Keeping the Supermajors Relevant

on Feb 24 in Oil Exploration tagged by Trevor Hicks

One of the topics I wrote about on my Schlumberger blog was the challenge the supermajor international oil companies (IOCs) have with their business model.  I’m not the only one who has expressed skepticism, indeed BP even addressed this specifically in their 2008 strategy report.  Note this quote from Andy Inglis, the firm’s head of E&P: 

Many people in the financial community are concerned that the business model of the international oil companies is dead.

Inglis then when on to explain why he thinks his firm is going to be just fine.

The challenge these firms face is two fold, one the one hand they are being challenged for access to the best prospects as the national oil companies (NOCs) become more sophisticated operators.  In the past, the NOCs needed both the expertise and the capital of the IOCs to successfully exploit their local resources but in recent years many of these firms like Petrobras and Statoil have evolved not just in to self-sufficient domestic players, but they have also established a visible international presence.  The very scale of the supermajors exacerbates their access problem, resource plays have to be big in order to have material impact and merit their attention.  But many of the countries possessing the biggest plays are generally the very ones offering the least access, think of Venezuela, Saudi Arabia and Mexico.  Russia’s environment hasn’t been the most hospitable for its international partners.

The other pressure on the IOCs has come from the major service companies like Schlumberger and Halliburton.  As those firms have beefed up both their technical and project management portfolios, the NOCs have begun to rely on them for expertise instead of the IOCs as partners.  Note the “O” in IOC stands for “Oil” - the IOCs insist on taking equity stakes in the resources where they work.  The service companies to varying degrees generally decline such equity stakes.  This appeals to the nationalist spirit of the NOCs that want to assure their populations that every drop of their national treasure belongs to the people and is being put to work for them.

Now we mix in a world where non-OPEC production appears to have peaked or at least plateaued and you see that the supermajors are challenged to generate growth in their reserves and production.  Ironically the collapse in oil prices has given them a little breathing room.  When oil was selling for more than $100 per barrel, the NOCs were flush with cash and didn’t require international capital.  And they also didn’t care as much about exploration or growth because the tight market meant higher prices.  You can work out the math using Hotelling’s Rule, but as long as the you expect the rate of increase in the commodity price to be greater than the prevailing interest rate, you’re better off leaving the oil in the ground and letting it appreciate.  Today, the NOCs have blown all their cash on social obligations in their home countries and the IOCs wisely preserved their huge cash hoards generated in the boom times.  Capital isn’t very easy to find anywhere, so the IOCs are much in demand again.  Certainly they are all working to exploit this temporary advantage into long-term access rights.

But having cash on hand in 2009 isn’t exactly a recipe for long term success.  The IOCs are publicly held companies and as such their equity holders have the reasonable expectation that the firms deliver growth.  If you don’t care about growth you buy bonds, not stocks.  And a growth strategy predicated on “we hope the price of the commodity increases” isn’t very attractive to investors.  The IOCs must grow their reserves and their production to satisfy their shareholders.

Access is beyond the control of the IOCs, as we’ve seen it varies with the markets and the times.  So their strategy must be to exploit tactical opportunities to increase access in established resource plays.  A more risky strategy is to be the first mover in un-established plays.  A country new to oil exploration will certainly need the cash and expertise of an IOC to get its program off the ground.  For instance, in the 2008 strategy document I referenced above, BP is touting its entrance into the Pakistan offshore market.  What?  Never heard of offshore drilling in Pakistan?  Exactly.  How to find the right opportunities is a bit beyond my expertise though.

The other angle for the IOCs is to strengthen their expertise.  They are still unchallenged as deepwater operators.  Indeed one of the big problems Mexico has is its inability to exploit its deepwater potential because its constitutional prohibition against allowing foreign companies to hold resource equity keeps the IOCs out.  Mexican production is plummeting as its giant Cantarell field has clearly peaked causing all sorts of fiscal challenges for the government.  But deepwater alone is not enough to deliver adequate growth for the IOCs.  There are a variety of emerging trends in oil exploration including both resource types such as heavy oil, shale gas and sub-salt formation as well as technology that can be applied to conventional production such as improved seismic imaging, intelligent completions and drilling & production optimization using real-time field data capture.  The IOCs must become masters of these various new kinds of expertise.  The service companies will get their share, but the IOCs have the opportunity to develop solutions that integrate the best technological offerings from all the various service companies and mix in their own expertise to develop a standardized and portable operating system.  Mind you, this isn’t easy as both the integration and standardization are huge challenges and will be expensive to develop, but it’s the key to differentiating themselves from each other and the service companies.  But the IOCs have the global scale to leverage the results from those investments.  If successful, they can deliver production growth with low risk that will make them indispensable in these emerging areas much as they currently are in deepwater exploration.

So the path to the future for the IOCs is not without challenge or risk, but I think it is there.  And these companies didn’t get where they are today by being afraid of some hard work and risk.