WORLD OIL SPECIAL REPORT

Independents must remain ready to adapt

Doug C. Nester, Vice President-Exploration, International, Devon Energy Corp., Houston

One can’t help but love this business. Always interesting, it was truly an emotional roller coaster ride in 2001. We began the year flush with cash, enthusiasm and optimism. The U.S. economy was strong, commodity prices were near all-time highs, and the long-reported natural gas bubble was believed to have finally burst. Today, we wake up to an entirely new world, dominated by global political uncertainty and an economy near recession. Gas storage is nearly full, and the spot market is 40% lower than expectations of a year ago. Crude oil prices are 16% lower for the same period. Thus, U.S. independents are looking at 2001 earnings well below their 2000 results.

Given these factors, does it still make sense for U.S. independents to maintain and grow international portfolios? Yes, and I believe 2002 will bring many new opportunities. September 11 and subsequent events may alter the way we do business, but the fundamentals remain intact.

North America is the world’s most intensely drilled, competitive province. The U.S. holds about 11% of global reserves, but it took more than 3 million wells to find them. In contrast, the Middle East has 50% of the world’s oil reserves after drilling only 100,000 wells. Meanwhile, U.S. output continues to decline, and independents find it difficult to establish strong positions in new trends. Thus, international operations remain important to many large independents.

All of the top 10 independents have active international programs, which, on average, contribute more to a company’s reserves than to its daily output. Devon is a good example. Our international division contributed about 10% of daily production in 2001, but it will account for 25% of total reserves at year’s end. This is due partially to new discoveries that are not yet onstream and the fact that international projects generally deliver larger, longer-lived reserves. The average U.S. reserves / production (R/P) ratio is less than 11 years, while it is more than 15 years for foreign reserves. In addition, Credit Lyonnais Securities reports that U.S. finding costs averaged $6.26/boe over the last three years, while international finding costs averaged $4.52/boe.

"As more independents go overseas, the search for high-potential, high-risk projects is increasingly competitive."   – Doug Nester

Perhaps the biggest attraction to international areas is the exposure to larger reserves through "impact" exploration projects. With the exception of the deepwater Gulf of Mexico, international opportunities can deliver consistently larger reserves than U.S. basins. A primary role for Devon’s international division is to build a drilling portfolio that includes a few selected impact projects each year. Success in chasing these high-potential, high-risk prospects requires a broad portfolio. As more independents go overseas, the search for these projects, also targets of the majors, is increasingly competitive.

Competition is also increasing as the industry relies on advanced technologies – attribute analysis, amplitude vs. offset, geostatistics, visualization centers, etc. – to reduce primary geologic risk, because companies are mainly exploring basins where geologic conditions support such technologies. Thus, deepwater exploration of Tertiary and Late Cretaceous sediments in the South Atlantic oil basins remained a hot spot in 2001. In this region that includes deepwater Brazil, Nigeria, Congo and Angola, technology-driven exploration has been very successful, with discovery rates of 48% to 65%.

In 2002, U.S. independents will continue competing for acreage in under-explored basins. Triton’s La Ceiba find in deepwater Equatorial Guinea is a great example of how an independent evaluated an under-explored basin, acquired a strategic position and then followed up with a significant discovery. It is also a good example of how difficult it is to compete for large reserves in basins where a significant find has recently been made. Within 18 months of Triton’s discovery, essentially all La Ceiba trend acreage was contracted with the government.

The South Atlantic margin will continue providing attractive grassroots exploration plays. Led by Brazil, this area allows usage of technology within a fairly immature exploration province. Until a new deepwater find spurs competition, independents should be able to compete for attractive acreage. In Brazil’s 2001 bidding round, 18 independents participated in winning groups that bid nearly $62 million on 24 blocks.

In addition, I see a significant increase in farm-ins, niche property acquisitions and larger merger and acquisition (M&A) deals. This year’s increased M&A activity will likely continue into 2002 and place more assets on the market. Companies like Devon and Burlington have already announced post-merger asset realization plans that include property divestment. Other independents are likely to follow suit. Many firms also want to see what properties will be shed from the Exxon-Mobil and Chevron-Texaco mergers.

Some regions may get less attention because of a perceived increase in political risks that are always key considerations in overseas operations. The possibility of sustained U.S. military action against international terrorists may raise long-term risks for U.S. firms operating in Central Asia, Indonesia and the Middle East, causing them to slow or delay non-essential operations.

Some of the most prospective basins are in North Africa. Wood Mackenzie said that only 30% of North African basins were licensed in 2001, and only 12% in Algeria. Favorable changes in some country contracts, and the bidding rounds held in 2001 by several nations, fueled hopes that access to this region would become a reality. But today, this is again in doubt. Increased risk to staff and operations, combined with a U.S. recession, will affect corporate strategies, including (perhaps) exiting some countries.

I enjoy thrill rides as much, if not more, than anyone does. Whenever I have the opportunity to visit an amusement park with my family, I always tell my wife that I am in search of the perfect roller coaster. Perhaps now, I can tell her my search is over.