Learning to Live with Low Break-even Oil Prices: Where Are We?

What if it is true, that the current situation is the new norm? In what ways do we need to change how we evaluate, plan and manage new development opportunities and ongoing production operations in a more uncertain and, possibly, declining market?

I started my career at a time when we knew that the REAL oil price had to rise to encourage supply to meet the world’s growing demand for reliable cheap energy. I have witnessed the disruptions caused by two oil price booms (1972-84 and 2004-14) and the subsequent corrections. In that time, the REAL oil and gas prices have slowly stair stepped-up to the current level. As many decision experts have pointed out, the current investor confidence problems with our industry may have more to do with our cognitive biases, than the inevitable variability of reality!

Source: Presentation to SPE Calgary Section by Tyler Schlosser of GLJ Petroleum Consultants; “Forecasting is Hard: How can we be less wrong?” (April 2017) www.gljpc.com/library

I feel woefully under-equipped for this new world order; and now recognise that being overly decisive (or brave (?)) likely only works when market or geo-political forces can rescue a sub-optimal approach!

What if there is no “last hurrah” for oil at the end of this particular tunnel? (A scenario apparently favoured by Dieter Helm, an economics professor at Oxford University, as reported by Jillian Ambrose in The Telegraph and Financial Post 19th April 2017). His prognostications suggest that an ongoing decline in REAL oil prices is inevitable, since the major producing countries (Russia, Saudi Arabia, USA, Iraq and Iran) have little choice but to encourage greater production to maintain their cash-flows; and to minimize the risks of having stranded resources by the time carbon emissions are finally constrained.

Similarly, the current wholesale natural gas prices are unlikely to achieve significant market expansion. Intercontinental gas price differentials may more or less reflect brownfield LNG plant expansion, operating and transportation costs. If, as a society, we want to encourage greater usage of gas as a cleaner, safer fuel, our Governments, Inter-governmental Agencies and Development Banks will need to share the near-term commercial risks for the required infrastructure, by providing loan guarantees and/or low cost loans.

Clearly, everyone in a capitalist system has to receive reasonable rewards for their efforts, expertise, technology development and life-long training costs, as well as a reasonable return on their investments. However, some distinguished economists, like Joseph Stiglitz, have suggested that the markets are less efficient than many of us think, because of a tendency towards ‘excessive rent-seeking’ by those controlling access to capital.

It has been reported that the weighted average cost of capital for the O & G Industry has crept-up to some 9 – 11% during the 2019-2014 boom, (according to data published in Bloomberg, as reproduced in the Guest Editorial by Martin Craighead (CEO of Baker Hughes) in the April 2017 JPT). This is much higher than I had imagined, based on my mid-career experience in the 1990’s.

This same Bloomberg data set suggests that between 2009 and 2014, the industry’s Return on Invested Capital (ROIC) slipped to between 6% and 12.5%, sowing the seeds for the current crisis in investor confidence, which was exacerbated by the subsequent, unanticipated (?) crash in commodity prices.

Arthur Berman has recently postulated that much of the cost savings achieved in the last three years have come from a combination of high-grading the best opportunities and squeezing the service, supply and EP & C sectors into non-sustainable positions. (An OilPro posting on 10th April 2017.)

Over the last decade, corporate look-back studies on Major Capital Projects, industry journals and SPE presentations have:

  • Highlighted our tendency to be overly confident about our rather optimistic “Best Estimates;” and
  • Provided lots of feedback on the cognitive biases that are seen as the root-cause of the under-performance

Human nature and vested personal interests exacerbate these “Blind-spot” and “Choice-supportive Biases” because of the competition for funding. (Notwithstanding, the efforts of independent peer reviewers and Decision Review Boards to keep us rational!)

See Part Two: Creating Incremental Value

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