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Sympathy For The Oil Industry:
Diminishing Returns Start To Hit Home

By Matthew Wild

24 April, 2010
Peak Generation

Despite constant growth in oil prices and projected record demand, many companies working in the industry are experiencing a tough start to the year and face “uncertainty over project costs and expected returns.”

A report created by UBS analysts looking at Oil services companies – which serve exploration and production industry but that do not typically produce petroleum of their own accord – in a sector with no apparent slack:

Oil prices have gradually risen back to more than $80 US a barrel after plunging
to around $30 a barrel at the end of 2008 when the economic crisis reduced
demand for energy products. But oil majors are still wary of awarding new
contracts.

“Returns appear to be reaching a trough at a much higher
level than in previous downturns,” UBS analysts wrote. “For many of the oil
services stocks, earnings estimates now assume — as do ours — that there is
little visible decline in earnings in 2009 or 2010 from already-high levels in
2008.”

Visibility over earnings is still poor, however, because of the
uncertainty over project costs and expected returns, the analysts cautioned.
Valuations are still at reasonable levels following an impressive rally in the
sector, they added.

Earnings remain strong – as you would expect with oil trading above $80 – and demand is rising to a projected new record, yet the sector is wary about what’s ahead.

According to the International Energy Agency’s latest Oil Market Report, published April 13, global crude demand is expected to reach 86.6 million barrels per day in 2010. This is greater than 2007’s figure, a then-record 86.50 million barrels per day, before the global financial crisis – triggered, many believe, by skyrocketing oil prices.

The problem can only be supply.

Clearly, non-Opec oil is in serious decline, and the majors are struggling to find large scale deposits. The UBS report is just the latest in a series of business-page reports illustrating that the easy-to-find, cheap oil is gone, and the only way to obtain new deposits is through risky ventures such as expensive offshore drilling and questionable investments such as the Canadian oil sands.

According to a report published March by the College of Engineering and Petroleum at Kuwait University, non-Opec production peaked in 2006. (And will do everywhere else in 2014.)

Later in March, Jim Mulva, CEO of ConocoPhillips admitted that seeking new oil reserves was not a money making venture. According to Chris Nelder, on Seeking Alpha:
On March 25, ConocoPhillips (COP) CEO Jim Mulva admitted that pursuing new oil reserves just doesn't pay. The remaining resources have become too marginal and too expensive, and the competition for them has become too intense.

Rather than keep slugging it out with bigger and better-funded players in pursuit of growth, Conoco has decided to sell $10 billion worth of its assets over the next two years, all of them in the marginal category, and concentrate on producing its core assets.

The proceeds will be used to buy back its stock, reduce its debt, and raise dividends — just as rival ExxonMobil (XOM) has been doing for the last five years or so.

The risks of searching for oil offshore were brought home this week with the explosion and sinking of the Transocean Ltd. oil-drilling rig Deepwater Horizon in the Gulf of Mexico.

An item on BNET Energy – which aims to provide “daily news coverage for managers and executives in the energy sector” – considers “how costly it’s getting to reach oil reserves.” Under the headline Peak Oil Era: Why the Cost and Risk of Oil Exploration Will Keep Rising, it suggests that the ultra-deepwater semisubmersible oil rig was only in use because the world’s easy-to-extract oil had already been drained.


Rigs like Deepwater Horizon will continue to push drilling depths merely because the company has to. The days of easy-to-access oil are gone. Now, companies like BP are faced with oil and gas exploration projects that require operating in politically unstable regions or working in technologically complex areas like the deep waters of the Gulf or offshore Brazil. Protectionist measures from countries like Russia have forced companies to look at friendlier, albeit more difficult and costly, areas including the Canadian oil sands.


The May 20 disaster is feared to have killed 11, who are still missing at this time, and injured 70. It also poses a major pollution threat.

Meanwhile, alternative sources such as the Canadian oil sands are struggling to live up to the hype. This oil is so expensive to extract, and at such environmental cost, that production has tended to be shaped by the volatility of the crude market rather than bringing calm to proceedings.

An April 23 report in Canada’s Globe and Mail newspaper, headlined Oil sands awash in excess pipeline capacity, suggests that the actual oil output from Alberta is not sufficient to fill the pipeline infrastructure.

Back in 2008, it reports, the industry was talking about expanding production by up to “an extraordinary 1.8 million barrels a day” – but has never “managed to post a single-year increase of more than 40,000 barrels a day.” But the pipelines have been built:
Despite resurgent oil prices, new production isn’t coming on fast enough to fill
up the pipelines. The frenzied construction has left a glut of unused pipeline
capacity that will take years to fill.

In a half-year span beginning
last fall, TransCanada Corp. and Enbridge Inc. have opened the spigots on two
pipelines that, together, have room to carry 885,000 barrels of crude oil a day.
Expansion plans call for the two lines, named Keystone and Alberta Clipper, to
carry 1.39 million barrels a day in coming years. That will mean new capacity
roughly equivalent to the entire current output of the Canadian oil sands.

The aftershocks of that construction will rattle Canada’s oil sands
producers, who are already facing soaring transportation tolls. The overbuilding
of pipelines has already led to legal wrangling between producers and pipeline
operators, and may sour some of those highly dependent relationships.

This is not just an infrastructure issue. Reading between the lines, it’s questionable whether the oil sands can deliver the long anticipated oil bonanza. Talk of having to wait seven years before the projected 2011 output can be obtained makes grim reading, considering the vast investment tied up in this project:
The energy industry’s ambitious growth projections back in 2008 were derailed by a myriad of problems. The economic crisis wreaked havoc on the sector. Projects faltered and timelines were extended. Technical issues, for instance, have so far kept both Husky Energy’s Tucker Lake and Nexen Inc.’s Long Lake oil sands projects far from their original production goals.

Starting in late 2008, fully 1.2 million barrels a day of future projects were deferred or cancelled in the oil sands, as soaring costs and tumbling crude prices scared away investors. The economic recovery has brought some of that work back to life, but even industry projections now show a sobering new reality. According to the Canadian Association of Petroleum Producers, the volume of oil previously expected by 2011, the first full year of operation for Alberta Clipper, will now not likely flow until 2018 or later.

Original article is available here