What’s new in exploration

	Vol. 230 No. 2
ARTHUR BERMAN, CONTRIBUTING EDITOR, bermanae@gmail.com

Low oil prices and the future of exploration: En aguas revueltas

The price of oil has fallen from more than $140 per barrel in July to less than $40 in January, and gloom has overtaken the E&P business. Companies are reducing staff and suspending or canceling project plans as they attempt to adjust to the collapse in energy markets. Projects that were conservatively based on $60−$70 oil prices a few months ago no longer make sense. In addition, the world is facing a global depression, and oil demand is expected to remain low for some time, perhaps for years. Because of this, I believe that we are entering a time of great promise and opportunity for some.

This summer, most analysts predicted that oil prices would remain near or above $100/bbl, and a few said they would rise to $200. Now, the US Energy Information Administration (EIA) forecasts that oil prices will not reach $130 again (in 2007 dollars) until 2030. The gap between oil price predictions now and five months ago is a good reason to question, if not to ignore, all long-term forecasts.

The EIA believes that it will take more than 20 years to regain what was lost in the five months between early July and year-end 2008. This baffles me. At the same time, published graphs of both the EIA reference- and high-case projections suggest the possibility of a return to prices in the $80−$100 range as early as 2010−2012. How should we interpret these very different outcomes?

It seems that EIA’s grim oil-price view is based in part on faith that election talking points about reducing carbon emissions, increasing use of biofuels, the wholesale conversion to hybrid and light vehicles to attain the congressionally mandated 35-mpg goal will collectively decrease demand enough to keep prices low for two decades. I am skeptical because consumers have already abandoned much of their interest in buying fuel-efficient vehicles now that gasoline is cheap again, and have regained their appetite for SUVs. (US consumers have a very short memory span.)

Jim Vanderbeek, a great mentor early in my career, taught me that all predictions, including price forecasts, are always wrong. He said that oil exploration is a business that loses money most of the time. Money can be made only during brief periods when oil prices first begin to rise, but before costs increase. A company, therefore, must always be ready to drill. This means spending money when price forecasts suggest not spending, in order to mature prospects, obtain leases and contract rigs while oil prices are low. Shortly after oil prices increase, the cost of drilling and other services inflate and consume most of the profit even when drilling programs are successful. By the time most companies recognize that oil prices are rising, it is too late to make money.

The current global financial crisis was not anticipated by most experts. Certainly not its magnitude or how quickly it spread. This is what author Nassim Taleb calls a “black swan,” an improbable event with great impact. Jim Vanderbeek believed that the world is full of black swans, and that it rarely works as forecast. He taught me that war, disease, famine, natural disasters, civil unrest and economic dislocation are always possible and will disrupt the supply of oil, as well as the plans of organized men who make price forecasts. Examples include the 1967 and 1973 OPEC oil embargos triggered by conflicts between Israel and its Arab neighbors, the 1979 Iranian Revolution and the 1980 Iran-Iraq war.

More recently, civil unrest in the Niger Delta region has disrupted world oil prices periodically since 2006. In fact, the current global economic crisis may produce intermittent black swans for as long as it lasts. The ongoing depletion of Cantarell Field in Mexico, which accounts for about 15% of Mexico’s GDP, could produce unanticipated disruptions, particularly in the United States because it imports and refines most of that oil.

Most people think that low oil prices make the E&P business unprofitable. This may not be correct, however, if the cost of services declines proportionally. Lower oil prices may also put financial pressure on countries like Mexico, Venezuela, Russia, Saudi Arabia and Iran to make deals that were impossible a few months ago. Hugo Chávez is now discussing renewed participation in Venezuela with Total, Chevron and Shell.

This week, ConocoPhillips announced that losses caused by low oil prices will force the company to reduce its staff by 1,300 employees and its budget by 18%. Some of the company’s troubles, however, result from re-purchasing $15 billion of its own stock during the past two years when share prices were high. ConocoPhillips encountered a black swan. The company, along with ExxonMobil, BP, Chevron and Shell, could not find better investment projects than stock re-purchase, because they are apparently out of ideas for oil exploration and production. Cutting staff and reorganizing will mean a few more lost years away from their core business of finding oil.

The E&P business is facing a period of both peril and great opportunity. Companies that decide to spend as little money as possible and devote themselves to cost-cutting will risk extinction. Companies that use this low-price environment to find ways to leverage lower costs to make a profit may find that low oil prices are not so bad after all. Those that seek inventive ways to gain entry into plays, countries and leases that were previously unavailable on favorable terms may find a way toward a bright future. Companies that recognize the necessity to retain staff, encourage new ideas and be ready to drill, despite unpredictable price reversals, will be the biggest winners of all.

En aguas revueltas ganancia de pescadores is a Mexican saying that means “In turbulent waters, fishermen profit.” It comes from the fact that during storms when the rivers are flooding, most fishermen stay at home. Those who deal with the danger of turbulent waters but still venture out, however, find that there is little competition: They catch the big fish.