April 13, 2009
Globe and Mail
Eric Reguly
Standard economics says the higher the price, the more you can invest.
The more you invest, the greater your ability to raise production to meet ongoing demand. The oil and gas industry has worked this way for decades.
Higher prices meant higher production, which meant everyone had enough fuel to drive stupidly big SUVs.
At least it did until recently. Then something troubling happened. Even as oil prices set records, and even as the investment spigot was cranked wide open to meet relentless demand, some of the world's biggest oil companies were incapable of pumping as much oil as they had before.
Overall production in this group went flat in 2003-2004 and declined thereafter. Between 2006 and 2008, the falloff was 4 per cent, an average decline increase of about one percentage point a year. "The analysis shows that decline rates in the industry are increasing despite the enormous amount of money spent on the base over the past two to three years," said Michele della Vigna and the three other authors of the report.
There you have it: Spend more, produce less. The analysts do not think the downward movement is a blip. They are "confident that there is a clear trend of increasing decline rates."
Why is this happening? The big old oilfields like the North Sea are running out of puff, which should come as no surprise since many of them have been on the trot for three or four decades. The new fields are the disappointment.
They are both smaller, and go into decline faster, than the magnificent behemoths discovered after the Second World War. Lower prices - oil has gone from $147 (U.S.) a barrel last July to about $52 - might only accelerate the decline because less cash flow per barrel inhibits any company's ability to invest the vast sums needed to keep the fields prolific.
The more-investment, less-production scenario doesn't necessarily mean global production faces a sudden drop, because many new fields have yet to open for business and some countries, notably Iraq and Nigeria, are pumping well below their potential because of nasty diversions like gunfire; production could even rise from last year's 85 million barrels a day. What it does mean is that the world may be closer to peak oil than anyone had feared only few years ago, and that oil prices are far more likely to go up than down in the mid to long term.
With oil demand on the wane as recession grips the planet - the International Energy Agency predicts global oil demand will fall 2.8 per cent this year - no one much cares that Big Oil is struggling to keep production stable, let alone growing. But watch out when economic growth kicks back in. A repeat of the 2007-2008 price spike is not out of the question.
The production decline rates have all sorts of implications besides increasing the likelihood of higher prices. It means oil companies will naturally gravitate toward long-life unconventional reserves, such as the vast heavy oil deposits in Canada and Venezuela and shale oil in the western United States. Total, to take but one company fretting about waning conventional production - its output fell 2 per cent last year - plans to invest as much as $20-billion in the Alberta oil sands (including the construction of a refinery) over the next decade or so.
It also means that investors will have to work harder to pick the best oil companies. Any analysis has to take into account oil prices, reserves, production rates, cash flow per share, refining margins, operational problems, dividend yield and political risk. To these, add decline rates.
Companies with the ability to use new fields to raise production, or keep it even, will likely fare better on the stock market than those without.
The Goldman analysts relegated BP, the former British Petroleum, to "sell" territory because of rapidly falling production. Goldman thinks 2009 will be BP's last year of production growth. Declines of 2 per cent a year after 2010 are likely because it has few new projects in the pipeline and recent startups have short lifespans. BP's valuation, Goldman said, "does not discount, in our view, the structural production decline that the company is likely to enter."
Spain's Repsol is another company that faces a big gap between volume growth from new discoveries and waning production from old fields (Goldman left its rating intact, partly because it appears the falling output is already baked into the stock). The companies with the best production growth outlook between 2008 and 2012 are BG Group, Norway's Statoil and Shell.
The good news for the production laggards is that oil prices are well off their lows, thanks in good part to OPEC's quick work to reduce supply. This will buy companies like BP and Repsol time - the trick will be using higher prices to make oil discoveries, and fast.
If they don't, the math says a few years will be shaved off their corporate lifespans.
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