doubt the majors’ sustainability. Price-earnings ratios for companies involved in the “basic materials” segment, when PFC Energy compiled data in March, were well below those for the healthcare, technology, consumer goods, and other industries, ranking above only conglomerates and the financial sector. And, within the “basic materials” segment, the integrated oil and gas companies ranked lowest, well below such industries as chemicals, gold, iron and steel.

“The market is demanding they create new models,” says Robin West, PFC chairman. “Until they do, they will have extremely low multiples.” He believes the companies that succeed in sustaining annual profits of $20bn to $40bn will be those that not only find new raw materials but also remain sources of technical or management expertise for the national oil companies.

The world’s biggest private oil company, ExxonMobil, is among the optimists. Itis confident that both it and the wider industry can meet the needs of the changing energy world.

“Throughout the industry’s history, we have faced numerous challenges, including economic disruption, political instability and res-ource nationalism,” says Rex Tillerson, Exxon’s chief executive. “The industry has consistently overcome these challenges to continue fuelling economic prosperity worldwide.”

Mr West says the majors are already gravitating toward natural gas, an area they still dominate because of the specialised technology and project management skills required, the reassurance they provide bankers in projects costing $10bn to $20bn, and their access to markets. But they will need more than that if they are to remain industry leaders.

“If they can see there is a return in renewables, they will go after it big,” says Priscilla McLeroy, a director at Arthur D. Little, the consultancy. But none has yet found anything in that area on which to bank their future. “I do not see any making a major course change or putting a different stake in the ground,” she says.

Technology kept the pumps running

As the private oil majors look to technology to give them an edge over state-owned rivals, they may take comfort from Chevron, a company that has come back before from what feels like a losing position.

In 1899, Chevron discovered oil at its Kern River field in California. By 1904 the Kern River field was producing 35,000 barrels of oil per day. However, in the 1950s, production declines led many to believe the field would have to be abandoned. Yet the company continued to test new technologies there and found it could use water and steam to get more out of the field. Today, more than 100 years after the field was discovered, it is producing 85,000 barrels a day and has given Chevron confidence that technology will keep it competitive ín spite of increasing difficulties accessing new reserves.

“Let me know when we reach peak technology, then we can talk about peak oil,” says Paul Siegele, Chevron’s corporate vice president of strategic planning.

Yet many energy consultants, as well as investors in capital markets, remain to be convinced.

“If they don’t have access to the resources, owning the technology doesn’t matter,” says Amy Myers Jaffe, energy expert at the James A. Baker III Institute for Public Policy at Rice University.

Copyright The Financial Times Limited 2008

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