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Summary

  • Oil and gas companies have been facing rising operational costs.
  • Cash flow rates have lagged growth in costs.
  • Restructured companies have reported better market value returns.

Crude oil and natural gas exploitation has been progressing into more challenging regimes. These frontiers such as the Subsalt as well as the Arctic among others are more geologically complex requiring enhanced technological applications to exploit; that inevitably means higher costs with implications on the operating companies' profitability and shareholder returns. The Energy Information Administration in a recent report indicated that among 127 major oil and gas companies, cash proceeds for the year ended 31 March 2014 totaled US$568 billion while cash usage was US$677 billion, or US$109 billion higher.

Three metrics elucidate this:

1. Upstream Unit Capital Productivity

In the seven years to 2012, unit capital productivity among the world's top 74 oil and gas companies declined in a near-exponential manner from 21.59 barrels of oil equivalent per dollar (boe/$) to 9.56 boe/$ (Figure 1), according to a Pricewaterhouse Coopers report. The report was based on the world's top 100 oil and gas companies as compiled by Evaluate Energy. Unit capital productivity measures the quantity of oil and gas produced for each dollar of capital employed by the companies. In other words, the quantity of oil produced by the companies per dollar employed has almost halved in the period under consideration. The decline is in spite of massive production increases mainly from unconventionals and is same even among the top performing (upper quartile) companies.

(click to enlarge)Unit Capital Productivity (2006 - 2012)

2. Crude Oil Production and Upstream Capital Expenditure

During the period 2006 to 2012, capital expenditure rose by a staggering 72.6% while the associated crude oil production only managed a 6.6% increase for the aforementioned 74 oil and gas companies. The implication then is that while companies have spent heavily on upstream activities, there has been no commensurate increase in production.

3. Discovery and Production

Finding and development costs are a key metric for oil and gas companies. In order to stay in business they need to ensure that the cost of finding and developing resources is at least matched by revenues from those resources. This has not been the case. According to Bernstein Research, for major International Oil Companies, IOCs, growth in cash flow per barrel (15%) was less than the compound annual growth rate (18%) for discovery and production in the decade to 2009. For the period 2008 to 2012, discovery and production costs for crude oil alone rose by an average of 10.3% for the world's top 74 oil and gas companies, according to Pricewaterhouse Coopers; cash flow rates for the same period have not given much cause for cheer either.

For major IOCs, the options are compounded by issues of resource nationalism as in Venezuela and political instability as in such countries as Iran and Iraq. Even where there is no overt resource nationalism, IOCs have to enter into Production Sharing Contracts, PSCs, or Joint Ventures, JVs, to access production acreages. Many PSCs require the IOCs to bear exploration and production costs -- including those for dry wells -- and then share production proceeds with host countries when discoveries are made. However, such proceeds often come under very steep royalty and tax regimes. Since these royalty and tax rates are on a sliding scale, usually indexed to oil prices, rising global crude oil prices offer no relief to the IOCs.

In order to grow reserves, meet dividend projections as well as tax provisions, many oil companies have instituted cost-cutting measures to ensure a more efficient deployment of capital. These measures in the main have entailed unbundling into sectorial segments as well as divestment of non-core or non-performing assets. In general, the nimbler Independents and segment-focused companies, as well as Integrateds that have split or are restructuring, have on average, returned better market value. For example, since breaking out from their respective parents, Marathon Petroleum (NYSE:MPC) and Phillips 66 (NYSE:PSX) have consistently been among the top 5 in IHS Energy's ranking for the Refining and Marketing segment.

(click to enlarge)

For companies such as Shell [(NYSE:RDS.A) (NYSE:RDS.B)], ExxonMobil (NYSE:XOM) and BP (NYSE:BP), restructuring in the main has been via assets divestment while for others such as ConocoPhillips (NYSE:COP) and Marathon (NYSE:MRO), it has been a combination of divestment and unbundling.

ConocoPhillips had substantial net proceeds from a US$15 billion divestment program between 2009 and 2010. This year it realized US$1.4 billion from assets divestment in Nigeria. The company topped IHS Energy's 2013 rankings for the Exploration and Production segment, while its spun-off half, Phillips 66, was second in the Refining and Marketing segment.

For Marathon, a split into two companies occupying two different operational -- Exploration and Production as well as Refining and Marketing --segments provided a combined market value increase of 24% the year after. Marathon Oil, the Exploration and Production company has been selling non-core assets to focus on liquid-rich operations and reported a 33% increase in its 2Q 2014 income over last year's.

ExxonMobil however, has had issues with reserves addition and some analysts believe it is because the company has become large and unwieldy, requiring a split or unbundling. The company in 2Q 2014 saw a better-than-expected rise in income, translating to US$2.05 a share compared to US$1.55 a share a year ago. According to Reuters, part of the increase was due to divestment this year, of its holdings in a Hong Kong utility and power storage company.

Shell, with its new CEO, has accelerated assets divestments and subjected projects to more rigorous analyses. Acreages in Nigeria as well as holdings in Canada among others have been divested. The company's 2Q 2014 earnings report showed a 33% gain in profits over a year ago (excluding one-time items and inventory changes), beating analysts' estimates.

National Oil Companies, NOCs, such as Columbia's Ecopetrol (NYSE:EC), Thailand's PTT as well as Russia's Lukoil (OTCPK:LUKOY) and Novatec have since undergone restructuring and refocusing. For some of them, the respective governments hold less than 50% share even if they still wield considerable influence. Nigeria's NNPC with such enormous potential, sadly, is still hobbling along; a Petroleum Industry Bill, PIB, which was designed to completely overhaul the country's oil and gas sector, has been mothballed in the country's legislature since 2008.

Source: Why Oil And Gas Companies Must Restructure To Remain Profitable