Royal Dutch Shell drills ahead even with future uncertainty about crude oil prices

Analysis by: Michael Lynch

Analysis of: Shell Open to Offshore Drilling

Published at: www.rigzone.com

Gerson Lehrman Group – New York,USA

July 13, 2009

Implications

The Rigzone Newsletter for July 10 reported on Royal Dutch Shell’s offshore drilling plans for the next few years. Even with relatively low crude oil prices, RDS intends to maintain a strategy which includes upstream development. But the company has reduced activity slightly to overcome increasing costs. Production is expected to increase by 2 to 3% annually for the next three years. In 2008, RDS added 1.2 billion barrels of oil equivalent by drilling and is currently in the process of bringing three deep water fields on line including one in Brazil, one in Malaysia and one in the Gulf of Mexico. The company is running 22 offshore rigs worldwide. RDS employs more rigs than any other public company of its size. Major national oil companies currently have more rigs running. Petrobras (Brazil) operates 46, Pemex (Mexico) 38 and ONGC (India) 37. Costs for the RDSl rigs are in line with industry averages. 

Analysis

Working all over the world, looking for new reserves even as it sells refined products in its several international markets, Royal Dutch Shell can analyze its financial performance on a regional basis. This permits a geographical allocation of downstream funds based on where the growth is. The other half of the profit equation is the alignment of income producing expenditures to get the maximum number of barrels at the least cost.  There were times in the history of the company when it did not drill at all, preferring to buy inexpensive crude oil from low cost producers most of them in the Middle East. That era is long vanished and no one thinks it will ever return. Now, like all of the super majors, RDS tries to achieve a blend of purchased  and equity crude that will result in the greatest profit. RDS sells finished products equivalent to about twice is crude production. Part of the strategy is rig selection. Until mid-2008,  all companies were at the mercy of the drilling contractors. They had to pay the going price whatever that happened to be. It was a price that went up with each new engagement. As a consequence of an ever-rising market, drilling contractors began building on speculation (as they always do). At the time that crude oil prices plunged last summer, every shipyard in the world was full to capacity with new construction and most yards had long waiting lists. Those rigs are now being delivered and taken by oil companies at contract prices negotiated at the top of the market. Some of the rigs under construction have been cancelled but many more will appear on the scene during the next few years. Many of them will have no contracts. At the same time, for the rest of 2009 and all of 2010 and beyond, old contracts will begin to run out, many during the remainder of 2009. RDS and others are now releasing over-priced rigs as contracts expire. They will be replaced by new rigs at much lower prices. If the downturn continues, as many expect it to do, rigs will be stacked out, further depressing dayrates. this happened in the late 1980s and is still vividly remembered. It means that over the next several years, the average daily rig rate will fall. As these rate fall, drilling becomes less expensive. RDS will announce second quarter earnings on July 30 and will include language demonstrating which markets are strongest, which ones are improving and which ones are getting worse. They will also discuss how quickly they are obtaining operating cost reductions. From that picture the company will be better prepared to replace rig contracts expiring in 2009.  All of the oil companies do this and the result is steady downward pressure on costs. It is a process that has been repeated many times as companies go through the recurring cycles of ups and downs. The super majors, like RDS, are those who correctly analyze the cycles. Those that do not, fall by the wayside. This is a long and growing list.

More About Michael Lynch

Member of GLG Energy & Industrials Council

Michael Lynch is an independent consultant specializing in providing consulting services in the oil and gas industry. Mr. Lynch provides consultancy on reservoir engineering, reserves estimation, production forecasting, and redevelopment planning for depleted oil fields. He has been a practicing petroleum… See full Bio

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