Terra Incognita: A Continuity of Energy Surprises


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The keynote presentation from the Energy Forum hosted by MBA Focus on the campus of Houston's Bauer College of Business.

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Terra Incognita: A Continuity of Energy Surprises

  1. 1. Terra Incognita: a Continuity of Energy Surprises Energy Recruiting Forum August 1,2012 1
  2. 2. Outline• Myths and realities of the sunset industry narrative• The energy industry offers fulfilling career opportunities• Reasons to think the next forty years will be at least as interesting 2
  3. 3. The legacy: 22 years of downsizing and 8 years of recovery “Difficulties mastered are opportunities won” Winston S. Churchill Total Employment in Oil and Gas ExtractionSource: Bureau of Labor Statistics 3
  4. 4. The myths of the sunset industry narrative“Criticism is easy; achievement is difficult” Winston S. Churchill We’re running out of oil Oil and gas is low tech Oil and gas is a dying industry Oil and gas employs good ole boys from Texas Oil and gas companies manipulate oil and gas prices Oil and gas companies are indifferent to the environment Oil and gas companies ride roughshod over indigenous peoples Oil and gas companies are in denial over climate change Oil and gas companies are hostile to energy efficiency Oil and gas companies are unable to operate safely It’s a bad idea to own oil and gas company shares Renewables represent the future Oil & Gas is not a viable career choice 4
  5. 5. The reality: 2001 proved reserves are double those in 1981 World Proved Oil Reserves (Billion Barrels)18001600140012001000 From 1980 through 2011, 820 Billion800 barrels of oil were produced globally, while proven reserves increased from 680600 Billion to 1652 Billion Barrels400200 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: BP Statistical Review of the World Oil Industry 5
  6. 6. The industry’s ability to generate new resources is astounding!• Deep water exploration – Visualizing the subsurface 20,000’ below the sea bed under layers of salt – Drilling, designing and installing platforms in 10,000’ of water – Remote operated vehicles doing unimaginable tasks – Moving towards subsea processing and power generation …• LNG projects – The Gorgon project, costing ~$40 billion, with reinjection of produced carbon dioxide – The PNG LNG project with a pipeline through land owned by multiple tribes secured by a benefits sharing agreement – The AP LNG project liquefying coal seam methane• Shale oil and gas – Horizontal wells with 10,000’ laterals and up to 40 fracturing stages – Micro-seismic analysis to understand fracturing mechanics• Oil sands – Transition to SAGD – Experimentation with solvent extraction to reduce energy intensity 6
  7. 7. But there is a legacy of neglecting communications “Politics are almost as exciting as war, and quite as dangerous. In war you can only be killed once, but in politics many times” Winston Churchill 1921Arthur D. Little report to the NPC on Future Issues , 1995• “Over the past 25 years, the petroleum industry has faced a series of difficult challenges of significant consequence for its various stakeholders… From periodic supply disruptions and price volatility, to the rising tide of environmental regulations, entrenched public distrust, shareholder disaffection and subsequent cost-cutting programs, the barrage of dissatisfaction expressed from many quarters – customers, communities, shareholders and employees – has left the industry reactive and defensive. However, our research shows that the petroleum industry has a rare historic opportunity to reposition itself from the largely defensive and reactive posture of the past quarter century, into a more positive, proactive and forward looking force in national and international communities.”Pat Yarrington, Chevron 2005 (interviewed for Terra Incognita)• “The industry … abdicated a very important role of communicating to people the value proposition of energy: the efficiency of the industry; the size of the industry; the reliability of the industry; the relative affordability of our products over time; and the values of the industry. We’ve also not communicated sufficiently about the enhancements in the industry, whether it be through technology, or whether it’s through the environmental footprint. A lot of the progress that’s been made in the industry in the last 20 years we haven’t communicated in a sustained, comprehensive, impactful way at all.”Prophet, 2015-2016 Reputation Survey• “Oil & Gas industry reputation improved substantially in the industry rankings with markedly higher scores for ethics and openness” 7
  8. 8. Renewables have a role, but are not “the answer” “This is one of those cases where the imagination is baffled by the facts” Winston Churchill 1941, referring to Rudolf Hess parachuting into Scotland• Biofuels suffer from serious challenges of “energy Biofuels as a % of total liquids density” consumption 3.0% – Land and water requirements – Energy used in planting, harvesting, processing 2.5% – Intermittency• Consequently, they are generally expensive and 2.0% unreliable sources of energy, requiring subsidies at a time when government funding is under pressure 1.5% – Algae have the potential to address the biofuels energy density challenge, but naturally occurring 1.0% algae may need genetic modification – Onshore wind is close to economic, but requires 0.5% back-up generation capacity and extensive new transmission – Solar panel prices are distressed, but solar power is 0.0% still not economic 2010 2015 2020 2025 2030 2035 2040 XOM WEO CP WEO NP EIA BP 8
  9. 9. All super-majors’ except BP created TSR above S&P and Brent oil price increase Company TSR (CAGR) Vs. Indices14.00% • Over the period 2001-2011, all the super- majors exceeded the returns provided by the12.00% S&P 500 and all except BP significantly exceeded the oil price increase.10.00% • Chevron provided highest total shareholder 8.00% returns among the Super-major oil and gas TSR segment 6.00% S&P500 TSR • ConocoPhillips also delivered relatively high 4.00% Brent returns, and ExxonMobil exceeded the group Rivals Average average. 2.00% • Shell TSR exceeded Brent crude oil price 0.00% increase, Total TSR was just below the group average, while BP lagged its rivals
  10. 10. Large independents showed more variability with oil/gas mix Independents’ TSR June 2007-June 2012 OXY 49.0% High oil weighting; balanced portfolio NBL 29.2% Levant Basin opener; balanced portfolio West African Margin, Mozambique Basin APC 14.0% opener; balanced portfolio N. America focus; successful shift from gas EOG 13.1% to oil Redeveloper; balanced portfolio but -2.2% APA concern over Egypt unrest -40.9% ECA Over-weighted to natural gas -48.0% CHK Over-weighted to natural gas. Financial and governance issues-60.0% -40.0% -20.0% 0.0% 20.0% 40.0% 60.0% 10
  11. 11. For more excitement, there are the smaller independents Dividend Adjusted Share Prices – Small Independents400.00%350.00%300.00%250.00%200.00%150.00%100.00% 50.00% 0.00% -50.00%-100.00% CIE PXD ROSE OAS 11
  12. 12. Outline• Myths and realities of the sunset industry narrative• The energy industry offers fulfilling career opportunities• Reasons to think the next forty years will be at least as interesting 12
  13. 13. Affordable energy is the foundation on which the economy is built Crude Oil Prices over Three Eras (2011 $/B)140.00 Standard Oil TRC/ Seven Sisters OPEC/ NOCs Standard Oil120.00 First OPEC Meeting100.00 80.00 60.00 “State of Insurrection” in Texas (Gov. Ross) 40.00 20.00 0.00 13
  14. 14. The past 40 years have seen astonishing change OPEC Nationalization 14
  15. 15. Oil industry issues addressed over one career Real Oil Prices 1966-2011 ($2011/B) Renaissance, 120.00 New Frontiers v2 New Frontiers v1, Demand Destruction, 100.00 80.00 OPEC Emerges, Growth Agenda Nationalization Privatization Vs. Peak Oil Fears 60.00 Downsizing, 40.00 Suez Virtualization Canal Closed 20.00 Environmentalism 0.00 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 BP Management Consulting Bauer SONATRACH Majors PDVSA NPC Terra Supply Chain LP Modeling Crude oil, LNG International- YPF Argentina Future Issues Incognita Major ProjectsIndustry negotiations ization Privatization PDVSA “White Space” Value Decision Trees Reopening Maxus PMIIssues Independents CIED Technology Creation OPEC Market outlook Consolidation Independents Strategies Diversification PDVSA Quotas Upstream, & Portfolio growth for Oil & Association Shell Messaging downstream Exploration Gas Pricing contracts Sustainable strategy Oil sands Research Carlos Development Technology 15
  16. 16. Twilight of the Seven Sisters era Majors Comparative Crude Production, 1950-1970 1966-73: Burning Issues for BP KBD6000 • LP Modeling of BP’s global refining system, then for SFBP in Paris – Standard Oil adapting to Suez closure in 1967 Shell5000 BP and disruption of Nigerian oil Gulf supplies during the Biafra war Texaco4000 Socal • Back in London Mobil  What should senior executives3000 say about rising prices and negotiations with OPEC countries?2000  Should BP diversify beyond oil and gas?1000  How should BP use decision trees in capital project s 0 1950 1955 1960 1965 1970 analysis? Source: British Petroleum and Global Oil 1950-75 by James Bamberg 16
  17. 17. Early days of OPEC and National Oil Companies 1974-78: Burning Issues for SONATRACH• Holding on in 1975 to oil prices negotiated in 1974. Setting quality and location differentials.• Negotiating innovative, oil linked LNG and LNG tanker contracts with U.S. and European utilities.• Should OPEC index oil prices to recover value lost due to inflation and dollar depreciation? First OPEC Meeting in 1960• Should Algeria reopen to foreign investment in the oil and gas sector?• How should OPEC coordinate oil pricing and set production quotas?• What would happen to ADL when our client was kidnapped with various OPEC ministers by Carlos the jackal? OPEC Meeting March 1973 17
  18. 18. Maturing and evolving NOCs in Latin America Burning Issues in Venezuela (1980-2000)• How can we create security of demand for our heavy crude oil while demand for residual fuel oil is being destroyed? – Which U.S. refineries should we buy and how much should we pay (1990s)? – How can we minimize market damage from fraternal rivalry among PDVSA subsidiaries (Lagoven, Maraven, Corpoven, CITGO) – Should we IPO CITGO (2000)?• How can we make the case to Congress to open the Orinoco tar belt for foreign investment?• Can we create a world class training function for crafts, professional and management development (CIED)?• Should we consolidate the subsidiaries into a single PDVSA operating company? Burning issues in Argentina (1990-95)• How should we transform and restructure YPF Argentina so we can privatize it with an IPO?• How do we integrate the Maxus acquisition? 18
  19. 19. Back to North America in the 2000s Burning North American Issues (2000-Present)• Should we continue to support our LNG regasification project?• What are realistic scenarios for natural gas supply, demand and price?• Should we integrate oil sands into refining through acquisitions or joint ventures?• Are our strategies “right” for the changing business environment? – What are we missing in the “white space” between our functional businesses? – What overall corporate portfolio will provide greatest shareholder value? – What should be our Gulf of Mexico deep water strategy and how can we bid successfully at lease sales? – How do we add most value through technology?• Is our organization effective? – How can we improve our supply chain function? – Are we heading in the right direction to achieve world class project management? 19
  20. 20. Outline• Myths and realities of the sunset industry narrative• The energy industry provides fulfilling career opportunities• Reasons to think the next forty years will be at least as interesting 20
  21. 21. Our framework for thinking about value creation strategies Superior Shareholder Superior Management Performance Superior Financial Performance Performance Growth Strategy Choices (e.g. Portfolio Shape)Leadership and Total IntrinsicOrganizational Profitability Shareholder Value Effectiveness Returns Operating Model and Capabilities Risk Investor Value Proposition 21
  22. 22. So what’s next? “I always avoid prophesying beforehand because it is much better to prophesy after the event has taken place.” Winston Churchill, Cairo in 1943 Global Oil Consumption (Excluding Biofuels) 105000 • World oil demand will continue to grow 100000 • Oil Consumption (KBDOE) 95000 Robust oil prices and technological 90000 advances will open new resource opportunities world wide 85000 80000 • Natural gas demand will grow strongly 75000 • Secure electricity supplies depend on a 70000 2010 2015 2020 2025 2030 2035 2040 robust generation portfolio with intelligent infrastructure XOM WEO CP WEO NP EIA BP • Oil companies will continue to add “Dictators ride to and fro upon tigers which they dare not personnel, providing exciting opportunitiesdismount. And the tigers are getting hungry.” Churchill, 1937 for international careers • Social and environmental performance management will be even more important • We will understand more about climate change • Competition for access to resources will be intense • Geopolitics will continue to present more difficult challenges than geology and this is the basis for a “dark side” scenario 22
  23. 23. Shifting battlefields but continued high competitive intensityPlayers Competitive StrengthsLocals (MLPs) Low CostsIndependents Basin Opening1(e.g. Anadarko) Technology Deployment Difficult Resources Redevelopment2 IOCsIOCs Finance, Technology, Project(e.g. Chevron) Management Independents1 Stakeholder engagement Diversified markets Independents2 iNOCsINOCs Low cost of capital(e.g. CNPC) Government support NOCs Growing local markets LocalsNOC Local political mandate Difficult Places(e.g. Sonangol) Note: IOC = Integrated Oil Company; INOC = Internationalizing National Oil Company; NOC = National Oil Company 23
  24. 24. Project portfolios are being built around the “new” frontiers Project Portfolios by Asset Type ($M)120,000 NA SHALE GAS  ExxonMobil has the most valuable future100,000 NA SHALE OIL project portfolio, the execution of which will HEAVY OIL increase the firm’s rate of reinvestment in 80,000 SG growth and thus TSR. ARCTIC 60,000 – Relatively low weighting to GoM deep water LNG 40,000 OIL SANDS – Includes Point Thompson requiring AGPL DW - OECD 20,000 DW - NON OECD  Chevron is highly weighted to (Australian) LNG: - CONV XOM CVX RDS BP COP TOTAL – No new oil sands projects planned Project Portfolio "Shape" – Will become less “oily” over the next decade 100% 90% NA SHALE GAS  Shell reports a balanced but small portfolio 80% NA SHALE OIL – Highest proportion of deep water projects 70% HEAVY OIL 60% SG  BP has a legacy of conventional oil projects 50% ARCTIC LNG  ConocoPhillips has highest weighting to oil 40% OIL SANDS sands and to NA oil shales 30% 20% DW - OECD  Total has a high weighting to LNG and Stranded 10% DW - NON OECD (pipeline) gas 0% CONV XOM CVX RDS BP COP TOTAL 1. Weighted by value 24
  25. 25. All the portfolios include substantial technical and location risk Overall Project Portfolio Risk 8.00 SHELL • Shell is undertaking the highest technical risk 7.00 TOT project portfolio; ExxonMobil the least.Technical Difficulty BP • Total has the highest location risk projects 6.00 (many in Africa); COP the least (US, Canada, COP CVX Australia). The same rankings apply for XOM aggregate risk 5.00 • Shell, BP and CVX have similar aggregate risks in their portfolios, with ExxonMobil slightly 4.00 2.00 3.00 4.00 5.00 6.00 lower. Location Difficulty • We constructed an aggregate risk index (low Aggregate Risk risk > 1) by averaging location and technical Risk Index risks for each portfolio. This was used to “risk” COP 4.56 1.13 the project portfolios, amplifying for the low XOM 4.86 1.06 risk, high index companies the value of their CVX 5.18 0.99 portfolios and lowering the value of the higher SHELL 5.28 0.97 risk portfolios. BP 5.29 0.97 TOTAL 5.65 0.91 AVERAGE 5.14 1.00 25
  26. 26. Commitment to organic growth is an important driver of value • Results of regressions undertaken to “explain” TSR1 Value Driver Indices variations in TSR were surprisingly strong. Past Performance Future • Results for TSR suggest that over the period 2001- CAGR Growth3 Returns4 Risked Project Portfolio5 11, commitment to growth (in terms of organic capital expenditures/ total assets) was the mostChevron 12.80% 0.104 0.222 0.248 important driver of TSR: one point increase in theConoco-Phillips 12.53% 0.096 0.191 0.259 growth index produces a 2.1 point increase in TSR.Exxon-Mobil 9.86% 0.077 0.249 0.331 • We assessed the technical and location risks of each portfolio to derive a “risked” projectTotal 8.10% 0.093 0.229 0.180 portfolio value. This variable as a manifestation ofShell 4.62% 0.088 0.171 0.141 future growth potential was also statistically significant: a one point increase in its valueBP 1.83% 0.065 0.139 0.138 relative to end 2011 total assets produces a 0.43 Adjusted point increase in TSR. TSR Regression 2.09 -0.17 0.43 R2=0.94 • Average returns (in terms of EBITDA/Total Assets) were less important drivers: Higher returns were inversely related to higher TSR, but the variable Notes; had low statistical significance. 1. Total Shareholder Return from stock appreciation and dividends paid 2. Alpha is the return adjusted for overall market moves, Brent crude oil price changes, size of the firm and market/book ratio 3. Organic capital spending/ total assets 4. EBITDA/ Total assets 5. (NPV of future project portfolio/ Total Assets at end 2011) * relative risk
  27. 27. Thank you Christopher RossExecutive Professor, Bauer School of Business cross@bauer.uh.edu 27
  28. 28. Final thoughts“I don’t know if there will still be five Super-majors in ten years time, but I do think that if there are, the things they will be doing will surprise us.” Ian Howat, Head of Strategy for Total (2005) “The winds and waves are always on the side of the ablest navigators.” Edward Gibbon, Decline and Fall of the Roman Empire (1776) 28