Deepwater Activity

Deepwater investment provides a growing opportunity

Although difficult investment decisions remain to be made, there is no doubt that deepwater exploration will remain a critical element in global upstream strategy for at least the next two decades. Major players have more to lose by being conservative than by taking considered risks.

Andrew Latham, Wood Mackenzie, Ediburgh, Scotland

Much disagreement exists about the total size and accessibility of remaining, global, deepwater oil and gas reserves. At a time when investors strive to minimize risk, and invest in only the best, most secure opportunities, how accurately can one quantify the value that might be released from these assets and thus contribute to more effective decision-making?

To bring greater clarity to the subject, Wood Mackenzie teamed up with Fugro Robertson to carry out a definitive study, “The Future of Deepwater,” into the long-term potential of both known and as-yet-undiscovered deepwater reserves. This project combined fundamental geoscience principles with a practical understanding of commercial realities to give the complete picture. This wide-ranging study produced a comprehensive, definitive document that identifies locations, scales of opportunity and potential risks involved in deepwater E&P.

THE DEEPWATER REVOLUTION

Over the past decade, successful development of deepwater reserves has increasingly become the most important source of new hydrocarbon discoveries. These finds have accounted for a steadily growing proportion of newly discovered reserves, Fig. 1. By 2003, deepwater oil and gas, combined, made up 65% of all new discoveries. The trend should continue into the future.

Fig. 1. Global exploration successes are now mostly found in deepwater tracts.

Scale of discoveries. In addition, deepwater reserves continue to be much larger, on average, than new onshore discoveries.

Since 1996, roughly 1,100 deepwater wildcat wells have led to total proven reserves of 58 billion boe. This is a discovery rate of close to 50 million boe per well. Over the same period, 5,600 onshore exploration wells led to new discoveries of about 90 billion boe, or around 15 million boe per well.

It should also be noted that the onshore figure includes the massive Kashagan discovery in Kazakhstan. Take this field out of the calculation, and the average size of new onshore reserves is closer to 10 million boe. Accordingly, the difference in scale between recent deepwater and onshore discoveries is even more striking.

Success rates. Finally, at a time when general exploration levels are at historically low levels, there is no sign (yet) that deepwater discoveries are tailing off. The average success rate remains steady at close to 25%, and deepwater sources are now expected to represent close to 10% of all oil production by the end of this decade.

A long-term opportunity. Although the major contribution made by deepwater discoveries to total reserves is not in question, there is still disagreement concerning their long-term potential. Recent analytical work in the marketplace has focused on the apparently disappointing headline results announced for 2002 and 2003, where the true scale of success may not yet have been properly appreciated.

This has led some analysts to become unduly pessimistic in their judgments. After all, simply projecting recent trends into the future is no basis for sound decision-making. The study authors believe that, before investors change their policies in light of such projections, they need to go back to the geological and scientific basics, to test current thinking against hard, factual evidence.

To do this requires credible methodologies and clear-sighted analysis of underlying fundamentals. This is why Wood Mackenzie and Fugro Robertson joined forces to try to gain the clearest, most definitive assessment of the real global potential for deepwater reserves in the medium- to long-term future.

GEOSCIENCE ANALYSIS

Conclusions in the study have been based on in-depth knowledge of petroleum systems around the world, with analysis carried out by geologists who have direct, long-term experience in these regions. The work also takes into account a wide range of well and seismic data.

A reliable, objective view of available opportunities is supported by a clear commercial understanding of investment requirements. In contrast to other published studies, this work focused primarily on potential new discoveries, though due consideration was given to growth prospects within existing reserves.

Basin types. Researchers looked at 30 different basins around the world, all of which have substantial proportions of their areas lying within deep water at depths between 400 m (1,312 ft) and 3,000 m (9,843 ft). They include basins that are already known to be rich in available resources. Others possess geological indicators suggesting that they may have outstanding future potential, as well.

It should be remembered that between 1975 and 1995, all the so-called deepwater giant discoveries were made in water depths of 1,500 m (4,925 ft) or less, Fig. 2. Since 1995, nearly half of these finds have been made in water depths exceeding 1,500 m, and as deep as 3,000 m (9,843 ft).

Fig. 2. Since 1995, a growing share of giant deepwater finds has been made in water depths greater than 1,500 m.

Play fairways. The study analyzed all potential reserves in terms of play fairways. There are more than a hundred of these in total, of which 14 are undiscovered potential opportunities, while the others are all linked either to proven reserves onshore, or to recent deepwater discoveries.

Taking a holistic view of each potential resource area is critical for accurate evaluation. The joint research project included a database of all key resource components, together with an understanding of their development history over geological time. This enabled researchers to make reasoned predictions about the scale and accessibility of resources within a given hydrocarbon system.

Risks. Accurate geoscientific analysis makes it possible to quantify and mitigate technical risks through better understanding of factors, such as reservoir quality, deepwater structures, and seal and trap efficiency. Other risks are also involved in making investment decisions, covering the economic, development and political status of the host country concerned. Above ground, risks of this kind are also considered in setting out investment recommendations.

The study gives a 15-year view of exploration and development issues, providing a basis on which to build equivalent levels of knowledge concerning other risk elements. This should enable E&P departments to establish a reliable basis for rounded decision-making.

BUILDING A DEEPWATER VALUE EQUATION

Deepwater exploration still represents one of the best, most attractive oil and gas investment opportunities available in the decades ahead. Once again, headline figures help to make the case.

Total size. Researchers believe that the total of deepwater reserves, known and yet to be discovered, is likely to reach 260 billion boe, of which close to two-thirds (around 64%) will be oil, while the rest (around 100 billion boe) will be gas, pie chart, Fig. 3. So far, only around 8 billion boe have been produced, with a further 70 billion boe discovered and awaiting production. This leaves, in the study authors' judgement, about 180 billion boe of oil and gas yet to be discovered.

Fig. 3. As the data indicate, there appears to be plenty of exploratory life left in deepwater prospects worldwide.

If this calculation is correct, then deepwater reserves will be the key source of new value in the industry for many years to come. Given an average discovery rate of about 8 billion boe per annum, at least two more decades of steady exploration will be required before all accessible reserves have been discovered.

Value creation. Strategists within oil majors need to make the right case, both to their own boardrooms and, most critically, to the investment community before they can embark on the long-term development effort required to maximize this opportunity. That means they need to be clear about the value that can be extracted from deepwater assets.

The headline value calculation states that, using a now very conservative price assumption of $20/bbl, there is a total available value of $360 billion within deepwater reserves. This is made up of an estimated $130 billion from known reserves, close to $200 billion from yet-to-be-discovered reserves, and a further $40 billion of additional value from probable commercial improvements. With a potential risk downside of just $3 billion, this represents a demonstrably good investment risk as far as the underlying figures are concerned.

The Big Seven. Most deepwater specialists think in terms of the “Big Four” countries, where known, predicted reserves are concerned. These countries include the US (Gulf of Mexico), Angola, Nigeria and Brazil. Research suggests that it is more accurate to think in terms of a “Big Seven,” with Egypt and Australia likely to achieve the status of “deepwater gas giants.” Mexico could prove to have the largest undiscovered hydrocarbon reserves of all.

The scale of the liquid reserves in these countries is enormous, with the existing Big Four oil producers, plus Mexico, possessing somewhere between 20 billion and 40 billion bbl of oil in both known and yet-to-be-discovered reserves. Taken together, these countries account for around 90% of all potential deepwater oil reserves, or about 144 billion bbl.

In terms of gas, the four leading players are the US (Gulf of Mexico) and Nigeria, together with the emerging new giants, Egypt and Australia. Researchers estimate that each one of these possesses between 15 billion and 20 billion boe.

Other significant countries. No other countries come close to the potential scale of the Big Seven. Yet, a number of them do have reserves on a scale that could provide a high level of value to international companies and host governments, alike. They include Norway, Indonesia, Malaysia, India, Canada and a range of West African states, such as Cote d'Ivoire, Mauritania, Equatorial Guinea and Congo.

Most of these countries have deepwater oil reserves that range between 2 billion to 4 billion bbl. Norway and Mexico are also likely to possess sizable gas reserves of between 5 billion and 7 billion boe, each.

Major international players. The study's research also evaluated the current position and future prospects for the national oil companies (NOCs) and international oil companies (IOCs) that have significant positions in deepwater reserves. It is not surprising to see that the firms with assets concentrated in the Big Seven countries are best placed to see steady growth over the years ahead.

Of these, the largest is Petrobras, because of its near dominance of the Brazilian basin. BP, Shell, ExxonMobil and ChevronTexaco are the next largest firms, where known reserves are concerned. Thanks to their outstanding coverage of potential new opportunities, it is Shell, ChevronTexaco and ExxonMobil that appear to have the strongest, potential exploration upside.

It is not just the super majors that are well positioned to profit from deep water in the next decade. A range of independents also has very strong exploration positions. Researchers calculated that at least four of these companies – Devon, ConocoPhillips, Kerr-McGee and Murphy – could open up new discoveries worth between 200% and 400% of their current portfolios.

Costs and returns. In making clear-sighted judgements about potential value, investors need accurate insights about finding costs, which vary widely from country to country. Where gas is concerned, access to end-user markets is also a key factor in decision-making.

West African countries have the lowest finding costs of all, because of the high success rate they have enjoyed to date. This success is not expected to change fundamentally in the foreseeable future. The US and Brazil, on the other hand, have higher finding costs, because success rates in these areas have traditionally been lower.

Establishing full life-cycle returns, however, also requires taking into account a range of other factors, such as fiscal regimes, existing economic infrastructure, potential for OPEC quota restrictions and access to user markets. This more rounded, comprehensive approach changes the picture significantly. When all factors are taken into account, the US Gulf of Mexico remains the most attractive area for investment, with predicted returns of around 20% over the full life cycle. Nigeria comes a close second, while Egypt is the outstanding gas opportunity in deep water.

Good returns can also be made from smaller-scale reserves, such as those in Malaysian waters, while the massive potential of Mexican deepwater oil and gas remains one of the enigmas for the future.

MAKING THE RIGHT CHOICES

To turn raw opportunity into proven value creation, potential investors need to know where the best opportunities are to be found. They need to be confident about the scientific basis for all such knowledge, and they require a clear view of potential issues – ranging from commercial development to political concerns – that might impact the exploration process.

The work carried out during the study offers important new evidence on which to base accurate decision-making. In the end, however, each company needs to make its own judgement call, based on strategic vision and goals, investment potential, geographical presence and key skill sets. Investment decisions will also be influenced by fiscal terms, technological developments and infrastructure.

Fiscal terms. This is the single, most important factor in determining the value to be derived from each new deepwater opportunity. At present, there are wide differences between various regulatory and financial regimes. Potential investors need to take a clear, accurate view on how such regulations could change (for better or worse) over the years ahead. Speed and scale of exploration in the Mexican fields, in particular, will be defined largely by this factor.

Technological developments. This factor could continue to add value in deepwater operations during the next decade and beyond. This will be of particular importance in fields at ultra-deep level, or with highly acidic oils. The value equation for Brazil and Angola, therefore, will be more sensitive to technology improvements than it would be in most other areas. In turn, this means that companies focusing their activities on these regions are most likely to benefit from new technology breakthroughs.

Infrastructure. This group of issues will also be quite important, especially when it comes to exploiting stranded gas. This is a subject of great importance to the development of virtually all deepwater reserves, and it can be seen as both a technical and commercial matter. The balance between gas usage and cost of shipment (via pipeline or as LNG) occupies the minds of business leaders across the industry. It is especially relevant to the deepwater value equation.

One needs to bear in mind that realistic timescales are very important in judging the quality of deepwater opportunities. To be thorough, deepwater resources will require at least two decades to explore fully, and companies need to be in this effort for the long term, if they are to benefit.

Mexico offers an interesting example of problems that can be caused by short-term thinking when appraising opportunities. Researchers identified Mexico as a key, future source of deepwater hydrocarbon reserves. However, it may be a full 10 years from now before any foreign company is given permission to operate off the Mexican coast.

Calculations based on a short (say, five-year) time horizon would mean ignoring the vast potential of Mexico completely. This would virtually invalidate any objective analysis of total world reserves. This illustrates why it is essential to use a credible methodology for any form of predictive analysis.

Though difficult decisions remain, there is no doubt that deepwater exploration will prove to be a critical element in oil and gas strategy for at least the next two decades. Major international players have more to lose by being conservative in this area than by taking considered risks in pursuit of potential value creation. 

THE AUTHOR
	Dr. Andrew Latham is vice president, Upstream Consultancy, for Wood Mackenzie. He has been a principal consultant within the firm's energy team since 1995. Until the end of 2001, he managed the team responsible for Sub-Saharan Africa research products and consultancy. Dr. Latham has led the company's series of Global Deepwater multi-client studies. Since the start of 2002, he has focused on upstream consulting work, especially relating to exploration strategy. He began his career in 1990 as an international new ventures geologist at Ranger Oil, focusing on upstream projects outside of North America and the UK. Later, as that company focused on West Africa, he became project geologist for Angola, residing in Luanda for a time. Dr. Latham graduated from Imperial College, London, with a BSc Honours degree in geology. He also holds a PhD in geology from University College, Cardiff, Wales. Andrew.latham@woodmac.com