These super-sized, investor-controlled firms already have all their eggs in one basket – hydrocarbons. Now that basket contains fewer, bigger eggs that break more easily, and their attempts to mitigate the rising risks could end up exaggerating the next price cycle.
“If you call project cost the numerator, and market capitalisation the denominator then the denominator is constant but the numerator is growing,” said Clare Colhoun, chief executive of 8over8, which makes contract management software aimed at keeping a lid on megaproject costs.
“For the oil supermajors at least, the numerator increasingly comprises big projects rather than lots of small ones,” said Colhoun, whose company works for Royal Dutch Shell RDSa.L and other top oil firms.
Last week, Chevron CVX.N added $2 billion to the cost estimate for its Gorgon gas export project in Australia, taking the sum to a whopping $54 billion.
This is not the first time the cost has risen, nor is it a big jump by the standards of the liquefied natural gas (LNG) export scheme’s pricy history. But it brings Chevron’s 47.3 percent share of the cost to about $25.5 billion – well over half of the U.S. oil company’s budget of $40 billion a year.
Conclusive data on the changing relationship between the cost of single, large projects and spending power has proved hard to find.
Most oil executives and analysts contacted by Reuters, however, agreed that the biggest projects represent a bigger slice of the spending pie than they did a decade ago – though many are now more widely shared between groups of companies.
Arthur Hanna, managing director of consultancy Accenture’s energy industry group, says the resultant buffeting of planning regimes is impacting corporate thinking.
This is adding to the pressure on spending that is already coming from cautious shareholders who have one eye on cost inflation and the other on weaker prospects for oil prices. (Full Story)
“Projects today are so large that a cost overrun can fundamentally alter a company’s portfolio and the direction of their exploration strategy,” said Hanna, Accenture’s main adviser to BP BP.L.
The British group recently cancelled a costly, innovative extension to its Mad Dog complex in the Gulf of Mexico in favour of something off the shelf.
“Companies are looking at the cost implications of all projects and all regions much more closely now than they did 10 years ago and are having to make some tough decisions due to the much higher risk profile of projects today.”
World No.3 oil company Shell made one of those “tough decisions” earlier this month – abandoning a proposed gas to liquids (GTL) project that would have made diesel from natural gas in the U.S. state of Louisiana.
According to a senior industry source, Shell is particularly concerned about its record on cost overruns and project delivery as it prepares for life under a new chief executive from the start of next year.
But it is not alone.
BG Group BG.L, barely a third the size of Shell but a big player in LNG, worried investors when its QCLNG project in Queensland, Australia – the world’s first coal bed methane to LNG project – suffered escalating construction costs.
First gas to its island LNG plant has just arrived, and commercial production is on track for mid-2014, but a senior source at the company said:
“We won’t be doing anything that big on our own again.”
One snag with reining in ambitions is that Big Oil really has no option but to wrestle these money-eating broncos into submissive cash cows.
Reduced to mere contractors in “easy oil” regions such as the Middle East, companies face dwindling recovery rates in their offshore heartlands. These centrally planned giants of the corporate world have also failed to adapt to the well-by-well economics of the U.S. shale boom.
Applying their super-sized balance sheets to projects that are on a massive, uninsurable scale, often tapping the most inaccessible resources, has become their stock-in-trade.
“It’s true. We’re all betting the company, so to speak,” said Javier Diez, head of financial projects at Statoil STL.OL, Norway’s top oil company and a major international project investor.
Statoil this week cut its exposure to the Shah Deniz II gas project that will bring supplies to Europe from Azerbaijan. (Full Story)
Kazakhstan’s Kashagan oilfield, like Gorgon, has a $50 billion-plus price ticket already, and has suffered significant delays and cost overruns. It is slated to produce as much oil as OPEC member Angola at the field’s peak, and started more modest production earlier this year.
But it managed only a few weeks before shutting to investigate pipe damage caused by corrosive hydrogen sulphide – an indication that even after startup, modern megaprojects can hurt planning. Exxon and Shell are partners in the project and due to take over operations once it runs properly.
“The real issue is that projects are more marginal than they were 10 years ago,” said Elizabeth Sanborn of U.S-based body Independent Project Analysis, to which many top companies look for benchmarking of their project performances.
The scale of projects is not the problem, and cost overruns faced by Gorgon, Kashagan and others are the exception, not the rule, she argues.
However, “even controlling for the nature of the reservoir, capital costs have more than doubled … With downward pressure on oil prices, the margins will only become tighter.”
Analysts at Barclays detect a trend they saw a decade ago, the last time international oil companies overreacted to a perceived increase in risk.
“We think this period of underinvestment by the majors will lead to a period of underproduction and could drive a structural leg-up in international oil prices,” they said in a research note published this month.
“This dynamic is similar to the early-to-mid 2000s, in our view, when insufficient investment by the majors in 2002 and 2003 … contributed to significant oil price appreciation in 2004 and 2005.”
Editing by Dale Hudson – Reuters Messaging: email@example.com