Is less more?

It was just over a year ago that oil was trading at a record US$147 a barrel, but since then the rollercoaster ride, at least for the time being, appears to have stabilised.

We may not be out of the woods yet, but a hugely volatile period for upstream oil and gas players (and the global economy at large) may at least now become more predictable.

Oil tanked 70% in a matter of months on the back of the economic fallout triggered by the infamous sub-prime crisis Stateside. The impact on the exploration and production sector – always the hardest and swiftest hit in the cyclical downswing – was quick and hard – but arguably not as devastating as other major downturns.

Certain hydrocarbon hubs have been hit harder than others, specifically those with high project, execution and lifting costs, such as West Africa, Brazil and Canada. However, the mega-projects in these regions are simply too big to stop, and the wider expectation that prices will recover is keeping the spend on, even if the momentum and sense of urgency has dropped off somewhat.

In amongst all of this, the Middle East has fared fairly well. Companies have been hit, and margins have certainly been squeezed. It’s tough times, but still far from the crunch of the early 1990s.

OPEC quotas have played a hugely significant role in bringing about the current stability. Carefully chosen words from the Secretary General, and a combination of moderation and decisive action can be thanked for where we are today. The big question that is hanging in the air is what OPEC members will decide on September 9th. The cartel made a record cut back in December 2008, slashing 2.2 million bpd from supply.

This followed two previous cuts since September, so the cut since last summer represented a total of 4.2 million barrels per day coming offline in just four months. That’s the equivalent of all UAE and Nigeria production coming off the market completely.

Skip forward six months, and the price had indeed recovered, bouncing back from sub $40 territory to the $60+ region. In an interview with Oil & Gas Middle East, Secretary General Abdallah El-Badri said stability was his mission, and a fair production price to ensure future projects can be funded his priority. “I think that a price of up to $80 will not harm world growth. $70 to $80 would not harm or destabilise the global economy.”

With that price window now successfully achieved, the burning issue is whether the member states, which naturally want to push the price up to what the world will tolerate, see more production cuts, or rather, less oil is in fact the road to higher prices and more revenue.

Oil & Gas Middle East has no crystal ball, but a combination of macro factors suggest further cuts are unlikely, and if there are any, they will be of the fine-tuning variety as opposed to the scythe which sliced through output in 2008.

First up is market sentiment. Few think the recession is over, but the dust seems to be settling. Bullish reports of corporate earnings and moderation in EU and US economic contraction throughout the summer triggered the crude price through $70, albeit briefly. Secondly, OPEC and World Bank assumptions are that the world economy will contract by 1.4% this year – less than many feared, and that for 2010, the forecast has been revised upwards, from 2.3% to 2.4% growth.

Whether or not OPEC decides to make further cuts, the coral of OPEC ministers speaking out in the first half of 2009 all seemed to be of the school of thought that $65 – $80 was an acceptable price range.

Effectively this is a very public admission of what works for them. Well, we’re here now.

For national oil companies in the Middle East, the combination of easily achievable production figures, and coffers still awash with cash from the peak last year (traded oil averaged around $100 for 2008, quadruple the historical average of $25 – $30 over the last three decades), the issue is where and how to invest.

In an energy constrained world, the next economic boom will see demand considerably up on last year’s figures, and sure as anyone can be, the price is very likely to be above $100 again fairly soon. Maybe even 2010. The surprising consensus is that the national oil companies, and the major players that work with them, should take this opportunity to spread their wings a little beyond the oil well, and get behind green energy projects. Staying relevant in a carbon conscious world was the strategic mantra that came up time and again.

2009 has had its victims, and by no means are we out of the tunnel yet. However, from here on out, opportunity is the watchword. These are indeed exciting and challenging times for the region’s upstream companies, but never before have the rewards for getting it right been so great.

Expert Panel:

• Remi Eriksen, chief operating officer of DNV Energy
• Colin Welsh, CEO, Simmons & Company International Limited
• David Smith senior vice president, Celerant
• Tenbite Ermias, BCG partner & managing director
• Georges Chehade – principal, Booz & Co.
• Alexander Schindelar, Middle East bureau chief, Energy Intelligence

“The Middle East oil industry is in a unique position and is showing real leadership”
Georges Chehade – principal, Booz & CO

$70 oil:
I think $70 oil is much better than $35 for both the Middle East and the world. Many leaders have clearly mentioned that the fundamental difference is that $70 oil can fund investments in unconventional and more difficult resources. This is absolutely needed in order to avoid another spike in prices. Compared to $147, its not that comfortable, and local governments have shrunk their budgets accordingly, but enough of the national oil companies in the Middle East actually generated enough cash that surviving the $30 bump in the road was not too painful. The price recovered quite fast, and that has been quite positive for the region.

Project health:
$70 is ample for most Middle Eastern oil projects to go ahead, even $35 would have seen the majority go forward. I think the current price environment is good because it allows a lot of other projects around the world to go ahead, and that’s fundamental to the opverall oil industry health. A lot of projects have been delayed or put on hold because the national oil companies realised now was the time to reassess project prices and look at their budgets. Raw materials, EPC contractors and oilfield service companies have seen a lot of projects put on hold and they have reduced their prices too. They have brought headcount down, but they also seem to have reviewed pricing expectations too.

NOCs:
The NOCs in general have taken a very strong position throughout the recession. The signal that the national oil companies have sent to the world – that they are investing in future projects – was exactly the right one. The major risk is that as we emerge from the recession and demand picks up, the gap between supply and production may be too high and cause another spike. It all depends how fast demand will recover.

NOCs have delayed some upstream projects, but independents have significantly cut back on their plans. When you look at those two together, I think the impact of all of this is a significant reduction of new supply coming onstream. The main question is how fast demand is going to recover.

Challenges:
NOCs are in a position where they have accumulated cash and they had some structural gaps, mainly around know-how and technology. Today there is a unique opportunity to address these areas and strengthen their capabilities. The Middle East oil and gas industry is in a unique opposition and it has shown some real leadership.

Activity forecast:
It’s too early to say, but the next six months won’t necessarily be much easier than the last five months for a lot of upstream service providers. I think we may see some companies running out of cash, and either filing for bankruptcy or being bought out.

I think we are seeing two types of activity going on. The first is around cash and costs. For the first time in the region, companies are really focused on reducing costs, and that is a positive step towards being more competitive generally. Right now, and for the next six months, it is a fantastic time to invest in oil and gas related companies. I think some of the national oil companies will come forward and take some of these opportunities to build their portfolios.

“A controlled cost-base isn’t a bonus, it is a necessity”
David Smith – Celerant CEO

Celerant is a consulting practice with a focus on implementation. The firm is working with major upstream companies in the Middle East, to date mainly in the UAE. David Smith, Celerant CEO says the company is now looking at Doha and Kuwait, as well as the region’s other oil centres.

$70 oil:
Once you’ve tasted $147 dollar oil this environment doesn’t feel very high, but its sufficient for regional organisations to have sustainable business going forward. It wasn;t that long ago that $70 would have been a dream, and considered a rerally good price for the oil industry. It’s high enough to sustain what people are doing but there isn’t any room for complacency

Challenges:
IOCs have had ambitious programmes which require a high level of cash to support that, and I think several of those big players were super-optimistic about the oil price. There has been a change over the last year or two, whereby companies have realised that being efficient and having a controlled cost-base isn’t a bonus, it’s a necessity. I think efficiency now has to apply to all operations and oilfield activity.

Project activity:
This year the major players have put their marginal projects on ice. They’ve got pretty sophisticated models to figure out which to move forward with and prioritise, and the marginal ones have been slowed up. Going forward they need to be vigilant on cost, attract talent, (most are facing an ageing workforce crunch).

Now is an excellent time to address the structural issues facing national oil companies.

“Companies in a position to invest should definitely push ahead with that”
Remi Eriksen, chief operating officer at DNV Energy

DNV energy has an annual turnover of half a billion dollars, 90% of which is attributable to oil and gas activities. It came as a surprise then that Remi Eriksen, the man steering that ship was most enthusiastic about engaging oil companies with the firm’s other 10%.

Today’s market:
“For our Middle Eastern customers $70 is more than acceptable for most fields. There are other provinces and regions that struggle in the 60-70 bracket, particularly deepwater, Arctic and tar sands, these more expensive projects struggle in a depressed oil price environment. Some of these projects need $80 to make commercial sense. There are big opportunities in the region to extend the assets they already have. The potential here is in taking fields beyond their 30 year range. Finding out what has happened during the life of the asset, and establishing how it will behave in the future is important for this region.

NOC perspective:
It’s important that companies in a financial position to invest should definitely push ahead with that.

Some capacity building projects are on hold, and companies are holding on hoping that construction costs come down further. Our prediction is that energy demand will go up and oil, gas and coal will play a major role in meeting that need. There are massive gas reserves which are being developed now. The Middle East is contributing to 30% of that global energy need, but it has around 60% of the resources, so that in itself presents a huge potential for the region.

Biggest gain:
I think energy efficiency will play a big part in improving operations. There are big strategy questions at the moment about where investment should be flowing now. Energy efficiency and CCS are the two biggest buttons companies in this region can push to become cleaner, better oil producers. CCS technology is expensive, but the costs are coming down. This solution can reduce the environmental footprint of oil companies significantly. We are currently working with customers in the Middle East on CCS development projects, and we have some prospects too.

The oil price today should not govern what companies do in terms of investment now. The price in the future is much more important. Companies in the Middle East are not bound by the same constraints as shareholder owned firms. Ultimately I think the price of oil will only be going one way in the coming decades, what we have now is a correction, but it is not in the $10 – $20 range which poses a danger to the Middle Eastern projects.

Opportunities:
Now is a fantastic time to invest in alternative energies. In a 100-years time oil, gas and coal will not dominate in the way they do now. Of course, the next 30 years is still hydrocarbon focused. There is nothing yet that can take its place. But energy companies, which NOCs are, should have an eye on the very long term too.

I’m a firm believer that companies should be using that financial strength to develop alternative resources. Now is absolutely the time to get right behind this push.

Biggest challenge:
No question, the need for more energy, and the need to address climate change are the two biggest hurdles right now. Companies which have these missions at their core have a massive challenge, but dealing with these two is going to define energy companies for decades to come.

Also, selecting the right project, executing it in the most efficient way, and then managing operations in an optimised fashion is something that national oil companies are doing in a much more coordinated way now, and that’s helping them deliver much better, very impressive results.

Looking ahead:
I am a cautious optimist. I’m expecting 10-15% growth for the DNV energy group for this year and next, against a backdrop of 20% growth previously. That is a product of the financial environment to a certain extent, but I think all things considered that is a healthy growth rate in the current market. In this region, our operations have grown 30% in the last year. We are growing both market share and expanding the remit of what we do. The renewed focus on life-extension and Greenfield projects throws open new business areas for DNV to engage in. I don’t think we’ll see the rampant market conditions we saw in 2007 and 2008, rather I expect something more sustainable.

“Iraq is the crown jewel for IOCs”
Tenbite Ermias, BCG partner & managing director

Boston Consulting Group partner and managing director, Tenbite Ermias, says the accelerated pace of development may have slowed, but critical upstream capacity building in the Middle East is still on track.

Key developments:
Since oil has come down NOCs in this region have changed development plans. Originally a lot of projects were being accelerated because the price was so high, and pressure was growing from consumer economies to produce more. Now we are in a rationalising period where many of those plans have been put back to the original schedules prior to the artificial acceleration plans that 2007 and 2008 generated. It’s slower development plans, but only compared to a pace that was feverish. In 2008 the focus was very much on increasing production capacity, whereas today the focus is efficiency and cost. We have seen this played out with NOCs renegotiating prices with contractors, especially oilfield service providers, but also with everything that falls into the E&P sphere. Bringing projects in on time and on budget is more important now than before.

Shifting sands:
In this region the NOCs seem more thoughtful and more focused on what they really need to do. Primarily that scale back has been on the oil projects. The region is short on gas, so as the NOCs have looked again at their domestic mission, we’ve seen gas projects prioritised. Meeting these domestic commitments only forms a part of the thinking behind what the NOCs do. In an export orientated, $140+ market, most efforts go on that. The domestic projects could take a back seat in such conditions. Very few projects actually came on stream because of the $140 oil, because it was a relatively short period. In effect there wasn’t the time to do that.

Structural risks:
NOCs must build a talent pool. Originally they worked very closely with IOCs to get that skills base almost by proxy. For a number of years the big players in this region have seen that they need to capture more of the value. They need to get their own people ready to compete head to head with the IOCs.

Land of opportunity:
Iraq is a special case as its coming from a different place completely to the GCC countries. It is not easy to find the right balance between what the Iraqi government wants, and what the IOCs get out of the equation. The bidding so far was just the first round. There’s bound to be more tightening of the terms, and more finessing of the deals. If you consider deals truly in the magnitude of what’s on offer, for both parties in Iraq – it’s rare to get that just right straight off the bat. Iraq is like a crown jewel in terms of the opportunity it presents.

ROAD AHEAD:
Looking at the long term picture, upstream companies need to look carefully to make sure their products are relevant in a carbon constrained world.

“Oil prices will certainly be up above $100 a barrel by the middle of next year”
Colin Welsh, CEO, Simmons & Co International

Simmons & Company is an independent investment bank specialising in the entire spectrum of the energy industry. The firm has acted as financial advisor in nearly $140 billion of transactions, including 550 merger and acquisitions worth over $97 billion. During 2008 Simmons closed 39 M&A transactions worth US$8.5 billion and co-managed 8 offerings worth nearly $8 billion. Oil & Gas Middle East spoke to Colin Welsh, CEO, Simmons & Co International about where we are today, and what opportunities are out there for energy investors.

$70 oil:
It’s important to put $70 crude into some sort of perspective. The average cost over 30 years has been in the region of $20-$25. For the Middle East, $70 crude yields a reasonable profit, with sufficient capital to reinvest. That’s a major reason why the Middle East is a key area of production growth going forward. From the NOCs perspective its almost business as usual.

Who’s winning?

It’s a far tighter market than it was 10 years ago. Oil prices will certainly be up above $100 a barrel by the middle of next year.

TAQA have been very acquisitive, and I think they’ve done a really fantastic job of gathering an interesting portfolio of assets. If you roll forward five years, and try to image what the energy landscape will look like, I think you can expect that sovereign wealth funds, and Middle East money is going to be financing a significantly greater proportion of energy than it has done at any point in the past. If you roll forward 10 years I wouldn’t be at all surprised to see Abu Dhabi as the next Houston. Or at least the Houston of the Eastern Hemisphere. It will be home to significantly higher levels of activity, higher numbers of smaller E&P companies and oilfield service companies in that hub environment.

Future prognosis:
A few things that come together that make me very optimistic about the future investment in oil and gas sphere. At the moment there is an existing production of about 80 – 84 million barrels per day. Because most of the world’s giant oilfields are more than 40 years old that production is falling at something like 7-8% per year. As far as replacing that is concerened, all the big fields were found very quickly, most 30 years ago or more. Now we are looking at smaller accumulations, which peak more quickly, and decline more rapidly. Trying to maintain that production flat is a challenge. The BRIC economies are growing at somewhere between 5 and 8%, so when the economy is returned to growth, that demand requirement is going to blast its way through 90 million barrels per day fairly quickly.

“Tens of Billions of dollars in upstream investment is coming through in the Middle East”
Alexander Schindelar, Middle East bureau chief, Energy Intelligence

Energy Intelligence publishes Petroleum Intelligence Weekly. Middle East bureau chief Alexander Schindelar says regional expansion plans are largely going ahead.

Price satisfaction:
OPEC ministers said at the beginning of the year that they would be happy at $60, and most commentators thought this was extremely bullish. By making these statements they were effectively admitting what price was working for them. I think the local upstream industry is doing quite well all things considered. Of course, producers will always want to push for what the world will bear, but it’s likely the moderates will reign in the most aggressive voices. I think, considering the cuts that have been made already, most producers in the region have already exceeded their expectations as far as price goes. $70 – $75 by August would almost certainly have been the most bullish prediction back in March.

Project Activity:
Most Middle East countries that have committed to expanding capacity have kept to the plans they originally announced. Saudi Arabia has completed its capacity plans as far as its 12.5 million barrels per day target, and hasn’t reviewed that yet. The United Arab Emirates paused some major projects last year but now seems to be pushing ahead again and taking advantage of real cost reductions. They’ve actually showed a surprising willingness to keep moving. Literally tens of billions of dollars of investment will come through in the Middle East over the coming decades.

NOC spotlight:
NOCs have been successful at reducing costs, particularly drilling down contractor costs, and generally the contractors are playing ball. This has been the case in the UAE in particular. In KSA, the priority is shifting to gas and petrochemicals. The returns on their oil are very high, and the returns on gas just aren’t the same. Balancing these projects as a company whilst making a profit is going to be tricky for them.