The Biggest Oil Projects Need High Prices to Make Sense

The U.K.-based think tank Carbon Tracker Initiative is out with a compilation of the world’s costliest oil projects under consideration by big oil companies. The report lists 20 projects with a combined price tag of $90.6 billion. Nine of the top 20 are in Canada; Eight of those are oil sands projects in Alberta. The rest are either deepwater or Arctic projects. All of them, according to CTI’s analysis, need oil prices to be at least $95 a barrel.

Despite all the chaos in oil-producing parts of the world, (Libya and Iraq in particular) crude prices have been remarkably flat over the past three years, averaging about $109 since 2011. Last year marked the smallest range of daily price movements in more than 10 years, according to the U.S. Department of Energy. That’s largely a function of the U.S. shale boom, which has cushioned the blow of all that geopolitical chaos and kept plenty of oil flowing around the world

CTI's analysis suggests all these projects need an oil price of $95 to work Carbon Tracker InitiativeCTI’s analysis suggests all these projects need an oil price of $95 to work

Still, the report touches on a central problem facing most major oil companies: Oil is becoming harder to find and more expensive to produce. That means big oil companies are having to spend more money to produce less oil. Just to keep replenishing their reserves, oil companies need to work harder,  look farther, and spend a lot more money. That’s a terrible problem in any business. But for an industry that needs to operate in some of the riskiest places in the world, whether it’s the Arctic or Middle East, it’s especially troublesome.

In a weird way, the U.S. shale boom has worked against the big oil companies by keeping prices lower than what they would’ve otherwise been given all the chaos. On top of that, a lot of the major oil companies missed the early days of the shale boom. Most of the first movers were smaller companies like Chesapeake, Pioneer, Devon. When the majors bought in, a lot of them did so at higher prices. That’s pushed their cost curve up even more over the past decade.

Douglas Westwood Major oil companies have increased spending on exploration and production by 14 percent a year since 2005, only to see their combined production fall.

Profits among some of the biggest oil companies were sharply down at the end of last year. Under increasing investor pressure, that led a lot of them to finally bite the bullet and cut back on capital spending this year: ExxonMobil (XOM) by 6 percent, Chevron (CVX) by 5 percent. Royal Dutch Shell (RDSB:LN) is looking to reduce spending by 20 percent this year. Along with oil prices hovering well over $100, those spending cuts helped lead to some blowout profits during the second quarter. Exxon profits jumped 28 percent. Chevron’s profits beat estimates. So did Shell‘s and ConocoPhillips’s.

Still, the longterm risks are there. But not necessarily for the reasons you might think. As difficult and expensive as it is to produce oil, the world is still very well-supplied. According to the International Energy Agency, which tracks oil markets, oil output by non-OPEC producers will rise by 1.7 million barrels per day in 2014, while total global demand will grow by only 1.4 million barrels. That has some analysts predicting a crash in prices.

And as technology improves, the cost of extracting oil in certain areas has come down. In the U.S., for example, according to Goldman Sachs’ oil analyst Damien Courvalin, the break-even price to produce oil is $85. That’s down from around $90 a couple years ago.

If oil prices do dip below $100, profits on those mega-projects will get very thin. All these companies have shareholders. If they have to spend more money to produce oil than they can make selling it, investors will eventually revolt. The CTI report lays out the risks to shareholders:

To create shareholder value, oil majors need to reduce exposure to exploration projects requiring the highest oil prices, rather than solely pursue production volume. To help investors, CTI lists the top 20 undeveloped high-cost oil projects, by size. They are primarily a mix of Alberta oil sands and deep water projects in the Atlantic, representing $91 billion of capital (over the period 2014-25), which could be returned to shareholders rather than have oil firms gamble it away.

The trouble is, oil companies have no choice but to make these bets. And right now, they’re caught between two competing forces: they have to keep going after costlier oil, but they can’t rely on higher prices funding those costs since the U.S. shale boom is keeping a lid on prices.  

Overall though, the CTI report may be overplaying the risks posed by these mega-projects. Take the oil sands in Alberta for example. Last December, a study by two former Deutsche Bank (DB) analysts cast doubt on the economic viability of western Canada oil sands projects. The report, titled, Keystone XL Pipeline: A Potential Mirage for Oil-Sands Investors, calculated that producers in Western Canada will need to fetch at least $65 a barrel to attract new investments and ensure that current projects remain profitable.

Things looked particularly dire then, when the price of Western Canadian Select (WCS), the main benchmark used to price Canada’s heavy oil, was around $58 a barrel. It’s since come up to $77, largely due to increased railroad access to parts of Alberta. With Keystone XL held up by the Obama Administration, the Canadian government is approving pipelines to take that oil sands crude east and west, but not south into the U.S.  That’s boosted Alberta oil sands production and has the Alberta economy booming.

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15 August 2014 | 4:09 pm – Source: businessweek.com

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