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Summary

  • After Exxon-Mobil, BP, Shell and Chevron all suffered production declines in 2013, this year is shaping up to be a repeat of last year, establishing a clear trend.
  • Causes include resource nationalism, depleting old fields, and lack of new conventional discoveries.
  • Consequences include an eventual decline in the industry's ability to undertake challenging and capital intensive risks on frontier opportunities such as deep water exploration.

Last year was not a good one for global oil and gas giants. BP (NYSE:BP), Exxon-Mobil (NYSE:XOM), Chevron (NYSE:CVX) and Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) all experienced declining production volumes as I pointed out in an article a few months back. This was despite a rising trend in capital spending. In other words, these companies spent more and produced less.

BP is kicking off this year by keeping to the same trend as last year. Excluding BP's Russia partnership with Rosneft, where BP's share of production is one million barrels per day, production declined 8.5% compared to last year (link). Lower production in the second quarter is expected as well, therefore there seems no end in sight to the slide in production.

Exxon Mobil released Q1 results and it is more of the same. Production of oil and gas declined 5.6% year on year (link). Royal Dutch Shell reported a year-on-year decline of 10% in liquids production and an 8% decline in gas production (link). Chevron fared a little better than its peers with year-on-year production declining only 2.5% (link).

There are many reasons why these oil and gas giants are now shrinking. One of the main reasons being that they have many old depleted and declining fields in their portfolio, while there are also fewer and fewer opportunities to tap new fields. The reasons why there is a lack of new fields include resource nationalism in an increasing number of major oil producing countries as well as a lack of new viable discoveries. Some estimates put last year's discoveries of oil and gas at 20 billion barrels of oil equivalent, while consumption was 50 billion barrels (link). Conventional crude oil discoveries have been lagging production volumes for a few decades already. Natural gas has been doing somewhat better, but even so, it is not looking good.

Hope increasingly lies in unconventional resources, but here too there are difficulties. Shell abandoned its attempts to produce oil out of kerogen in the Powder River Basin. It also abandoned Arctic exploration in Alaska. It announced a massive $2 billion loss on its Eagle Ford operations as part of its recent divestment program. Exxon left Poland in 2012 after disappointing drilling results and also left Hungary a few years before for the same reason. Chevron is continuing its efforts to frack in Poland and in Romania. In Romania it encountered very strong local resistance to fracking, which disrupted its operations. Increasingly the realization is setting in that the only place to expand production is in North American unconventional plays where the geology and the culture are more accommodating.

North American prospects are no longer what they used to be either. The cost of getting in on prime acreage in already proven fields has gone up substantially and increasingly only less desirable sites are left in places like the Eagle Ford or the Bakken. Unproven fields such as the Monterey in California are proving to be very difficult to develop due to technical and economic challenges. It is therefore hard to see where any prospect of increasing production will come from.

Long-Term Consequences

The world's giant oil and gas companies will continue the trend of divestment and shrinkage. It is the only path left after the one-time boost the industry received from the 500% growth in crude price since the year 2000. It was an event which is unlikely to happen again because all evidence suggests that the global economy cannot support prices far above $100 a barrel for a prolonged period of time, without demand destruction and therefore economic stagnation or contraction occurring.

Stock buybacks and dividends will continue to add to the value of these companies even as investment in exploration, innovation and development will continue to decline in importance. Stock buyback schemes cannot be continued forever as a means to boost the stock price through creating scarcity, because at some point stocks will become too scarce and the market cap will be too far from reflecting revenue.

As these giants continue to shrink we will notice a gradual pull back from the industry's tendency to explore the last frontiers such as the arctic and deep water fields. Over a hundred million dollars just to drill a test well in deep ocean territory in the hope of finding a giant field will increasingly become an activity only reserved for state-owned entities, which themselves will be more cautious in doing so.

Some may be tempted to argue that the current trend will inevitably give rise to new giant oil and gas producers which will replace the role played by the current giants. It is sort of like a Darwinian process of survival of the fittest envisioned, where the old became too heavy and leaner meaner competitors will take their place. I have no doubt that there will be many new and successful companies growing into much larger entities than is currently the case. It is important to remember however that companies currently growing on the back of unconventional resources have a very limited resource base to expand. The whole potential technically recoverable shale oil resource base in the United States is about 50 billion barrels. Even this is arguably an optimistic number given that institutions such as the EIA already consider the potential resources in fields such as the Monterey as being technically recoverable, while in reality it is possible that most of it will remain in the ground forever. I doubt very much that companies currently growing on the back of oil and gas fracking activities or oil sands will ever become pioneers in other frontier areas such as deep ocean exploration or Arctic drilling. These companies will start shrinking once the unconventional fields will stop increasing production, which I believe will happen sooner than most people think.

With a decline in the oil industry's ability to tackle more challenging and capital intensive projects diminishing gradually at first and then more abruptly, perhaps as companies give up on such projects altogether, the global economy will be denied from being able to access new oil and gas frontiers in order to feed our growing appetite for these commodities. This is the beginning of a new chapter in the oil and gas industry. For the first time, I believe it will pull back from many frontiers and learn to be content with shrinking production at least when it comes to non-state owned publicly held companies. It is perhaps time to contemplate adjusting the global economy to this reality, even if it involves doing things differently than we are used to.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Oil And Gas Giants Continue To Shrink In 2014