This presentation covers factors that caused the petroleum industry to decline during the 1980s, and then leading to the recovery beginning in 2008 through some possible future development trajectories.
US Petroleum Renaissance: A Holistic View Lorna Greening March 8, 2013 University of Tulsa
Today’s Presentation• What the majority of the petroleum industry missed in the early 1980’s or ‘Why did I end up at the back of that unemployment line?’• Understanding how the industry is evolving or will evolve is cheaper than a therapist!• The petroleum industry is far more complicated in 2013 than in 1973; and, as a result producers need to think strategically.• Future factors, events or developments to be watching.
What Led to the Decline of the US Petroleum Industry in the Early to Mid-1980’s?• Unsupported price expectations by producers.• Producers failed to recognize the power of price in inducing efficiency gains (i.e., decreases in energy intensity). And, those gains were not reversed once prices declined, i.e., little or no rebound effect.• The industry did not recognize that OPEC needed cohesion in order to set world oil prices; and, that cohesion was disrupted in the early 1980’s resulting in lower prices.• US energy policy which included an emphasis on conservation and fuel substitution, price controls for natural gas, and a wind-fall profits tax on crude.• Penny stock market offerings during the 1970s brought in organizations without the skills to understand or prosper in the oil industry. And, lots of ego. . .and hubris!• Macroeconomic effects including stagflation, and higher costs of capital for investment.• The bottom-line: Those of us in the petroleum industry during the 1970s and early 1980s were primarily focused on finding and producing oil and gas. In the course of that endeavor, the majority of the industry overlooked major factors that would impact it eventually.
How did the Structure of the Industry Change?• Surprisingly. . .the industrial organization or structure of the petroleum industry has not changed since 1973. There are still essentially four segments in the industry.• Performance or benchmarking measures vary by segment. In 2011: – Large independents and independents had capital expenditures twice that of the majors, and spent nearly 2.25 times on exploration and development. – Results from operations were just about equal between large independents and independents versus the majors. – Expansions of gas reserves by large independents and independents was 3 times that of the majors. – Meanwhile production costs for large independents and independents were approximately 2/3 of the majors, and the large independents and independents had replacement rates (excluding purchases and sales) of over two to 3 times that of the majors.• This indicates the differences in strategy between the segments with the majors relying on acquisitions and large processing projects as opposed to the independents who concentrate on exploration and development.
What Happened to Hubbard’s Peak?• Hubbard’s peak is based on the premise that conventional oil resources are finite in any geographic region. – US peak oil was achieved in the 1970 with production of 10.2 m B/D. – World peak oil was expected around half a century after the initial publication of the theory in 1956 with OPEC extending the peak out by about 10 years.• Unconventional oil and gas resources have disrupted this relationship. – US proved reserves (conventional and unconventional) total 22.3 billion barrels and reserves of natural gas total 272.5 trillion cubic feet. – Undiscovered technically recoverable oil are estimated at 139.6 billion barrels, and natural gas at 1445.3 trillion cubic feet. – Since 2008, US oil production has increased by approximately 25% and imports have declined from 60% to 42%. – The US has now overtaken Russia as the world’s largest natural gas producer. – Refined product exports are now averaging almost 3 m B/D.
Tapping the Riches: Tight Crudes and Shale Gas• According to the USGS, whose numbers are generally more conservative than industry estimates which are more than twice to three times those of USGS, the US has as a resource base: – 46 different potential shale gas targets with an estimated 95% confidence interval of 318.4 to 935.8 TCF of natural gas and 12541 million barrels of natural gas liquids. – 23 different potential tight oil targets with an estimated 95% confidence interval of 5048.9 to 12497.2 million barrels of crude. – Some of these potential targets are stacked as in the Eagle Ford making the economics more attractive.• Technology was and will be the key!• Large shale gas reserves have major economic and other implications.• Efficiency gains are reducing finding costs as experience is gained. – Costs for a Bakken well declined by about 29% during 2012 and a well now costs approximately $6.5 million to drill. – Efficiency gains result from increased pad drilling, determination of the optimal number of frack stages and lateral lengths, and a reduction in cycle times.• However, wells in tight oil plays have steep decline rates, averaging between 65-75% during their first year of production.
The Refining and Logistic Bottlenecks• Lack of key infrastructure is leading to bottlenecks in moving produced tight oil and could result in stranded resources. – Bakken and Eagle Ford production is being diverted to barges, railroads, and trucks due to insufficient pipeline capacity. • Freight costs for Bakken crude range between $5/B to $18/B depending on final destination. • Over the last year, increased take-away capacity has been added from the Bakken. – Gulf coast refiners are having difficulties matching new crude with different qualities with existing processing equipment. • Refiners over the last decade have invested over $100 billion in upgrade capacity. • Crack spreads for gasoline have widened during the first quarter of 2013. • Domestic demand for refined products was impacted by the recession. – The Jones Act is impeding the efficient movement of crude and refined products between US markets. – These logistical bottlenecks distort the pricing structure of tight oil in comparison to benchmarks such as West Texas Intermediate. And new benchmarks such as Louisiana Light Sweet (LLS) are being used.• However, domestic tight oil has resulted in the revival of refining on the East Coast.
Impacts of US Abundance on World Oil Markets?• World oil prices are determined by global supply and demand.• For the first time since the 1960s, the US may achieve energy independence and may become the world’s leading oil producer by 2020. – The IEA in November, 2012 predicted that North America would become “a net oil exporter around 2030”. – Implications for security and trade: • Incremental oil production would be large enough to more than moderately diminish exposure to Middle East politics. • Expanding US production will reduce the trade deficit and reduce costs to consumers.• OPEC controls on oil prices are diminishing; and, Russia’s power over European gas supplies is declining as a result of shifting LNG to those markets.• Disruption of US tight oil development by OPEC is unlikely. – In the mid-1980s and again in the late 1990s, OPEC boosted their production triggering low prices that killed development of more expensive sources of oil. – Social and political turmoil in the Middle East requires OPEC to maintain revenues. – Saudi Arabia needs oil prices on average at $70-$85 per barrel; and, tight oil producers need prices of $50 to $80 to achieve returns on capital.
Can US Crude be Exported?• New sources of crude have been hailed as a means of reducing the trade deficit through exports.• Crude oil exports are prohibited from the US by statute which list crude as a commodity in ‘short supply’. – Energy Policy and Conservation Act (1975) – Mineral Leasing Act (1920) – Outer Continental Shelf Lands Act Amendments (1978) – Navel Petroleum Reserves Production Act• Crude exports, even to Canada, require a ‘swap arrangement’ whereby – US crude is exchanged for more or better crude and products. – Contracts can be interrupted if necessary. – Swap is needed for refining or marketing reasons which are beyond the exporter’s control.• US international trade commitments may limit the ability to prohibit exports.• Exports of refined products are not under these restrictions.
Can Excess Gas be Exported?• Currently, the price differential between the US and the Asia Pacific is on the order of $10 to $13/mmBtu.• However, natural gas exports require the approval of US DOE. – Currently, there are fifteen export permit approvals pending. – Approval is basically automatic for countries that have free trade agreements (FTA) with the US. – For non-FTA countries, DOE must do a thorough review of the “public interest” (economic, energy security, and environment) before allowing export. Non- FTA countries include Japan, China and India. – Maximum total volumes exported to non-FTA countries from the 15 pending and one approved facility are estimated to be 23.71 Bcf per day.• In addition to DOE approval, LNG project developers must receive approvals from the FERC.• Further, US energy-intensive industry and power generation oppose exports as increasing volatility and hurting competitiveness.• In addition to the hurdles posed by regulation and public opinion, LNG export projects face high capital costs, and significant commercial risks from price volatility and competition.
An Abundance of Riches: The Next Power Play• Except for the late 1990’s, the majors have not had a significant role in the electric power sector.• Recent events suggest that these firms should diversify into this business activity. – Gradual shift to electric vehicles which could be economically viable in US markets by 2020. – Increasing electricity consumption in response to concerns about climate change.• Three sources of value accrue from integration into gas-fired electric power: – Captive markets for part of a gas sales portfolio potentially increasing sales volumes. – Capture of the “spark spread”. – Increased flexibility when either natural gas or electricity markets are unfavorable.• Business models for participation in power generation can take a number of different forms with some options less capital intensive with greater flexibility: – Investment in construction of new generation assets as IPPs. – Partnerships with suitable utilities.• The move into the power sector would require a new set of skills and understanding since the two sectors are different.
An Abundance of Riches: Gas-to-Liquids• Gas-to-liquid (GTL) fuels and methanol overcome the barriers that have impeded the penetration of CNG and electric vehicles.• Liquid GTL fuels contain no impurities and avoid refinery processes required to remove crude impurities. However, the overall efficiency is only 57-58%.• Major investments have been announced for GTL facilities.• Small modular GTL systems are being developed to take advantage of more site-specific opportunities. – Small plants cost about $100,000 for every b/d capacity. – At $4.00/mmBtu a barrel of finished diesel product can be produced for $66.00 ($1.57/gallon) as compared to approximately $124/barrel ($2.95/gallon) for diesel refined from crude.• New methods using bio-catalysts are being developed. – Methanotrops are bacteria that can use methane as a sole carbon and energy source. – These have been bio-engineered to use shale gas for the production of fuels and petrochemical feed-stocks. – Advantages include lower costs than cellulosic feed-stocks, operation at lower temperatures than thermal processes (greater efficiency), scalability, and smaller environmental impacts.
Will Oil Companies be Players in Clean and Renewable Technology Development?• In the last decade, the petroleum industry has invested $71 billion in ‘clean’ and renewable energy as compared to $43 billion by the US Federal government. Examples of industry investment include: – Shell has invested the most primarily in alternative fuels using biomass (e.g., Brazilian sugar cane). – ExxonMobil is investing $600 million in algae biofuel development, and has spent $7 billion in alternative fuels since 2005. – BP has developed a gross generation capacity of 1955 MW of wind in the US.• Major oil companies are still focused on their core business of exploration, production, and mid- and down-stream activities.• The majority of clean technology start-ups are funded by venture capital funds.• Energy Security Trust – Fund would pay for the development of biofuels, electric batteries and cars and trucks power by natural gas. – Redirects about $200 million per year in royalties for drilling on federal lands; would operate for 10 years.
Uncertainties for the Industry• Greater regulation of hydraulic fracturing (‘fracking’). – Fracking receives exemptions seven federal environmental statues amplified by EPAct 2005. – Regulation of fracking is largely left to the states with varying sets of regulations and several states have banned the practice. – EPA and the Department of the Interior are now in the process of evaluating the issue with the intent of regulating waste water disposal and air quality. – Estimates of additional costs of new regulation are unlikely to exceed 50¢ per barrel.• Deficit reduction and revision of the tax code – Removal of favorable tax provisions for the industry might raise government revenues by as much as $40 billion over the next decade. – Major tax code provisions that might disappear: • Intangible drilling costs. Independent oil companies currently may write off 100%, while majors may only write off 70%. • Dual capacity rules. Companies with foreign operations may receive a credit for taxes paid in the foreign country. • Percentage depletion. Independent oil companies may take a tax deduction of 15% per year of resources in the ground, while majors are excluded from this provision. • Domestic activities deduction. Oil companies may claim a 6% deduction from US production. – Arguments for abolishing these tax provisions stem from the current high prices.
Some Final Thoughts• The industry did learn from the experiences of the 1970s and 1980s.• The industry is now shaped by an awareness that: – Price does play a role in bring on supplies and expanding resources. – Energy is a commodity, and the demand for it is a derived demand, i.e., energy services. The market for energy services can change substantially over time as a function of price, and a change in preferences. – Petroleum is part of a much larger interconnected energy system. – An organization’s niche within the petroleum industry is important in strategy development since each niche has its own unique characteristics and views of risk. – External factors, such as world markets, have as much to do with success as finding oil or natural gas. – Business opportunities exist as a result of new technologies or in other sectors of the energy industry. – If an organization wants to prosper and grow, it take the ‘long view’ and continually scan the horizon for changes in its business environment.