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Shell takes to high seas to escape oil gloom

The Sunday Times

August 2, 2009

Turbulent times are forcing energy giants into uncharted waters


How Shell’s floating LNG plant might look: it would be twice the length of an aircraft carrier and cost up to $6bn

Danny Fortson

It was a week of unrelenting gloom for the oil industry. As one boss after another revealed unprecedented plunges in profits, tens of billions of dollars were wiped off company values. They warned of savage jobs cuts to come and none ventured a guess as to when the recession might end. All is not well in oil-land.

Yet it was a largely ignored announcement by Shell that illustrates the depth of the probems facing the industry. The company approved a plan to build a fleet of floating natural gas plants. Each will be twice the length of a Royal Navy aircraft carrier and weigh 200,000 tons. They will sail to gas fields located either so far out to sea or in such environmentally sensitive areas that the pipelines and surface infrastructure required make them unviable. Until recently, the idea was dismissed.

“We’ve been looking at this for more than a decade,” said Jon Chadwick, executive vice-president of Shell’s Upstream division. “But in the last couple of years, things have changed.”

Liquefied natural gas (LNG) plants, which extract gas from deep underground and purify, compress and superchill it to liquid form, are expensive and technologically complex. One can easily cost $4 billion (£2.4 billion). Chadwick declined to say how much it will cost to make LNG plants seaworthy, but shipping sources say the price could top $6 billion.

“This way we can drain one field and move on to the next. Nobody has ever built anything like this,” Chadwick said. It seems an extraordinary effort to reach fields that recently were deemed unviable.

Shell, like its rivals, is facing a harsh reality. A combination of the recession, last year’s drop in the oil price, weak gas prices in America, high costs and dwindling natural resources could lead, say insiders, to a reshaping of the sector as profound as the 1990s merger frenzy in which several big names disappeared.

Jeremy Wilson, vice-chairman of energy at JP Morgan, the investment bank, said: “The bottom line is that oil is a challenging industry. Growth of more than 1%-2% a year outside of Opec will be difficult to deliver. Oil companies aren’t like Coca-Cola or Microsoft, which have differentiated products and sustainable competitive advantage. The industry is full of similar companies with similar capabilities, delivering the same products.”

Executives are already tackling the most pressing problems: high costs and unpredictable cashflow. The oil price has more than halved from its record $147 a barrel last summer, while costs that rocketed in the boom have been slow to fall. The result is that oil firms’ cashflow is being eaten up by dividends and exploration, so many are having to borrow to meet payments.

Bosses are having to wield the axe. BP has shed 5,000 staff and Tony Hayward, chief executive, said last week he expected to shave another $1 billion from costs, mostly by squeezing suppliers. Peter Voser, who took over at Shell a month ago, could cut 10,000 staff. Exxon Mobil, which last week posted a two-thirds drop in quarterly profits, may freeze spending levels.

Solving the fundamental problem of replacing falling reserves is more difficult. Consider Shell. Last year it spent $30 billion on exploration and production, one of the largest investment programmes of any company in the world, while its production fell 5%.

Gordon Gray, an analyst at the broker Collins Stewart, said: “The decline of mature assets is relentless. They are all fighting hard against it but they are approaching it in different ways.” Analysts say, however, that cuts now will only lead to a new oil price spike when the developed economies come out of recession.

Anthony Lobo, head of oil and gas at KPMG, said that in the short term small mergers of, say, £20 billion, and joint ventures with national oil companies (NOCs) are more likely than huge mergers. “The deals of £40 billion or more seen in the last decade are unlikely to happen because one international oil company [IOC] buying another arguably compounds the problem,” he said.

“The magic formula is the combination of cash and reserves. The IOCs have cash and access to debt but the NOCs hold the keys to many of the reserves. As NOCs are not up for sale, we are likely to see international oil companies proposing joint ventures.”

This is because the “easy” oil — on land and in politically friendly regions — is drying up. NOCs own 80% of the world’s reserves, leaving the industry to fight over a shrinking number of fields in hard-to-reach places. Manouchehr Takin of the Centre for Global Energy Studies said: “The IOCs need the NOCs a lot more than the NOCs need them.”

This is why companies such as Shell and Exxon have been increasingly aggressive in marketing their technological know-how. “If you can prove to the Iraqis, for example, that you can get another 10% out of a field, that could give you the edge,” said an industry source.

Companies may also shed older assets or quit entire regions to focus their spending on big-ticket projects that will bring long-lasting production on to the books. Afren, an independent producer in Nigeria, said oil giants were looking at selling 250 fields in the country, which is riven by conflict.

A month ago, Iraq auctioned rights to develop six huge oil fields and two gas fields. It was the first time in three decades that the owner of the world’s third-largest reserves had invited foreign companies into the industry. More than 30 companies expressed an interest but in the end only one bidding group, BP and China National Petroleum, won a concession on one field. The others baulked at the harsh terms.

One source said: “BP is going to make $2 a barrel on that. Unfortunately, that is a sign of things to come.”

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