Analysis & Opinions - The New York Times

An Uphill Climb for the Oil Giants

| September 30, 2013

The big international oil companies are going through a crisis little noticed by analysts and the markets. It is a crisis of results and of vision.

Simply put, the majors — companies like Exxon Mobil, Royal Dutch Shell and BP — aren’t growing. They have discovered relatively little oil in recent years despite increasing investment. They also have lost their exclusive lock on the skills that made them indispensable to oil-producing countries.

Several factors are at play. The big companies are gradually becoming producers of natural gas more than oil. In some cases, 50 percent of their reserves, their unproduced resources, consist of natural gas. It might be appropriate to call them gas majors than oil majors.

The problem with this transformation is that it threatens their profitability, which is today still largely based on oil fields that were developed many years ago and whose output is in steady decline.

Natural gas is worth much less than oil. It is often difficult to market, and most of its margins are taken up in the cost of transportation and liquefaction. This is the situation for some of the big discoveries of gas in Australia, for example, that may wind up being marginally profitable at best.

It may also prove difficult to make large profits from other large recent gas discoveries, for example in African countries like Mozambique and Tanzania. Everything needed to develop these finds, including highly skilled people, will need to be imported at very high cost.

On the other hand, the big gas discoveries in the United States have caused the price of gas to drop to a point where it is worth about 20 percent of oil for the same energy output, making many gas projects barely profitable.

The signs of trouble are already evident in oil majors’ profits today, which are far lower than those of seven or eight years ago, taking into account the crude prices at the time.

Let’s take as an example the two biggest oil majors, Exxon Mobil and Royal Dutch Shell.

In 2012, with an average oil price of Brent crude higher than $100 per barrel, Exxon Mobil posted net profit of $44.9 billion. However, in 2005, when Brent averaged slightly less than $55 per barrel, Exxon Mobil’s profit was $36.13 billion, about $42 billion in today’s dollars.

In other words, the price of oil almost doubled from 2005 to 2012, but Exxon profit edged up only a few billion dollars. Shell did worse, posting a profit of $27 billion in 2012 compared to $26.3 billion in 2005.

At the same time, oil majors are struggling to increase their production. In the best cases they are maintaining their levels of barrels of oil equivalent, mainly through increases of far less profitable natural gas. Most majors are producing less than they did in the mid-2000s, with some like BP doing much worse.

The majors have also watered down many of the capabilities that once required countries to turn to them if those countries wanted to develop their oil and gas reserves.

In the 1990s the oil majors began to cut costs sharply, in part by reducing the number of people they employed.

They have outsourced some of their essential functions on a large scale in order to maintain profits. For example, more than 75 percent of the value of the work of exploration and production of oil and gas worldwide is performed by service companies like Halliburton and Schlumberger on behalf of oil companies, not by the giants themselves.

Companies have also cut back on research and development. As a result, oil majors have been equaled or even surpassed in technology by others including the service companies and some of the national oil companies like Petrobras in Brazil, which is now a world leader in deepwater technology.

The trouble with this strategy is that the oil industry relies on capital and skills rather than being labor-intensive.

Cutting back on specialized people and on research and development while continuing to invest billions of dollars a year can eventually become a recipe for bad decisions and poor performance.

The majors also largely missed out on the shale gas revolution in the early 2000s, which was led by small- and medium-sized independent companies; then they tried to get in. but it was already too late. In 2009, Exxon bought out the largest American shale gas producer, XTO, for $41 billion, at a point when gas prices were high. A little more than a year later, gas prices collapsed amid a huge wave of new gas coming from shale.

As with shale gas, the oil majors have not been major players in the other great hydrocarbon revolution, American shale oil, in which independent companies are also in the lead.

Many of the big discoveries in other parts of the world like East Africa were made by smaller companies rather than the oil majors.

By diluting their skills, the oil majors have lost negotiating power with the producing countries that own most of the oil and gas these days. After all, a Chinese or Russian company can do the same things as a Western oil giant, because everyone is using the same service companies. And national oil companies can employ the service companies directly.

The producing countries have taken advantage of the situation. Since the beginning of this century, they have appropriated most of the profits from oil and gas activity by means of contracts that are ever less profitable for the oil multinationals. Probably the extreme case is that of post-Saddam Hussein Iraq, which the oil majors expected to be a potential El Dorado. It turned out to be one of the countries with the least remunerative and riskiest contracts of all.

But the same could be said for many countries, from Norway to Nigeria, where the “total government take”, meaning taxes, royalties and other fees on oil and gas activities, sometimes exceeds 90 percent.

Of course, almost all the oil majors can rely on two points of strength: enormous financial power and very low indebtedness, both the result of cash flows from investments made 20 or 30 years ago.

To take advantage of these strengths, they need to rethink their business strategy, rebuild their human talent and focus on skills and technology, including those that may allow them to effectively deal with the environmental problems associated with oil production.

They also need to consider preserving capital for a time when prices may be lower and opportunities more attractive. These companies still have time to reverse the decline, but their window of opportunity is shrinking.

For Academic Citation: Maugeri, Leonardo.“An Uphill Climb for the Oil Giants.” The New York Times, September 30, 2013.