OilVoice Magazine - April 2014

Edition Twenty Five April 2014
US shale oil production costs on the rise

Oil & Gas Boom 2014: Happy 65th, Hydraulic Fracturing
Ukrainian crisis highlights political risk in long term gas sales
Cover image by Berardo62

1 OilVoice Magazine | APRIL 2014

Issue 25 April 2014
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Adam Marmaras
Chief Executive Officer

Welcome to the 25th edition of the
OilVoice Magazine.

It's incredible how fast time has flown
by, just last month we celebrated the
2nd year anniversary of the OilVoice
Magazine. We continue to deliver you
the best Oil & Gas content in the
industry, seen featured in our Opinion
& Commentary section, and we'd like
to thank our carefully selected authors
for their contributions over the last
couple of years. If you're interested to
know more about seeing your articles
featured on OilVoice, please get in
touch.
This month we have great articles from
Evaluate Energy, FTI Consulting,
Wikborg Rein, Blank Rome LLP and
Practicus. We'd also like to welcome
back some of our regular authors,
including Gail Tverberg, Kurt Cobb and
Andrew McKillop.

Adam Marmaras
CEO
OilVoice

Contents

Featured Authors
Aprils featured authors
3
Will OPEC collapse - Libyan P.M. flees to Europe
by Andrew McKillop
5
Ukraine, Russia and the nonexistent U.S. oil and natural gas "weapon"
by Kurt Cobb
9
US shale oil production costs on the rise
by Mark Young
11
Oil & Gas Boom 2014: Happy 65th, Hydraulic Fracturing
by David Blackmon
16
Putin's energy stranglehold on Europe
by Andrew McKillop
18
Skills and capability challenges facing upstream
by Giles Lewis and Jon Sasserath
25
The Fracking Flip - U.S. Domestic Oil Production's Radical
Transformation of the North American Tanker Trade
by Keith Letourneau and Matthew Thomas
39
Ukrainian crisis highlights political risk in long term gas sales
by Dag Mjaaland and Aadne Haga
44
Beginning of the end? Oil companies cut back on spending
by Gail Tverberg
45

Featured Authors

Andrew McKillop
AMK CONSULT
Andrew MacKillop is an energy and natural resource sector professional with
over 30 years experience in more than 12 countries.

Mark Young
Evaluate Energy
Mark Young is an Energy Analyst at Evaluate Energy.

Kurt Cobb
Resource Insights
Kurt Cobb is an author, speaker, and columnist focusing on energy and the
environment. He is a regular contributor to the Energy Voices section of The
Christian Science Monitor and author of the peak-oil-themed novel Prelude.

David Blackmon
FTI Consulting, Inc.
David Blackmon is managing director of Strategic Communications for FTI
Consulting, based in Houston.

Gail Tverberg
Our Finite World
Gail the Actuarys real name is Gail Tverberg. She has an M. S. from the
University of Illinois, Chicago in Mathematics, and is a Fellow of the Casualty
Actuarial Society and a Member of the American Academy of Actuaries.


Giles Lewis
Practicus
An experienced Market Researcher, Giles heads up Practicuss Research
capability globally, with a particular interest in Oil & Gas.

Jon Sasserath
Practicus
Jon has a deep background in Oil & Gas in both corporate leadership and
consulting roles, with a particular interest in technology-enabled change.

Keith Letourneau
Blank Rome LLP
Keith Letourneau is a member of our Maritime Emergency Response Team
(MERT). He focuses his practice on maritime and energy transactions and
litigation matters.

Dag Mjaaland
Wikborg Rein
Dag Mjaaland is a Partner at Wikborg Rein's Oslo office and is part of the
firm's Petroleum and Energy practice.

Will OPEC collapse -
Libyan P.M. flees to
Europe

Written by Andrew McKillop from AMK CONSULT
Inevitable Break-up of Libya

Presaged by months of political infighting, and street fighting outside parliament,
former Libyan prime minister Ali Zeidan fled from Libya, 12 March, according to
newswires. Reuters explained his flight to Europe as due to parliament voting him
out of office on Tuesday March 11, following his inability to stop rebels exporting oil
independently. Reuters and other newswires added that the rebel forces set a
'brazen challenge to the nation's fragile unity', and had actively threatened Ali Zeidan
with assassination, several times.

Zeidan stopped over in Malta for two hours late Tuesday before going on to "another
(unspecified) European country", Malta's Prime Minister Joseph Muscat told state-
owned television TVM. No European government had confirmed the arrival of the
Zeidan 'hot potato' by Wednesday, but observers suggest Germany may be Zeidan's
final destination.

The standoff for control of oil exports and revenues from exports has since the 2011
ousting and killing of Muammar Gaddafi intensified the longstanding regional and
tribal faultlines in a country whose territorial integrity - like that of Iraq or Ukraine -
was always stronger on paper than the real world. Only due to Libya's role as a
significant oil exporter, this de facto break-up of 'a country that never was' is treated
with alarm in Western capitals, especially in oil import-dependent Europe.

Can Libya Unwind OPEC?

Claimed bases for alarm over the prospect that Libya 'descends into anarchy' include
the very hypothetical argument that a fragile new Libya ruled by rival militias grouped
into Tripolitania and Cyrenaica - east and west - each with their own allied and
dependent political factions in the still-transitional government, will undermine
OPEC's unity. The argument continues by suggesting a divided Libya will be
supported and opposed by different OAPEC (Arab OPEC) states, who may utilise
the Libyan state of anarchy as a lever for their own infighting.

Backing this claim, OPEC full-plenary and other meetings, since 2011, have steered
away from taking any decisions relating to Libyan oil production and export volumes.
A major reason for this is usually not discussed by the Western 'oil expert fraternity'
but is very simple. Since 2011, Libya's oil production and export volumes have wildly

varied, from as high as 1.6 million barrels a day (mbd) to nearly zero, but this has
had no real impact on global oil prices, which remain high. In other words, global oil
markets are very amply supplied. Removal of almost all Libyan supply, for relatively
long periods measured in months, has been easily compensated by other exporters.
The only possible conclusion is there is incipient or real global oversupply - not
shortage of oil.

Despite or because of this, Iraq like Libya is another 'too hot to handle' subject at
OPEC meetings due to its own national territorial fragility, on one hand, and also due
to Iraq's increasing oil exports, on the other. Including Kurdish production and
exports, the former Iraq is rapidly moving back towards its previous peaks of oil
production and export supply, dating from the 1970s. Western observers claim that
OPEC member states will be unable to control and limit oil export supply when it is in
excess, or compensate oil export shortfalls due to endemic political crisis in Libya
and Iraq, when it is in deficit. OPEC will become unstable, and could even break up.
Other oil exporter states could then follow the Libya-Iraq models of nation-shattering.

The Libyan Breakdown Model

Arguments backed by facts are easy to produce, that Libya's descent into anarchy
will cause longterm, maybe irreparable damage to its oil industry, with a concomitant
longterm reduction of its oil export capacity and oil exports. One counter-argument is
that after break-up, former Libya's two main oil production and export regions, and
especially Cyrenaica, can attract investment capital and oil industry know-how, and
reattain the country's former total maximum export capacity of about 1.6 mbd. The
only question would be the political implications and the timelines.

Claims that each new part of a two-nation Libya would be 'too small' as national
entities, both politically and economically, can be dismissed by considering small or
ultra-small but large or major oil exporter countries such as Kuwait, UAE, Oman,
Brunei, Equatorial Guinea and others. In effect, oil production in and exports from
small or very small countries is often easier, than in and from large countries.

Iraq's breakdown path is significantly different from Libya's, due to the historical fact
of the Kurdish nation, and the endemic shia-sunni rivalry and armed conflict in 'rump
Iraq'. Libya's national identity, we can easily argue, was even less credible than
Iraq's, and only continued or was maintained due to the dictator, Muammar Gaddafi.
Also unlike Iraq, the historical antecedents of its breakdown into at least two
separate and independent states or nations, can be traced back to at least the
1830s. The necessity or obligation for armed conflict in Libya, by the central or
'legacy government' in Tripoli, is far lower than the Baghdad's government need to
use force to maintain the semblance of a united country - if only to attract oil sector
financing and investment.

Libya's Parliament can be considered to have acted rationally after Cyrenaican
rebels holding three key ports in the east disobeyed government orders and loaded a
North Korean-flagged tanker with oil as part of their drive for political autonomy as
much as for gaining oil dollars. The Parliament dismissed Ali Zeidan as incompetent.
Libya's state prosecutor Abdel-Qadr Radwan then issued a travel ban on Zeidan,
also because he faces an investigation over multiple alleged irregularities involving

the misuse of state funds.

Military Power is Final Arbiter

Following the escape of Ali Zeidan, Libya's General National Congress or transitional
government quickly named the Defence minister Abdallah al-Thinni as acting prime
minister. Another replacement will be picked sometime later this year. Al-Thinni can
however be considered as only the Defence minister and PM of Tripolitania, and
faces the difficult task of trying to unite and lead a country that is deeply divided
along tribal-political and regional-political faultlines, where not only Islamists oppose
more European-oriented 'liberal' politicians such as Ali Zeidan.

Like large and increasing areas of Iraq, Libya has no effective police or political
institutions. The Tripoli 'legacy government', like that of Baghdad is in permanent
danger of running out of money because rebel activity at oilfields and export
terminals chokes off vital oil revenues, the process being even further advanced in
Libya, than in 'rump Iraq'.

The role of defence and military forces is certain to increase, in both cases. This
week, in Libya armed clashes have broken out between rebels and pro-government
forces in Sirte, the central coastal city dividing western and eastern Libya. Whichever
way the armed forces tilt will decide the outcome in the Sirte case.

Also similar in these two open and fast-advancing processes of national breakdown,
the final arbiter is military. Government spokesmen in Libya said on Tuesday that
gunboats loyal to Tripoli had chased the North Korean-flag tanker along Libya's
eastern Mediterranean coast and opened fire on it, adding the claim that Italian ships
were aiding the effort, which was denied by Italy. As in the cases of Iraq and
Ukraine, peaceful or armed separation into stable elements, of the now-unstable and
unsustainable former Libyan state of Muammar Gaddafi, is almost certain.

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Ukraine, Russia and
the nonexistent U.S. oil
and natural gas
"weapon"

Written by Kurt Cobb from Resource Insights
Commentators were falling all over themselves last week to announce that far from
being impotent in the Ukraine crisis, the United States had a very important weapon:
growing oil and natural gas production which could compete on the world market and
challenge Russian dominance over Ukrainian and European energy supplies--if only
the U.S. government would change the laws and allow this bounty to be exported.

But, there's one very big problem with this view. The United States is still a net
importer of both oil and natural gas. The economics of natural gas exports beyond
Mexico and Canada--which are both integrated into a North American pipeline
system--suggest that such exports will be very limited if they ever come at all. And,
there is no reasonable prospect that the United States will ever become a net
exporter of oil.

U.S. net imports of crude oil and petroleum products are approximately 6.4 million
barrels per day (mbpd). (This estimate sits between the official U.S. Energy
Information Administration (EIA) numbers of 5.5 mbpd of net petroleum liquids
imports and 7.5 mbpd of net crude oil imports. And so, to understand my
calculations, please see two comments I made in a previous piece here and here.
My number is for December 2013, the latest month for which the complete statistics
needed to make my more accurate calculation are available.)

The EIA in its own forecast predicts that U.S. crude oil production (defined as crude
including lease condensate) will experience a tertiary peak in 2016 around 9.5 mbpd
just below the all-time 1970 peak and then decline starting in 2020. This level is far
below 2013 U.S. consumption of about 13.2 mbpd of actual petroleum-derived liquid
fuels. (This number excludes natural gas-derived liquids which can only be
substituted for petroleum-derived liquids on a very limited basis.)

So, when exactly is the United States going to drown the world market in oil and
thereby challenge the Russian oil export machine? The most plausible answer is
never. And, the expected 2016 peak in U.S. production is only about 1.5 mbpd
higher than production today. That's really quite small compared to worldwide oil
production of about 76 mbpd. And, there's no guarantee that the rest of the world
isn't going to see a decline in oil production between now and then. So much for the
supposed U.S. oil "weapon" taming the Russian bear.

But what about natural gas? Surely, America's great bounty of natural gas from shale
could challenge the Russians. Well, not really. It's true that U.S. natural gas
production trended up significantly from its post-Katrina nadir in 2005. But the trend
has now stalled. U.S. dry natural gas production has been almost flat since January
2012. The EIA reports total production of 24.06 trillion cubic feet (tcf) for 2012 and
24.28 tcf for 2013, a rise of only 0.9 percent year over year.

Not mentioned by any of the commentators touting the U.S. natural gas "weapon" is
that U.S. natural gas imports for 2013 were about 2.88 tcf or about 11 percent of
U.S. consumption. So, let me see if I understand this: The plan seems to be to
import more so we can export more. And this would change exactly what in the
worldwide supply picture?

Certainly, it is true that low U.S. natural gas prices have reduced drilling and
exploration dramatically. But prices will likely have to rise above $6 and trend higher
as time passes as the easy-to-get shale gas is used up and only the more costly and
difficult reservoirs remain. Drillers don't keep drilling unless they can make money
and that will require significantly higher prices.

And, here's the kicker. In order to ship U.S. natural gas to Europe or Asia, it has to
be liquefied at -260 degrees F, shipped on special tankers and then regasified. The
cost of doing this is about $6 per thousand cubic feet (mcf). So, the total cost of
delivering $6 U.S. natural gas to Europe is around $12 per mcf. With European
liquefied natural gas (LNG) prices mostly below this level for the last five years, it's
hard to see Europe as a logical market. Japan would be a better target for such
exports with prices moving between $15 and $18 per mcf in the last five years. But a
U.S. entry into the LNG market could conceivably depress world prices and make
even Japan a doubtful destination for U.S. LNG. And, what if U.S. prices rise
significantly above $6?

But all this presupposes that the United States will have excess natural gas to
export. As my colleague Jeffrey Brown has pointed out, "Citi Research [an arm of
Citigroup] puts the decline rate for existing U.S. natural gas production at about
24%/year, which would require the industry to replace about 100% of current U.S.
natural gas production in four years, just to maintain current production."

It seems that U.S. drillers are going to be very, very busy just keeping domestic
natural gas production from dipping, let alone expanding it to allow exports. And
remember, we are still importing the stuff today!

How many companies will actually risk the billions needed to build U.S. natural gas
export terminals to liquefy and load exports that may never appear? I doubt that very
many will actually go through with their plans.

What is truly puzzling is that all the information I've just adduced--except the cost of
liquefying, transporting and regasifying natural gas--is available with a few clicks of a
mouse and a little arithmetic performed on tables of data. I got the cost information
on LNG from a money manager specializing in energy investments. And yet,
commentators, reporters, and editorial writers don't even bother to check the internet
or call their sources in the investment business.


Perhaps the facts have become irrelevant. Only that would explain the current
hoopla over the nonexistent U.S. oil and natural gas "weapon" in the face of the all-
too-obvious and readily available evidence.

Resource Insights

US shale oil
production costs on
the rise

Written by Mark Young from Evaluate Energy
It wasnt too long ago that a high oil price and a falling gas price prompted many
companies to abandon plans to develop major positions in shale gas plays and turn
their attentions to the more lucrative shale oil deposits around the country. According
to a new analysis of 2013 annual data from 20 US shale gas and shale oil producers
by Evaluate Energy, more and more of the companies that made this move could be
vulnerable to rising costs in the near future, if the oil price should fall.

To show this, Evaluate Energy has selected 20 representative US companies whose
production is either mostly or entirely from US shale gas or shale oil plays.

To download a free pdf with details of these 20 companies US shale acreage
positions, as well as performance metrics, click here.

The production costs per barrel of oil equivalent (boe) for each company in the group
is shown in the graph on the following page.


Source: Evaluate Energy. The companies are sorted in order of the percentage of
total US production that is made up by oil in 2013, starting with CONSOL Energy and
Southwestern Energy, both at 0% oil, and ending with Northern Oil & Gas at 90% oil.
Production costs per boe includes production taxes and transportation costs where
reported separately, as some companies combine all of these costs into one item.

It is clear from the graph that those companies producing mainly oil from shale plays
have higher costs to contend with. The companies on the right hand side of the
graph (those in orange) are all exclusively producing from the Bakken play and
Magnum Hunter the highest cost per boe of the oil & gas group produces
roughly 50% of its output in this play.

Overall, it is clear that oil producing plays cost more to operate in than gas plays on
a per boe produced basis. Evaluate Energys annual results of operations data for
the 14 out of 20 companies in the group whose 2013 production is oil-weighted or
whose production weighting has shifted significantly in the last 4 years towards oil
shows that production costs in shale oil plays are also trending upwards rather than
coming down, seen on the following page.


Source: Evaluate Energy. Production costs per boe includes production taxes and
transportation costs where reported separately, as some companies combine all of
these costs into one item.

The oil producing companies who make up the above graph all show an increase in
production costs per boe produced from 2012 to 2013. Magnum Hunter is the only
company here to show an overall downward trend over the entire 4 year period and
this is due to the fact that the companys high costs in 2010 and 2011 forced a
rethink in strategy; the company sold its Eagle Ford oil-producing assets and thus
afforded more weight to its gas-producing assets in the Marcellus play. Full analysis
of Magnum Hunters strategy upheaval and how it has benefited the company is
available in this article. These rising costs in shale oil plays revolve around the need
or desire to keep increasing production and revenues with wells that only produce
attractively for a very short period of time; efforts are needed to maintain economic
production in existing wells for as long as possible, whilst all the time constantly
drilling new ones.

However, these high and rising costs have only seen a handful of companies alter
strategies away from certain plays so far. Two examples of this are Magnum Hunter
and Resolute Energy, who sold its Bakken position for $70.1 million in Q2 2013 to
focus on its Permian and Powder River basin properties. BP, albeit not a huge US
shale acreage holder by any means, has seen fit to spin off its US onshore business
segment into a separate company, in order to try and manage the costs and other
difficulties this seemingly unique operating environment represents.
On the whole, however, companies appear to be happy to continue bearing the
burden of these rising costs, as withdrawals and restructures have been few and far
between. This is solely due to the fact that the margins are still there; in fact, margins

per boe produced (revenue per boe less production costs per boe) have generally
increased for each of the oil producers year-on-year since 2010 despite rising costs,
whilst gas producers have seen a general downward trend.

Source: Evaluate Energy Margin per boe in this graph is calculated by taking the
US Sales Revenue per boe produced and subtracting the US Production cost per
boe for each company. Production costs per boe includes production taxes and
transportation costs where reported separately, as some companies combine all of
these costs into one item.

Of course, while the margins are still there and increasing, the oil producing
companies will not be overly concerned in the short-term by rising costs. Any fall in
oil price, however, could leave them vulnerable in the long-term if they do not find a
way to drive these rising costs down soon, so expect a full-scale offensive on cost-
saving efficiencies by shale oil producers in the US to accompany their drilling
programmes in the coming years.

Evaluate Energy

Oil & Gas Boom 2014:
Happy 65th, Hydraulic
Fracturing

Written by David Blackmon from FTI Consulting, Inc.
This week, many people within and outside of the oil and gas industry are
celebrating the 65th birthday of hydraulic fracturing. We'll join them, but this
celebration is really technically coming two years late.

It is true that 65 years ago this week, Halliburton conducted the first commercially
successful application of 'Fracking', as it has come to be known, in Stephens County,
Oklahoma. But the process itself was actually invented and experimented with two
years earlier by Stanolind Oil and Gas Company, in the Hugoton gas field in Kansas.
While those experiments did not appreciably stimulate the wells to which the
technique was applied, this was the real birth of hydraulic fracturing, and since that
time, the process has been safely and effectively applied to well more than a million
oil and gas wells in the United States alone.

Regardless of which 'birthday' one chooses to acknowledge, hydraulic fracturing is
now a veritable senior citizen among the vast array of technologies employed by the
oil and gas industry. For the first 60 or so years of its life, the process was
completely non-controversial. But then along about 2008, it began to dawn on
agenda-driven media outlets and radical 'green' groups looking for a new
controversy to stimulate fundraising that the marriage of hydraulic fracturing with
horizontal drilling was beginning to create an oil and gas renaissance in the U.S. Out
of that realization, the anti-Fracking movement was born.

The initial environmental motivation behind the movement was the fear that the new
massive reserves of inexpensive natural gas would crowd renewables out of the
power generation marketplace, which at least had the positive aspect of being a
reality-based concern. So these groups and sympathetic media outlets embarked
upon a strategy of turning hydraulic fracturing into a national boogeyman (such
efforts always need a boogeyman to demonize, after all) complete with a new name -
'Fracking' - that they sought to turn into a new cussword. And, to a large extent, they
succeeded in that quest.

Knowing that hydraulic fracturing was a well-regulated, very safe process that had
been around for many decades, and thus in and of itself would be very hard to
demonize effectively, they also sought to confuse the issue by turning this new
cussword into media shorthand to describe basically everything that takes place in
the oilfield. And again, they have had great success in doing this, as pretty much
every media outlet now associates - incorrectly - essentially anything that takes

place in the oil industry, from drilling to processing to transportation to refining, with
the cussword, 'Fracking'.

The anti-fracking movement has over the last few years morphed into a fully
radicalized protest movement based pretty much entirely on fantasy-and-fear-based
talking points that bear only an occasional, passing relationship with the truth. As
we've pointed out before, this movement is now run and funded by the same activists
and organizations who ran and funded the failed Occupy Wall Street movement
several years ago. Same Usual Suspects, same dishonest tactics, different
boogeyman to protest.

It's all such a shame and a waste of time and resources, an entire movement based
on fear of abundant, plentiful and affordable energy, and on the demonization of an
historically safe and effectively regulated industrial process. This movement spends
tens of millions of dollars each year demonizing this process, media outlets spend
millions reporting on the movement, including 'fracking' in every headline in order to
generate more Internet hits, and the industry in turn spends tens of millions
countering all the resulting propaganda. What a needless drain on the economy and
society.

But the hydraulic fracturing process itself continues to produce results in a massive
way. U.S. oil production is at a 40 year high, and this country will soon become the
world's biggest oil producing nation. Where natural gas is concerned, Texas alone
would rank as the third largest producing country on earth, behind only Russia and
the rest of the United States. The displacement of coal by natural gas in the power
generation sector has allowed the U.S. to reduce its carbon footprint back to levels
not seen since the early 1990s, and the only response from the 'environmental'
movement has been to complain even louder.

Indeed, the ongoing boom in oil and natural gas production made possible by
'fracking' has been the saving grace of the entire U.S. economy since the advent of
the Great Recession in 2008. It is one of the great positive quirks of national fate that
the drilling by Petrohawk of the first successful well in the enormous Eagle Ford
Shale formation of South Texas came in the same month the stock markets
collapsed, in October 2008.

Since that time, the oil and gas industry has produced millions of new, high-paying
jobs, while the rest of the nation's economy faltered. The new availability of cheap,
plentiful natural gas and refined products has produced similar booms in industries
that use these products as feedstocks - chemicals, manufacturing, plastics, fertilizers
and on and on it goes. Thanks to 'fracking', the United States is once again
becoming a global manufacturing powerhouse. Not only are U.S.-based firms
bringing back jobs that had moved overseas in the last two decades, but firms based
in other nations are developing plans to invest billions in new American plants.

If the anti-'Fracking' movement had had its way, all of this would have been banned,
and the U.S. economy would still be mired in a major recession, if not an outright
economic depression.

Any major resource boom such as we are currently experiencing with oil and natural

gas comes with a set of environmental and societal trade-offs. That's just the way the
world works. Responsible members of society work with industries to find ways to
manage and mitigate those impacts so that society as a whole can enjoy the fruits of
the boom. Unfortunately, the anti-Frackers have chosen to take a different course.

So long as the money keeps pouring in to the coffers of these cynical 'green' groups,
both sides will continue to waste significant resources on a debate based mainly on
fantasy and misinformation. But the much-demonized 'Fracking' will continue for the
foreseeable future, because on balance, it is unarguably a tremendous benefit for
this nation.

So Happy Birthday, Hydraulic Fracturing, and bless the memories of the men and
companies who made it possible more than six decades ago.

FTI Consulting, Inc.

Putin's energy
stranglehold on
Europe

Written by Andrew McKillop from AMK CONSULT
Outdated Geopolitical Musing

March 17, world stock exchanges from Moscow to New York and Frankfurt to
Shanghai gave a whoop of joy at the symbolic-only prospect of European and
American 'hard hitting sanctions' being set against Russia for its Crimean action. The
wait was over, the panic wasn't needed, at least not yet, so jobbers and traders got
back to doing the thing they know best of all - talking up share prices. The media and
press, however, did what they could to keep the story going, for example Garry
Kasparov's raging in the 'Wall Street Journal', telling us that Putin 'is another
Saddam Hussein or Slobodan Milosevic' and should be treated by the West the
same way. Kill him!

The outdated geopolitical theories and rationales used to bolster the panic and rage

were summarized and massaged into a would-be doctrine a long time ago, by
Zbigniew Brzezinski the former US National Security adviser to Jimmy Carter. His
theory basically claims that firstly the USSR, then the Russian Federation is using its
energy resources to bring Europe to heel through energy dependence. Russia needs
Ukraine for its energy dominance, as a 'pipeline corridor country' so the West and
Russia have totally opposing goals in Ukraine and Crimea. This could mean war.

The first problem is the 'Ukraine energy corridor theory' is a major exaggeration.
Ukraine is a critical corridor country for gas supply to Europe, only. Oil has got
almost nothing to do with it. Also, the gas pipeline transport role of Ukraine can only
decline and will decline, particularly as the Nord Stream and South Stream gas
pipelines, which completely avoid Ukraine, are completed and ramp up.

In addition LNG terminal financing, if not building, is now a fevered speculative boom
spreading across Europe. Some countries including Poland and France intend to
build enough LNG import capacity to cover their total gas needs, by or before 2017-
2020. LNG supplies, almost by definition, will come from a large and increasing
number of supplier countries, many of them 'exotic' such as Mozambique and
Australia (and Russia and the US, but in Russia's case that is not exotic).

Whether Crimea rejoins Russia, or stays with Ukraine has less and less real world
leverage and hold on European energy. The old geopolitical models and paradigms,
which in any case were weak, are being superceded and replaced.
Energy Colony of Russia

To be sure, Putin may have acted to force Ukraine to play the role of a Russian
energy subsidiary, but if it was forced to play that role, this is not how journalists or
Brzezinski want us to take it. Long running gas price and gas debt disputes between
Russia and Ukraine - whatever its government - have been constant since Ukraine
left the collapsed USSR in 1991. Major issues concerned the price Ukraine pays for
its own gas, and accumulated debt on unpaid (and stolen) gas. One key reason
Yanukovych was voted in by Ukrainians in 2010, and Tymoshenko was voted out,
was her extreme radical and probably corrupt attempt to pay Russia a much higher
price for domestic gas consumed by Ukraine, partly repay gas debt, and trade
Russian-sourced gas in other EU markets. Her attempt using a murky Swiss-based
trading and finance company created to those ends with a few chosen Ukrainian
oligarchs was a total disaster, and Yanukovych largely profited from it.

Today's arguments coming out of Washington and London, Paris, Warsaw and
Berlin claim that despite appearances, or reality, Ukraine's energy transport corridor
role is poised to grow. The country will become more strategic, not less. Its role will
expand. Ukraine will link oil and natural gas reserves and production in the Black
Sea and Caspian basins, with Europe.

The exact opposite is at least as likely, not because of the new political uncertainty,
but because European gas will be transported and sourced from and through
different countries on an accelerating basis. One factor bolstering this counter
argument is that European domestic shale gas development will move forward, as
well as European LNG import development.

The Russian energy dominance theory, and its subset of Ukraine's critical transport
corridor role was cobbled during the Cold War era, and heavily used by Brzezkinski
for his own political grandstanding. The theory seemed seductive to its writers,
perhaps, but is light years away from the real world situation and the powerful global
energy trends setting the future.

Taking only gas pipelines serving Europe, the total quantity of transport lines from a
few inches diameter (the industry uses inches for measuring) to 4 feet diameter, both
public and private, both national and international is so huge it can only be
estimated. One guess would be about 400 000 kilometres. Only the much-larger
area United States has more, at about 450 000 kilometres. When we add local
(sometimes regional) gas distribution lines, for example in cities, the numbers can be
doubled to near 1 million kilometres total.

This oversupply problem also concerns oil pipelines, you can be sure. Renovating
and replacing, and simply keeping the lines operating and filled, is a major task.

To date, projected new east-west oil pipelines serving the EU states are almost
absent. One reason is that Europe's oil demand, like its gas demand is on a
downward track that all analysts agree 'has no light at the tunnel's end'. This could or
might change, for sure, but since 2005 in some EU states - long before the 2008
financial economic crisis - and since 2009 for the rest, their national oil and gas
demand has been declining, every year in the straight majority of countries. This
trend is called structural, by more and more analysts. In some cases their oil and gas
needs, today, are back to 2000-2003 levels, and declining, making their existing
energy transport infrastructures more than sufficient.

When we look at electricity demand in EU28 countries, the 'decline paradigm' has
been operating since the late 1990s in an increasing number of countries.

Oversupply

One immediate result for oil is that European refining and oil transport capacity are
both heavily surplus to needs. Analysts and sector specialists suggest at least 15%,
even 20% of refinery capacity will have to be cut, trimmed, outplaced or shut down
by 2020. Linked and associated oil pipelines, mostly local, will also have to go. Oil
refining, in Europe, is a sunset industry heavily dependent on state subsidies in most
countries and mostly unprofitable. Its needs for new pipelines is very low.

Transport infrastructures for oil supplied to European refineries are in surplus for
another simple reason. The intensely developed 'legacy network' of oil shipping
routes and maritime installations including mostly seaboard-located refineries,
throughout Europe and across SE Europe and west Central Asia, makes oil pipelines
unattractive - we mean unnecessary - so the financial investment rationale for new
European oil pipelines very, very weak.

Europe's combined oil transport and refining capacities must fall - not increase. Put
another way, who wants to finance new oil pipelines for uncertain and unlikely
needs, when new large diameter oil pipelines cost $7.5 million-per-kilometre?

Only the many projected - but few financed and built - new gas pipelines in the wide
area spanning the Caspian, south and east Europe, and the MENA region are
potential but small scale game changers. Small scale means their capacity to
capture more than 5%-10% of the EU's total 600 billion cubic metres annual gas
consumption, which is declining, is either low or zero. Apart from the Nord Stream
and South Stream gas pipelines, building progress with new gas lines is slow or very
slow, in part because of the existing high level of 'legacy infrastructures' and falling
gas demand.

The essential point is that Ukraine's role in European oil transport is close to zero,
and its role in European gas transport, although still significant, is declining.
Massaging this reality into a major geopolitical crisis is at worst war-hungry political
grandstanding, and simple ignorance at best.

The Image of Scarcity

Also massaged into the media and worked by grandstanding politicians eager to pick
a fight with Russia, perhaps confusing it with Mali or Iraq, the image of gas and oil
scarcity always gets a major stand-in role. Some journalists have even claimed this
scarcity was another reason Ukraine's PM Viktor Yanukovych rejected the EU
association-partnership deal he was on the point of signing, in the weeks before he
was overthrown by the Kiev Flash Mob. Apart from Putin's offer of a one-third (33%)
cut in the extreme gas price that Yanukovych's hapless predecessor Yulia
Tymoshenko tried to force on Ukainians, and the $15 billion state debt repurchase
offer by Moscow, his government also turned down US Chevron Corp's and
European Shell's fuzzy-edge but claimed-as-enticing proposals to accelerate
investment in shale gas and shale oil E&P (exploration & production) in Ukraine.

The argument is these proposals, if they ever became plans, could or might at some
unspecified future date also have included oil pipeline construction activity, some of it
in Ukraine, able to bring new non-Russia gas and oil to 'energy-starved Europe'. The
proposals were backed by Washington and the EU, so when Yanukovych turned
them down he was obviously acting to artificially maintain energy scarcity in Europe,
to the benefit of Putin.

In fact hydrocarbons E&P is powering ahead in the region without any special needs
for increased US or EU political support to energy corporate investment and activity.

Reported by media including the UK 'Independent' and energy sector 'Offshore'
magazine, US Exxon and Russia's Rosneft have made encouraging finds in Crimean
and Russian offshore areas, while in the Romanian sector test drilling by Austria's
OMV found interesting deposits, so much so that the majors are bringing in the
panoply of deepwater drilling technology. Other majors cited by the specialty press
that are either already operating onshore and offshore in Ukraine and Crimea, or are
considering near-term action, include Spanish, Chinese, French and Malaysian
companies, among others. Canada's Trans Euro Energy has already found
commercial resources of natural gas on the Crimean mainland, underlining the
distinct prospectivity and probable large gas and condensate potentials in Crimea.

Available public data only concerning Ukrainian and Crimean conventional onshore

gas resources published by the IEA, EIA, CIA, European Commission, and energy
majors indicate the country (or 2 countries) have around 1.25 trillion cubic metres of
conventional gas - about 120 years of Ukraine's bloated national gas consumption.
However, the country's gas production peaked in 1975 and has declined ever since.
Very basically, and impossible to be ignored (even by geopolitical 'hawks') this has
nothing to do with resource scarcity or Ukraine 'depending on Russian gas'. Ukraine
has profited from ultra-cheap Russian gas - and even forgot to pay for it! Why
produce it at home?

Eastern Ukraine's giant Donbas coal field is estimated by many analysts as holding
very impressive quantities of coalbed methane, with published outline estimates from
the US EIA and other sources extending well above 1 trillion cubic metres. The coal
field is also deep, due to depletion, incurring high coal production costs and methane
or coal dust explosion danger for miners, making coalbed methane extraction,
instead of physical coal, the logical future path. Onshore shale gas potentials in the
region, including Ukraine and Crimea are also probably large or very large. There is
no shortage.

Scarcity is Off the Menu

The Brzezinski line of patter has the article of faith that both oil and gas resources
are limited and declining, but natural gas resource scarcity does not apply in the
Black Sea-Caspian Sea region. This is also shown by the massive gas discoveries,
and start of production, from Azerbaijan's gas and condensate fields. In the eastern
and southern Mediterranean, gas E&P continues to make large new finds and
extend previously-known offshore gas and condensate reserves, for example
offshore Israel and Cyprus. Further away, in east Africa, truly gigantic offshore
stranded gas resources have been discovered offshore Mozambique and Tanzania,
since 2009.

The argument that Russia is making an 'energy resource and transport corridor grab'
in Crimea and perhaps subsequently in east Ukraine, driven by energy scarcity
among other factors, is therefore impossible to take seriously. Another key reason
includes the huge amount of cash already invested by Moscow, in oil and gas E&P in
the region. This has helped accelerate - not hindered - discovery and development.
In theory at least, this would heavily play against Russia's ability to get the whip hand
on this large region's large proven and potential reserves and so doing, dominate the
energy importers of Europe. In other words, Russia like other players is speeding
hydrocarbons E&P - and is hard to portray as a geopolitical power trying to limit E&P
with the sole intent of profiting from scarcity.

Especially in the Ukraine case, the scarcity theme has also been projected on gas
and oil pipeline and transport capacities and oil and gas infrastructures in the region.
While this applies to some extent in the east of the region, Caspian Sea and
onshore, it is easier to talk of overcapacity and oversupply in the west of the region.
Ukraine, notably, is oversupplied with massive but outdated and badly maintained
gas pipeline and gas storage infrastructures, while it is undersupplied with gas and
oil E&P financing and technology, to develop its own domestic reserves.

In the Caspian, as Italy's ENI and its consortium partners (Shell, Exxon, Total,

Conoco, the Kazakh government and Impex) have found in their Kashagan project,
extreme high costs and a harsh environment, plus a lack of infrastructures have
heavily slowed down development of this giant oil and gas field. In the region's west
and Black Sea, these barriers are lower, and timelines for projects to reach export
status will be shorter, making it even harder to portray Putin's strategy as a resource
grab.

One clear bottom line is that simply due to the region's gas resource endowment,
and its energy infrastructures including pipelines, Gazprom will soon have no other
option than to cut gas prices. Supply from non-Russian sources will grow, and prices
will fall. This is hard to portray as a 'resource grab' profiting from scarcity!

Resource Scarcity Fears and Geopolitical Musings

From the right distance away, from roughly 8000 kilometres in Washington that is, in
the 1990s, Brzezinski could announce that both eastern and western Europe are
energy resource depleted regions, in which Russia's Vladimir Putin would later make
a thinly-disguised energy resource grab. More than 15 years ago, Zbigniev
Brzezinski was advising US political leaders that the 'real meaning of the Cold War'
was an attempt by Russia to make Europe dependent on Russian energy and cut off
western Europe's access to energy resources and energy transport routes of the
Black Sea, Caspian Sea and Central Asia.

We can note Brzezinksi in the 1990s did not include the Suez Canal, because that
theory of Russian conspiracy to cripple Europe's oil transport security, by supporting
Egypt's Nasser, was put to bed long ago. Today, his 1990s-vintage theories also
need putting to bed - or in the document shredder.

US energy corporations, to be sure, are still interested in eastern Europe-Central
Asia, but since the 1990s the often extreme high costs, lack of infrastructures, and
unpredictable local political partners - usually recycled Soviet era party bosses now
calling themselves 'democratic' - have tamed US and international energy corporate
hopes - and their willingness to spend in the region. To be sure, the western fringe of
this large region, including Ukraine, is better served with energy infrastructures, but
as present events show, political turmoil and unpredictability still runs high, and at
least as important, Ukraine already has more gas infrastructures than it needs.

More important for US energy corporations who were drawn to the region, their own
shale gas and shale oil revolution is led by and focused on North America. Home is
best.

US Big Energy's political masters, in Washington, may still be steeped in Cold War-
vintage geopolitics and Peak Oil energy resource shortage themes, but these are not
the reality on the ground. Since at latest the period from 2005 to date, outlooks for
hydrocarbons reserve discovery, and output development and growth have radically
increased on an almost worldwide basis - including SE Europe and Central Asia. At
the same time, only taking Europe, its oil and gas demand trends are on a sustained
downward track, meaning the continent has overcapacity of its existing energy
transport and refining infrastructures. This is the real European energy problem,
today.

Europe's key trade surplus status with Russia is also a major factor heavily shading
the Cold War geopolitical musings of Brzezinski. EU trade surplus with Russia
basically means that Europe trades manufactured goods and services, for Russian
energy. This commercial interdependence of Europe and Russia makes it unrealistic
to imagine that Washingtonian paranoia has any rational basis, suggesting again
that the EU, sooner rather than later, will shelve its talk about sanctions against
Russia and support to the anti-Russian aggressivity of the new and instant Kiev
'government'.

As we know, political shadowboxing and geopolitical musing can fly far over the
cuckoo's nest, tempting would-be Great Statesmen or women to raise their stupidity
quotient, even further. To be sure, the financially overheated SE European and
Central Asian 'energy and pipeline play' will likely suffer from the recent and present
turn of events in Ukraine and Crimea, but this will have little effect over time on
hydrocarbon E&P and infrastructure development in the region. Among other real
world results, this certainly implies a downward trend for both oil and gas prices in
Europe.

AMK CONSULT

Skills and capability
challenges facing
upstream

Written by Giles Lewis and Jon Sasserath from Practicus
Purpose

This report aims to explore and explain the capability challenges now facing the
Upstream Oil & Gas industry. A product of detailed discussions with numerous
industry leaders, it highlights the principal approaches the industry is taking to tackle
these problems and suggests further required changes.

Method

Practicus's research function has contacted over 350 senior leaders from across
Upstream, including Operational, HR and C-Suite professionals. We have taken a
holistic view of the global Upstream industry and our research engagements have
included IOCs, mid and smaller operators, Oil Field Services companies and expert
consultants to the industry from all the major oil producing regions of the world. The
research has been supplemented with quantitative data produced over the last 10
years. The aim of this research has been to create a detailed picture of the way
capability challenges are manifesting within the Upstream industry and to suggest
positive steps to address them.

Overview

'We have been watching this issue develop over the past 20 years and it is definitely
there and it is definitely getting worse.' - Regional General Manager (Global Services
Company)

The 'Great Crew Change' has been a much-discussed subject within the Upstream
industry for some time, but it is clear that the skills and capability challenges facing it
are very real and in general are not being tackled effectively. This is an area of acute
concern for many and is having a real impact on business operations.

With some businesses expecting a peak exodus of experienced talent in the
immediate future, it is clear that the industry needs to understand and address this
problem seriously. Even for those who expect to be less impacted by this issue the
knock on effect will be significant and should be considered.
This is a complex problem that is difficult to tackle and has proven easier to ignore in
the past. However, for some it is beginning to have a serious effect on their
business; for others those impacts may yet be further down the line but are no less

real. Some organisations are making concerted efforts to address these problems
but few feel they are doing enough to avoid them altogether.

Historically, the issue been seen purely as a 'people' problem to be tackled by HR. In
the majority of businesses this prevails. However, it is clear that the solution requires
a more joined up approach, with the problem properly acknowledged as a business
capability issue and a response driven from the top.

Effectively addressing this problem for the long term requires a shift from capability
and expertise as individual capital, vested in individual employees, to organisational
capital, embedded in the processes and culture of the business. This requires a
blend of people, process and technology initiatives alongside a context of wider
cultural change to create environments where knowledge sharing is rewarded,
naturalised and expected.

'A crucial battle is about mind-set and culture first of all. There is more process
needed around developing and transferring knowledge and skills.' - HR Director
(Global Services Company)

The Upstream industry is diverse, both in global spread and in the nature of its
component companies. Different parts of the industry are experiencing different
aspects of this problem and there are differing scenarios for the various constituents
of the industry. The problem is impacting in slightly different ways on each but
broadly the core issues and approaches are the same.

The roots of the problem

'The industry in general has struggled to see training and development as an
investment rather than something it must do.' - Independent Consultant

The capability challenge is a complex, multi-faceted problem for which there is no
single, immediate solution. Addressing the issue effectively requires a significant
commitment for the long term and a holistic approach to delivering real process and
cultural change.

Across the industry, the following core issues create the capability challenge:

Each of these component issues is discussed in more detail on subsequent pages.
Later in the report you can find a summary of approaches and solutions to address
each one of them from the research.

Addressing the skills bleed

'There is now an acute lack of skills and depth of competency is eroding.' - CEO

The 'Great Crew Change' is the tip of the iceberg

A significant proportion of the Upstream workforce is moving inexorably towards
retirement, creating a substantial bleed of knowledge and expertise as these
individuals leave the industry. Many companies are fast approaching a peak skills
exodus and not enough has been done to address this. The capability drain is
exacerbated by the lack of experienced workforce sitting behind them and the
growing need for new and highly specialised capabilities driven by changes in the
way the industry identifies and accesses reserves.

An unprecedented capability gap looms. More experienced talent is becoming rarer
amid a general skills shortage. This is the most obvious part of the problem, but
considering its causes exposes wider issues that lie beneath the surface. The whole
problem must be addressed.

'There is still a lot of tough oil out there but this needs high technology and very
experienced, specialised people. The problem is going to compound with time.' -
Exploration Director (Global E&P Company)

Bridging the widespread capability shortages and retention challenges

There is a shortage of technical (engineering, geoscience) skills and organisations
across the industry struggle to attract and retain talent. Fewer young people are
taking engineering and science-based degrees and fewer still see Oil & Gas as an
attractive career opportunities.

Competition for key skills can be fierce, driving up the cost of securing the right
capability and making it equally difficult to hang on to. Much of the industry is able to
access the new talent it needs but is often paying an escalating premium to secure
these skills.

'The size of many of the projects we are working on now are unprecedented. There
are serious challenges around finding the right people to fill these projects.' - CEO

Growing ties with learning institutions, becoming more active in schools and
universities and improving the perception and understanding of the industry among
upcoming talent is a key part of the solution to attracting the next generation. Oil &
Gas is not a sunset industry - there are real opportunities for graduates. The industry
also needs to work with governments to address the wider shortage of technical /
engineering skills.

Recruiting experienced talent with relevant skills from other industries (e.g. military
and aerospace) and training them is also a popular initiative for bridging the
capability gap. However, this is not a total solution in itself.

'Building the right behaviours is key so that people naturally pass on their knowledge
and mentor others. A crucial battle is about mind-set and culture.' - Head of Talent
(Global E&P Company)

There are significant shortages in soft skills- mentoring, coaching, leadership,
strategic and management skills particularly. This is an 'on the tools' industry for
many, and collaboration and knowledge sharing are not naturalised. The global
nature of the industry complicates this as many operations are in countries where
businesses of global scale are rare and in order to operate credibly on the world
stage there are significant challenges around identifying and developing the right
capabilities in-region - both technical and soft skills. Recognising this is an important
step - integrating technical training with soft skills development is an important part of
the answer.

Fast tracking talent is insufficient

As the veteran workforce retires, it exposes an acute capability gap in the 10-15 year
experience segments across the global Upstream sector. This dearth is the result of
previous underinvestment in talent and the industry's history of periodically cutting
the workforce.

This is not new but current initiatives to bridge this gap as retirees leave are not
universally effective. Fast-tracking upcoming talent, encouraging mentoring activity
and buying in short-term capability are all initiatives in play but none wholly address
the overall problem of transferring knowledge from the individual to ownership by the
business.

The days of huge ex-pat reward packages and jobs for life are largely gone and as
locations become increasingly remote or harsh it is becoming harder to secure the
level of capability that is needed globally. Improving mobilisation programmes,
understanding and responding to the drivers and aspirations of talent and embracing
technology that facilitates new ways of remote working and virtual teams will help to
address this.

'Instead of taking people to the work, sometimes we need to take the work to the
people. But mobilising people virtually needs the right systems and the right
attitudes. It means more travel but less relocation.' - General Manager, Engineering
(Global E&P Company)

Securing niche skills as demand peaks

As the business of extracting Oil & Gas becomes more technically challenging, the
demand for highly specialist capabilities will increase faster than the talent pool
available. There is a core challenge around how to manage peaks in demand for
emerging capabilities - particularly if the skill capacity remains untested and an
unprecedented demand is on the horizon. Investing in developing capability and in
institutionalising this knowledge will help to reduce this risk.

'There are new and complex skill requirements driven by changes in the way we
extract oil and new technologies and techniques to do so. These are becoming more

specialised and complex and may be very scarce.' - Independent Consultant

M&A activity and joint ventures have long been a method of gaining access to
capability without having to buy it in directly. Organisations need to recognise where
the acceptable balance lies in developing in-house capability, partnering with other
businesses and load balancing with contractors. These activities are likely to
continue to be seen as an option across the industry. Indeed we would expect to see
an increasing emphasis on this as a part of the answer.

Towards a longer term solution

The issues we have described are all inter-related and the tendency currently is for
organisations to view them as purely 'people' challenges. This is overly reductive and
restricts the organisation's ability to effectively tackle the problem. Initiatives to
address these issues tend to focus on plugging short term capability gaps and
relying on the experience of individuals. This is especially risky in an industry where
retention is a core challenge.

A more holistic, long-term approach is required that is fully integrated with the wider
business strategy. Businesses need to shift to a longer-term mind-set and find ways
to transfer the knowledge, experience and capabilities of key individuals through
process and cultural changes - facilitated in part by technology - into organisational
knowledge and capability. There is a growing issue of a dearth of technical skills
globally and this will impact on a number of industries, including Oil & Gas. This will
increase competition and therefore these challenges cannot be ignored.

Effective knowledge management and transfer

'There is a lot of talk about knowledge management but no-one has really solved
this. We need to work out how to encourage people to share knowledge in a sensible
and accessible way and how to make this a natural part of the business culture and
process.' - General Manager, Engineering (Global E&P Company)

The industry is not currently realising the potential of knowledge management and
transfer initiatives that could play an important role in creating a solution to the
problem and help to grow organisational capability.

Talent and capability development, particularly outside of IOCs, is often hugely
fragmented and there are real challenges around how to formally develop capability.

Transforming knowledge from individual to organisational capital

How to shift knowledge from individuals within the workforce to embedding it in the
organisation is one of the most important challenges facing the industry. Businesses
have not effectively captured the knowledge of their employees and turned it into
organisational capital, meaning that capability walks out of the door as people leave.
Attempts to capture this knowledge have been ineffectual or fragmented in their
implementation to date. Many organisations rely heavily on contract resource to
provide capability for when they need it but this is only a short-term fix. This
contracted capability remains with the individual and is often not retained effectively

when they leave.

Fragmented training and development

Larger organisations can have sophisticated training programmes but struggle with
retaining the capability they have invested in. For many, intensive training drops off
after an initial period while developmental needs remain. Developing further
structured training could help retain upcoming talent after the initial honeymoon
period.

However, training and development programmes often separate the technical
competence from the behavioural and soft skills needed. Training is not always
followed up and coached in effectively, meaning potential gains are lost.
Understanding behavioural and technical competencies required for the specifics of
Upstream environments and ensuring a joined up training programme - including real
world experience - are significant areas for improvement.

Mentoring is a significant part of the solution for many organisations. But mentoring
is difficult to get right - this is an unexpected role for many veterans and one for
which not all are equipped.

Knowledge Management Tools Remain Underdeveloped

There is a general level of cynicism towards knowledge management tools. This is a
result of a lack of understanding of their potential, the complexity of systems and
previous fragmentary or ineffective implementations.

Many organisations are wrestling with how to drive meaningful engagement with
these systems and gain employee and business buy-in. Making knowledge
management mechanisms easy and intuitive is a core challenge, but the industry
has much to gain from developing effective central repositories of knowledge and
rewarding knowledge sharing and engagement. The most effective processes are
those that encourage further learning collaboration on a person-to-person level and
that use a variety of media to drive engagement. In reality, existing knowledge
management mechanisms are rarely developed, embedded and enforced effectively.
Driving regular meaningful engagement and maintaining data quality are key
concerns, as is ascribing ownership of these systems, but effective implementation
can provide real benefit in addressing the capability challenge.

Knowledge management initiatives tend to have been too haphazard in their
implementation and not driven from the top, creating a fundamental lack of
understanding of the value these can bring. A lack of leadership and belief in
knowledge management tools exacerbates the problem, as does uncertainty about
who owns the tools and how to manage them effectively. This is a key missed
opportunity for addressing the capability problem.

As the industry turns to mentoring and training programmes to address these issues,
there needs to be a broader cultural change from an industry of time-earned, 'on the
tools' expertise to one where knowledge and experience is shared and rewarded.
Knowledge sharing and collaboration cultures need to be developed where they do

not exist and normalised. Technology and knowledge management tools will assist
this process change but they need to be effectively developed, implemented and
established with leadership from the top.

A 'heads down' approach that needs to change

'There is no plan to replace these people - beyond poaching them from competitors.'
- General Manager (Global Services Company)

Will we always be able to buy capability for when we need it?

The 'boom and bust' cyclical nature of Oil & Gas has created a very reactive and
short-termist relationship with resource, with a heavy reliance on contractors and
spiralling costs of attracting talent. The industry has tended to cut vast swathes of
the workforce in a downturn, trusting that it can buy in what it needs when it needs it.
Again, this ensures an emphasis on individuals as the locus of capability.

'You can't plan for succession effectively when people are liable to leave at any time.
Opportunities for growing knowledge and transferring experience are being lost all
the time.' - Independent Consultant

The industry is too reactive and focussed purely on 'now' rather than planning for the
future. Endemic short-termism has eroded in-house capability development and
training programmes and ensured a low level of talent commitment and retention. It
has created an environment where there is very little investment in developing
organisational capability and knowledge transfer mechanisms. As a result, depth of
competence is diminishing.

This has resulted in a high cost associated with buying in expertise in times of need.
Load balancing with contractors is an understandable solution, allowing
organisations to flex their workforce depending on what they need at a given time,
but when relied upon to the current degree it ensures that core expertise is not
developed, retained and owned by the business. Many organisations rely on buying
in short term capability that they should be developing internally for long-term
advantage.

The cyclical nature of the industry and the accompanying 'knee jerk' reactions to
deliver short-term fixes doesn't allow organisations to develop and embed
capabilities effectively. Salary escalation is a significant problem - even if you are
offering exposure to leading edge projects and have a compelling employer value
proposition.

'The industry is very fragmented in its approach and needs to think in a more
connected way.' - HR Director (Global Services Company)

There is a growing acknowledgment of the need to adopt more of a 'heads up' and
integrated approach to long term capability planning and some businesses are
starting to address this. This is no mean feat in an industry as global and diverse as
Oil & Gas, particularly since the 'heads down' view is so entrenched. Upstream as a
whole is poor at planning beyond immediate delivery cycles and this is a core root

cause of the capability challenge. Longer term planning is more sophisticated within
the larger businesses and IOCs, as you would expect, but there is significant room
for improvement even here and an over-reliance on contract resource still hampers
the development of organisational capability and truly effective knowledge transfer.

Some HR functions are developing increasingly sophisticated approaches to
workforce planning but in general this is still an ongoing challenge. The long range
view needs to be addressed beyond an HR environment and integrated with wider
business strategies.

The industry in general is poor at collecting and analysing data about internal
capability and using this for long-term planning and this is a major area for
improvement. Organisations that are developing their abilities in this space will be at
a definite advantage.

Companies need to find where their acceptable balance is between building and
institutionalising internal knowledge and experience capabilities and on retaining the
flexibility afforded them by using outsourced talent.

The industry in general needs to adopt more of a long term approach to strategic
planning. Companies that successfully do this quickly will accumulate the greatest
benefit and will likely gain an additional protection for long-term profit.

The way forward: solutions and approaches

This section summarises the ways forward discussed in previous pages and
provides additional insight on solutions arising from the research.

Develop, extend, improve and better integrate mentoring programmes.
Select mentors and pair with key developing talent. Improve understanding of
mentoring and what makes a successful mentor.
Provide training for how to mentor.
Develop and extend reward mechanisms.
Naturalise and embed mentoring cultures and effectively communicate the
value of continuous knowledge sharing.
Fast track upcoming talent.
Develop and populate matrix of capability/experience needed for key roles,
enabling better structured training - both technical and behavioural.
Identify how to (safely) accelerate graduate and career converter learning
more effectively.
Recruit career converters from allied industries and train them to fill the gap -
building relationships with these donor industry sectors.
Accumulate capability through JVs & M&A.
Flexible working arrangements for veterans- phased retirement programmes.
Develop training/mentoring hubs or centres of excellence globally.

Develop more sophisticated understanding of in-region talent and
complicating cultural factors to enable better identification of key individuals,
development opportunities and current/future capability gaps.
Work collaboratively with other Oil & Gas companies, industry bodies and
governments to develop methods to reverse the decline in technical (e.g.
engineering) skills and engage future generations of potential talent.

Develop document writing and reporting processes to ensure key knowledge
is stored, and develop more user generated content across the workforce in
various formats, e.g. video, audio, presentations, written documents, photos
etc. Maintain data quality.
Drive engagement and embed knowledge management systems, e.g.
'lessons learned' capture mechanisms. This should be a two-way learning and
sharing process, not just veterans educating new talent.
Identify 'at risk' knowledge and break this down into particular elements.
Identify where these sit and then capture them.
Rationalise the boundaries between developing in-house capability and
relying on contractors.
Cultural change: grow and normalise knowledge sharing to create
collaborative cultures - focus on developing and training knowledge sharing
and mentoring behaviours. Normalise and reward these. Give a heavier
weight in performance objectives towards knowledge transfer and
collaboration behaviours.
Identify subject matter experts across the business; task them with sharing
their knowledge across a range of formats and reward them for this.
Assess where the gaps are - what capability needs to be developed in-house?
Actively plan to transfer this from contractors and key individuals.

Work collaboratively with other Oil & Gas companies, industry bodies,
governments and learning institutions to improve industry reputation for the
long term.
Move to a more structured approach to long term planning - predict where
gaps will be and identify key individuals the business needs to retain and
transfer capability from. Identify key local talent in-region and structure plans
to develop/retain this.
Improve global mobilisation programmes. To do this organisations must build
a more sophisticated understanding of talent and its drivers within different
segments of the workforce - cultural, geographical, generational - as well as
defining the appeal and challenge of the regions in which the business
operates. Organisations must better identify development opportunities and

create more committed and contextualised approaches for talent/capability
development in their core regions.
Develop and extend structured training beyond initial early career period.
Adopt new ways of working- facilitated by technology' that take the work to the
people as much as possible (e.g. remote management and monitoring).
Pursue joint ventures and M&A that enable the accumulation of capability.
Develop more sophisticated understanding of drivers of key talent and
variations between different regions; use this insight to develop initiatives to
develop and retain it and develop a more sophisticated and segmented
employer value proposition.
Standardisation of processes; identify where opportunities for standardisation
lie and link strongly with knowledge management mechanisms.
Create capability development centres of excellence and training hubs to
develop internal capability - graduate, mid-career and leadership
development.

Identify the capabilities that will be needed in the future and when. Track
these and better identify opportunities for talent development and knowledge
transfer. Develop processes and approaches to embed emerging capabilities
and secure them as organisational capital.
Understand the existing capability in-house (and understand how that
manifests itself in various regions, e.g. taking into account cultural differences
and behavioural differences) - develop actionable and measureable strategies
for retaining, developing and sharing this knowledge.
Identify key learning institutions and donor sites of future talent in particular
territories and build relationships with these, e.g. military headcount
reductions and specialist learning centres.

Develop more advanced succession planning and workforce management
approaches - collecting, analysing and utilising more workforce data in more
sophisticated ways .
Acknowledge that addressing these challenges requires a long-term
commitment and investment - a mindset and cultural change will be required
to address this, and it will need to be led from the top down.
Create centres of excellence for long-term development, sharing and transfer
of knowledge.


Develop and populate a matrix of capability/experience needed for each key
role to structure training around both technical and behavioural needs.
Diagnose how training fails. Diagnose where we can improve our
understanding of the technical skills and behavioural styles needed for the
particular environments of Upstream. Is this a feature of training? Is training
followed up and trained in effectively? Does it separate technical/behavioural?
Is the team engaged or just individuals? How much new knowledge is
retained and how can we improve this?
Fully integrate training with knowledge management systems. Better
understanding of the workforce (generational, geographical, cultural) will allow
the identification and introduction of more personalised and contextualised
learning opportunities. Technology will facilitate this. Improve documentation
and knowledge sharing- diaries etc.
Integrate various training programmes/units and make them less modular and
siloed - promote continuous training across the business with consistent
approaches, evaluation and reward.
Combine this with real world experience. Training will only have impact if it is
then applied on the job. Harness individual motivation, leadership and peer
support to make this happen.

Provide top-down leadership and communication of the value of knowledge
management tools.
Diagnose how previous implementations have failed and create plans to avoid
these pitfalls. Work more collaboratively with knowledge management
suppliers (internal or external) to better communicate needs and ensure more
mechanisms are truly fit for purpose, with a degree of flexibility baked in to
allow for regional differences in requirements.
Define who owns knowledge management systems and assess how to drive
meaningful engagement across the workforce (multimedia, collaboration
across generations and understand how different generations engage) -
integrate with training and mentoring programmes and person-to-person
knowledge transfer.
Under investment in knowledge management tools
Make it easy to use knowledge management systems and make benefits real.
Personalise and contextualise learning. Take advantage of existing and
emerging technology to vary and improve learning/sharing opportunities.
Identify new learning and development opportunities and how to embed these
in business processes.

Conclusions

The capability challenge is a complex and difficult issue that will require a range of
actions to address it. Making a range of blended people and knowledge
management interventions, and developing a culture of knowledge sharing and
collaboration are important parts of a solution.

More process is needed around developing and transferring internal capability and
experience to embed high level skills within operating procedures, transferring
individual capital into organisational capital and reducing the risk of relying on
individuals who are difficult to retain. Long-term and genuine cultural change is
required to create environments where knowledge sharing is expected and
normalised.

A strategy will be most effective when these interventions are blended together and
combined with a shift to longer term planning and strongly linked with the wider
strategies of the business.

The problem needs to move from being purely an HR 'people' issue and the solution
needs to be seen as a mix of people, process, cultural and technological solutions
working together. The solution needs to be driven from the top, with senior leaders
making a visible commitment to this amid a wider industry acceptance of and
commitment to address these challenges.

Addressing the Capability Challenge
No single solution is apparent. Successful approaches will include a range of
activities:
Engage future talent; grow ties with learning institutions and sell the Oil & Gas
sector
Extend and better integrate training and mentoring programmes
Pursue M&A and joint ventures
Improve mobilisation programmes and embrace new ways of working
Invest in and commit to knowledge management tools
Create sharing and collaborative cultures
Improve longer term capability planning
Provide top down leadership and acknowledgement of capability challenges
Recruit and upskill career converters with relevant skills from allied industries
Final thought

'The industry is at a tipping point. The peak of retirees is approaching. Has the
business done enough? Has the industry done enough?' - HR Leader (IOC)

It is clear that the majority of businesses have now acknowledged these issues to a
degree and are at varying stages of addressing them. Most feel that the industry has
awoken to the capability challenges it is facing and is starting to move in the right
direction. However, there is also a strong current of feeling that not enough is being
done and further solutions are needed. From the discussions we have had with
industry leaders over the past few months the view within HR is broadly more

positive, with a feeling of moving in the right direction. This is not always reflected in
views across the wider business though, with some respondents painting a bleak
picture of an industry blindly marching towards impending disaster.

There is no shortage of discussion around the 'Great Crew Change' and related
challenges but the causes and effects of the problem are not being addressed
consistently or often coherently.

Key individuals are very focussed on the day-to-day delivery of their role, and frankly
the capability challenges are very difficult issues to tackle. For many these are still
purely HR problems that are being addressed through limited succession planning
and knowledge transfer mechanisms that often remain ineffective, ad hoc and
disconnected with the wider business context.

Across the industry there is still a general lack of top-down leadership on these
issues. Trying to cling on to an exiting workforce is clearly not a long-term solution to
a serious problem. It's astonishing how this capability and experience is being lost to
the industry as individuals retire, and this is creating a frustrating scenario.

The 'Great Crew Change' is real and is upon us. The industry is at a crucial decision
point in how it addresses this issue. Actions that are taken now will have long term
impacts on the future of the Oil & Gas industry and shape the key players within it.

Practicus can help

Our expertise within organisational change and transformation, combined with our
deep understanding of the Oil & Gas industry, allows us to rapidly assess where
positive, tangible changes can be made within your business that will improve the
way you handle your own unique capability challenges.

Working in partnership with you and your teams, we can identify key areas where we
can help, then design and implement a tailored series of interventions that will deliver
real value to your approach to this problem.

Practicus

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The Fracking Flip -
U.S. Domestic Oil
Production's Radical
Transformation of the
North American
Tanker Trade

Written by Keith Letourneau and Matthew Thomas from Blank Rome LLP
A flurry of recent economic data and activity suggests that U.S. tanker markets, both
Jones Act and international, are riding swift new market currents that were
unforeseen just three years ago. The White House announced on November 14,
2013, that the United States for the first time in nearly two decades is importing less
foreign oil than we are producing domestically. By the end of FY-2014, imported
crude-oil shipments are expected to fall below 7.0 million barrels per day (bbl/d). As
recently as the summer of 2010, imports reached nearly 10.0 million bbl/d. Domestic
production is up 39% since 2011 and now exceeds 8.0 million bbl/d. The U.S.
Energy Information Agency estimates that in 2013 the United States became the
world's top oil and natural gas producer, exceeding the production of both Russia
and Saudi Arabia, and is poised to become the leading crude producer next year.
The increase is largely due to the rapid development of advanced drilling techniques,
including horizontal drilling and hydraulic fracturing (fracking) in Texas, North Dakota
and Pennsylvania.

In the process, domestic production has flipped the crude oil import market on its
head and accelerated the construction of U.S. built tankers for the coastwise trade.
The Jones Act mandates that only U.S.-owned, -built and -flagged vessels carry
cargo between points in the United States. Approximately 42 tankers currently ply
the Jones Act trade. At least eleven product tankers, with options for quite a few
more, are currently under construction at the Aker Philadelphia and General
Dynamics-NASSCO San Diego shipyards, though the first of these are not expected
to come on line until 2015. As well, new domestically-built, crude-carrying integrated
tugs and barges are under construction. Meanwhile, charter rates for domestic
tankers are reaching market peaks.

Yet, while coastwise tanker owners demand ever higher freight rates with domestic
production accelerating, charterers are not sitting idle as they consider alternative
modes of transport. Unprecedented investments in rail, pipeline, and terminal
capacity are underway, fueling growth in Gulf Coast refining capacity and bringing

new life to East Coast refining centers, where many facilities are better suited to
light-shale crudes. The Philadelphia area alone is seeing an unprecedented influx of
hundreds of thousands of barrels of Bakken crude every day, bound for local
refiners. In addition, although much is made of the U.S. becoming a net exporter of
refined products, sourcing products from overseas via foreign vessels remains an
important strategic option for charterers.

Looking ahead, the outlook for the U.S. tanker markets hinges not only on the
continued domestic production boom, but also on regulatory and political
developments in Washington, particularly with regard to the decades-old ban on
exporting U.S. crude oil. The 1973 Arab Oil Embargo prompted Congress to pass
legislation that bans the export of U.S. crude, except to Canada, with only narrow
and largely untested exceptions. In an effort to lift the ban, certain oil industry
proponents contend that it has outlived its usefulness, artificially depresses prices,
discourages investment in new production, exacerbates the U.S. trade deficit and
violates World Trade Organization export restriction rules. Not all U.S. oil industry
businesses support lifting the ban, however. Some domestic refiners urge keeping
the ban in place, as domestic crude production has sparked a boom in refinery
investment, and lifting the ban could see the spread between U.S. and global prices
(the Brent-WTI gap) narrow or disappear. Their unease is understandable; all
investors in this sector - shipowners, refiners, terminals, pipelines and other
infrastructure - are struggling to weigh the risks and uncertainty caused by the
unpredictable long-term outlook for the U.S. crude export ban.

On January 31, 2014, Congress held the first hearing about the crude export ban in
a quarter century. Alaska Republican Senator Lisa Murkowski, Ranking Member of
the Senate Energy and Natural Resources Committee, is currently the most vocal
proponent of lifting the ban arguing that it adversely affects U.S. productivity and
contributes to supply disruptions. Proponents of lifting the ban received a boost in
recent days, when Democratic leadership announced that Sen. Mary Landrieu,
another supporter of crude exports, was tapped to take over as chair of the Senate
Energy and Natural Resources Committee. She and Sen. Murkowski will provide
powerful bipartisan Senate leadership on this issue. At the CERAWeek Energy
Conference in Houston on March 3, 2014, Sen. Murkowski proposed a three-part
plan to gradually lift the ban through executive action. Several members of
Congress, including Democratic Senators Ed Markey and Robert Menendez, oppose
lifting the ban because of the gasoline price effect, and it appears unlikely that
Congress will tackle this divisive issue head-on this election year. The Obama
administration has gone to some lengths to avoid articulating a position, or even
acknowledging that it is actively rethinking the ban. However, Commerce
Department and other officials have worked with individual companies to clarify and
apply little-used exceptions to the crude ban. For example, as news outlets have
noted in recent days, the Commerce Department appears to have begun licensing
shipments of Canadian crude for shipment from U.S. ports, and much attention is
being given to how the administration will apply its 'public interest' exception
authority to provide for physical swaps of equivalent import and export volumes.

While the clamor for reforming the crude ban has escalated in recent months, calls
for reexamining the Jones Act have been more muted. An unintended consequence
of the Jones Act is that it costs more to transport crude from Texas to New York than

it does from Texas to Canada because of the significant difference in freight rates
between U.S. and foreign tankers. Refiners on the East Coast are paying far more to
obtain domestic crude from the Gulf Coast than their Canadian counterparts. This
has led groups such as the American Fuel and Petrochemical Refiners to call for
changes to the coastwise laws; however, there appears to be little interest in
Congress or the Administration at this point for such an initiative. While there is
always talk about changes to the Jones Act, seeing is believing.

The exponential growth of domestic oil and gas production is also shifting the
landscape of import and export tanker activity. During the past forty years, domestic
refiners have imported a substantial amount of crude via tankers to provide
feedstocks for their terminals. That demand increased the size of crude tankers and
led to an offshore lightering trade in the Gulf of Mexico that employs smaller 70,000
deadweight ton (dwt) tankers to offload crude from 200,000 (and larger) dwt Very
Large Crude Carriers (VLCC's) and carry that imported crude to domestic refineries
for conversion. With the advent of domestic fracking, it is conceivable within the next
few years for many U.S. refineries to reverse that process in large measure such that
they will be refining primarily domestic crude. In 2014, the U.S. is expected to import
3.6 million bbls/d less crude oil by sea than at the import apex in 2005. That equates
to an astounding 1.3 billion barrels less per year, or - conservatively - enough crude
oil to fill a 200,000 dwt VLCC more than a thousand times every year. This import
decline is likely to continue until the U.S. reaches its maximum crude oil productivity.

The net effect is that crude imports will travel elsewhere, and domestically refined
products will dominate the export market. Charter rates for foreign-flagged tankers
carrying foreign crude sailed in the doldrums for much of last year with too many
ships ordered before the recession hit, though a number of companies including
Euronav and Teekay are investing in a crude-market turnaround. Foreign crude
carriers enjoyed a tremendous spike in rates at the end of last year, which allowed
owners to breathe a sigh of relief; however, expectations in the charter trade are that
rates will settle back down this year to levels more akin to 2013. Unless Congress
lifts the ban on exporting domestic crude, rather than crude carriers, the U.S. market
will demand ever more tankers that can carry substantial quantities of refined
product. The United States is currently exporting more than 3.5 million bbls/d of such
products. Charter rates for these product tankers are increasing accordingly.

The rise of domestic crude production is literally changing the course of foreign
crude carriers away from North America, while promoting a surge in domestic crude-
tanker capacity and boosting the export of refined products. In just a few short years,
domestic fracking has fundamentally altered the tanker trade to this continent and
the shoreside infrastructure that serves it, and it would seem there are more changes
to come.

Sources: Law 360 - Murkowski Offers Crude Oil Export Roadmap (4 Mar 2014); Roll
Call - Oil Export Debate Renews Fight Over Protections for U.S. Shipping (4 Feb.
2014); E&E Daily, Energy Policy: White House leaves door open to revising crude
export limits (31 Jan 2014); MARAD statistics, United States Flag Privately-Owned
Merchant Fleet, 2000-1014; Bloomberg, Oil-Tanker Recovery Trails Market With
U.S. Export Ban: Freight by Isaac Arnsdorf (9 Jan. 2014); Tradewinds article, Valero
Defends Ban (8 Jan. 2014); Bloomberg, Unforeseen U.S. Oil Boom Upends Markets

as Drilling Spreads by Asjylyn Loder (8 Jan. 2014); Oil &Gas Journal, Murkowski:
Ban on US crude oil exports should end soon by Nick Snow (8 Jan. 2014); Reuters,
Lisa Murkowski Urges Review of Oil Exports Ban by Valerie Volcovici (7 Jan 2104);
Law 360, US Trade Gap Narrows as Exports Hit $195B, Oil Imports Drop edited by
Philip Shea (7 Jan. 2014); U.S. Energy Information Administration (EIA), U.S. crude
oil production on track to surpass imports for first time since 1995 (26 Dec. 2013);
Bloomberg, Oil Industry May Invoke Trade law to Challenge Export Ban (5 Nov.
2013); Journal of Commerce, Could Crude Oil Put the Jones Act into Play? By Peter
Tirschwell (30 Oct. 2013); EIA, U.S. expected to be largest producer of petroleum
and natural gas hydrocarbons in 2013 (4 Oct. 2013); EIA, Oil and gas industry
employment growing much faster than total private sector employment (8 Aug.
2013); Reuters, Analysis: Shale oil storm blows U.S. tanker trade out of doldrums by
Anna Louie Sussman (1 Jul. 2012); EIA, A number of western states increased oil
production since 2010 (21 May 2013); EIA, Abundant U.S. Supply, low demand
could cut dependence on liquid fuel imports (17 Apr. 2013); Reuters, Analysis -
Texas oil sails to Canada, refiners fume over tanker law by Jonathan Leff and David
Shepard (1 May 2013).

Blank Rome LLP

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Ukrainian crisis
highlights political risk
in long term gas sales

Written by Dag Mjaaland and Aadne Haga from Wikborg Rein
Russia supplies around one third of Europe's gas, and around half of that gas
passes through Ukrainian territory. The political crisis in Ukraine, not least Russia's
recent involvement, has therefore highlighted the issue of political risk in gas sales,
with some nervous price movements seen in European gas trading markets and
importers rushing to reassure markets and customers that supply interruptions are
unlikely. But long term gas sales to Europe have shown surprising resilience against
political risk in the past, perhaps due to the particular level of mutual dependence
between the parties to long term gas sales agreements, but also to the benefits of
increasingly diversified supplies and competition.

At a global level, this situation is also relevant for Asian gas buyers, who import LNG
also from countries which have seen political unrest in the past, but also
systematically diversify their supplies and seek to adapt their historical supply
arrangements to new realities, in particular in terms of price.

European long term gas sales have been exposed to political risk since the
beginning of cross-border sales in the early 1960s, when the Dutch Government took
an active role in managing the Dutch super-giant Groningen field. The Dutch
government's changing policies, from conservation to increasing sales, and from the
invention of the oil-link to liberalization, have had a major influence on the European
gas market. Political risk increased with Soviet gas exports to Western Europe
beginning in the late 1960s and early 1970s. In the 1980s, the Reagan
administration imposed an embargo on the sales of gas compressors to the Soviet
Union, and attempted to speed up the development of Norway's super-giant Troll
field to limit Soviet exports. The collapse of the Eastern Block in 1989 and of the
Soviet Union in 1991 created new political risks, as much of the pipelines between
Russia's gas fields and the markets of Western Europe suddenly were in non-aligned
and independent States. In 2006 and 2009, disputes between Russia and Ukraine
reduced transit volumes to Europe.

Long-term gas sales have, however, proven themselves impressively resilient
against political risk. The Reagan administration's attempts at curtailing Soviet gas
sales in the 1980s were unsuccessful. The countries of the former Eastern Block
quickly transformed their former barter arrangements for Soviet gas into long-term
contracts in line with the concepts in Western Europe during the transitional years of
the 1990s. The Ukrainian transit disruptions in 2006 and 2009 were short-lived and
had commercial price disputes at their core. Recent improvements of infrastructure

and coordination, as well as increasingly diversified supplies contribute to the
European importers' recent reassurances that supply interruptions due to the
Ukrainian crisis are unlikely. The German border price dropped below spot prices in
late 2013 as buyers and sellers have realigned their relationships in the light of
European gas market liberalization.

In a comment to the current crisis in Ukraine, Fridtjof Nansen Institute Senior
Research Fellow Arild Moe notes that the mutual dependence created by gas
supplies is a stabilizing factor. On the one hand, gas supplies may raise
opportunities for games and pressure, but on the other hand strong common
interests tie the countries together. The parties' mutual dependence on each other is
also a main underlying characteristic of long-term gas sales agreements. Both
parties have to make major investments, and the lapse of an agreement will create
major challenges for both parties, who may not be able to find alternative partners on
short notice. This mutual dependence forms the background for the peculiar
combination of rigidity and flexibility found in most long-term gas sales agreements,
where the buyer has a long term obligation to pay for large volumes of gas which
cannot be terminated, but only at a fair price which adapts to changes in the market.
In our opinion, this strong combination of mutual dependence and flexibility has
contributed to the gas industry's ability to weather the political crises of the past, and
will contribute to Asian gas buyers' efforts to update their supply arrangements to
new realities, like today's waning relevance of oil as a competitor to gas.

Wikborg Rein

Beginning of the end?
Oil companies cut back
on spending

Written by Gail Tverberg from Our Finite World
Steve Kopits recently gave a presentation explaining our current predicament: the
cost of oil extraction has been rising rapidly (10.9% per year) but oil prices have
been flat. Major oil companies are finding their profits squeezed, and have recently
announced plans to sell off part of their assets in order to have funds to pay their

dividends. Such an approach is likely to lead to an eventual drop in oil production. I
have talked about similar points previously (here and here), but Kopits adds some
additional perspectives which he has given me permission to share with my readers.
I encourage readers to watch the original hour-long presentation at Columbia
University, if they have the time.

Controversy: Does Oil Extraction Depend on Supply Growth or Demand
Growth?

The first section of the presentation is devoted the connection of GDP Growth to Oil
Supply Growth vs Oil Demand Growth. I omit a considerable part of this discussion
in this write-up.

Economists and oil companies, when making their projections, nearly always make
their projections depend on Demand Growththe amount people and businesses
want. This demand growth is seen to be rising indefinitely in the future. It has
nothing to do with affordability or with whether the potential consumers actually have
jobs to purchase the oil products.

Kopits presents the following list of assumptions of demand constrained forecasting.
(IOCs are Independent Oil Companies like Shell and Exxon Mobil, as contrasted
with government owned companies that are prevalent among oil exporters.)

Thus, it is the demand constrained view of forecasting that gives rise to the view that
OPEC (Organization of Petroleum Exporting Nations) has enormous leverage. The
assumption is made that OPEC can add or subtract as much supply as much as it
chooses. Kopits provides evidence that in fact the Demand view is no longer
applicable today, so this whole story is wrong.

One piece of evidence that the Demand Model is wrong is the fact that world crude
oil (including lease condensate) production has been nearly flat since 2004, in a
period when China and other growing Eastern economies have been trying to
motorize. In comparison, there was a rise of 2.7% per year, when the West, with a

similar population, was trying to motorize.

Kopits points out that Chinas big source of oil supply has been US main street:
China bids oil supply away from United States, to satisfy its needs. This is the way
that markets have made oil available to China, when world supply is not rising much.
It is part of the reason that oil prices have risen.

Another piece of evidence that the Demand Model is wrong relates to the
assumption thatsocial tastes have simply changed, leading to a drop in US oil
consumption. Kopits shows the following chart, indicating that the major reason that
young people dont have cars is because they dont have full-time jobs.

Kopits makes a comparison of the role of oil in GDP growth to the role of water in
plant growth in the desert. Without oil, there is less GDP growth, just as without

water, a desert is starved for the element it needs for plant growth. Lack of oil can
considered a binding constraint on GDP growth. (Labor availability might be a
constraint, but it wouldnt be a binding constraint, because there are plenty of
unemployed people who might work if demand ramped up.) When more oil is
available at a slightly lower price, it is quickly absorbed by markets.

Supply Growth is the limiting factor in recent years, because the amount of
extraction is rising only slowly due to geological constraints and the number of users
has risen to the point that there is a shortage.

Experience of Major Oil Producing Companies

Kopits presents data showing how badly the big, publicly traded oil companies are
doing. He looks at two pieces of information:
Capex Capital expenditures How much companies are spending on
things like exploration, drilling, and making of new offshore oil platforms
Crude oil production -
A person would normally expect that crude oil production would rise as Capex rises,
but Kopits shows that in fact since 2006, Capex has continued to rise, but crude oil
production has fallen.

The above information is worldwide, not just for the US. At some point a person
might expect companies to start getting frustratedthey are spending more and
more, but not getting very far in extracting oil.

Kopits then shows another version of Capex history plus a forecast. (This time the
amounts are labeled Upstream, so the expenditures are clearly on the exploration
and drilling side, rather than related to refineries or pipelines.)


The amounts this time are for the industry as a whole, including NOCs which are
government owned (national) oil companies as well as IOCs (Independent Oil
Companies), both large and small. Kopits remarks that the forecasts shown were
made only six months ago. When talking about the above slide Koptis says,

People in the industry thought, Capex has been going up and up. It will continue to
do very well. We have been on this trajectory forever, and we are just going to get
more and more money out of this.

Now why is that? The reason is that in a Demand constrained model for those of you
who took economicsprice equals marginal cost. Right? So if my costs are going up,
the price will also go up. Right? That is a Demand constrained model. So if it costs
me more to get oil, it is no big deal, the market will recognize that at some point, in a
Demand constrained model.

Not in a Supply constrained model! In a Supply constrained model, the price goes up
to a price that is very similar to the monopoly price, after which you really cant raise
it, because that marginal consumer would rather do with less than pay more. They
will not recognize [pay] your marginal cost. In that model, you get to a price, and
after that price, there is significant resistance from the consumer to moving up off of
that price. That is the Supply Constrained Price. If your costs continue to come up
underneath you, the consumer wont recognize it.

The rapidly growing Capex forecast is implicitly a Demand constrained forecast. It
says, sure Capex can go up to a trillion dollars a year. We can spend a trillion dollars
a year looking for oil and gas. The global economy will accept that.

I quote this because I am not sure I have explained the situation exactly that way. I
perhaps have said that demand had to be connected to what consumers could
afford. Wages dont magically go up by themselves (even though economists think
they can).

According to Koptis, the cost of oil extraction has in recent years been rising at
10.9% per year since 1999. (CAGR means compound annual growth rate).

Oil prices have been flat at the same time. On the above chart, E&P Capex per
barrel is pretty much the same type of expenses as shown on the previous two
charts. E&P means Exploration and Production.

Kopits explains that the industry needs prices of over $100 barrel.

The version of the chart I have up is too small to read the names of individual
companies. If you would like a chart with bigger names, you can download the
original presentation.

Historically, oil companies have used a discounted cash flow approach to figure out

whether over the long term, pricing for a particular field will be profitable.
Unfortunately, this standard approach has not been working well recently.
Expenses have been escalating too rapidly, and there have been too many new
drilling sites producing below expectation. What Kopits shows on the above slide is
the prices that companies need on different basisa cash flow basisso that each
year companies have enough money to pay todays capital expenditures, plus
todays expenses, plus todays dividends.

The reason for using the cash flow approach is because companies have found
themselves coming up short: they find that after they have paid capital expenditures
and other expenditures such as taxes, they dont have enough money left to pay
dividends, unless they borrow money or sell off assets. Oil companies need to pay
dividends because pension plans and other buyers of oil company stocks expect to
receive regular dividends in payment for their equity investment. The dividends are
important to pension plans.

In the last bullet point on the slide, Kopits is telling us that on this basis, most US oil
companies need a price of $130 barrel or more. I noticed that Brazils Petrobas
needs a price of over $150 barrel. (OSX, Brazils number two oil company, recently
went bankrupt.)

In the slide below, Kopits shows how Shell oil is responding to the poor cash flow
situation of the major oil companies, based on recent announcements.

Basically, Shell is cutting back. It no longer is going to tell investors how much it
plans to produce in the future. Instead, it will focus on generating cash flow, at least
partly by selling off existing programs.

In fact, Kopits reports that all of the major oil companies are reporting divestment
programs. Does selling assets really solve the oil companies problems? What the oil
companies would really like to do is raise their prices, but they cant do that, because

they dont set prices, the market doesand the prices arent high enough. And the oil
companies really cant cut costs. So instead, they sell assets to pay dividends, or
perhaps just to get out of the business. But is this sustainable?

The above slide shows that conventional oil production peaked in 2005. The top line
is total conventional oil production (calculated as world oil production, less natural
gas liquids, and less US shale and other unconventional, and less Canadian oil
sands). To get his estimate of Crude Oil Normal Decline, Kopits uses the mirror
image of the rise in conventional oil production prior to 2005. He also shows a
separate item for the rise in oil production from Iraq since 2005. The yellow portion
called crude production forward is then the top line, less the other two items. It has
taken $2.5 trillion to add this new yellow block. Now this strategy has run its course
(based on the bad results companies are reporting from recent drilling), so what will
oil companies do now?

Above, Kopits shows evidence that many companies in recent months have been
cutting back budgets. These are big reductionsbillions and billions of dollars.

On the above chart, Kopits tries to estimate the shape of the downslope in capital
expenditures. This chart isnt for all companies. It excludes the smaller companies,
and it excludes the National oil companies, so it is about one-third of the market. The
gray horizontal line at the top is the industry consensus back in October. The other
lines represent more recent estimates of how Capex is declining. The steepest
decline is the forecast based on Hesss announcement. The next steepest (the
dotted gray line) is the forecast based on Shells cutback. The cutback for the part of
the market not shown in the chart is likely to be different.

Oil and Economic Growth

Kopits offers his view of how much efficiency can be gained in a given year, in the
slide below:


In his view, the maximum sustainable increase in efficiency is 2.5% in non-
recessions, but a more normal increase is 1% per year. At current oil supply growth
levels, OECD GDP growth is capped at 1% to 2%. The effect of constrained oil
supply is reducing OECD GDP growth by 1% to 2%.

Conclusions

While demand constrained models dominate thinking, in fact, a supply constrained
model is more appropriate in recent years.

We seem to be short of oil. Whenever there is extra oil on the market, it is quickly
soaked up. Oil prices have not collapsed. No one is nervous about a price collapse.

China recently has been putting little price pressure on the marketits demand is
recently less high. Kopits thinks China will eventually return to the market, and put
price pressure on oil prices. Thus, oil price pressures are likely to return at some
point.

Gails Observations

An obvious point, which I thought I heard when I listened to the presentation the first
time, but didnt hear the second time is, Who will buy all of these assets on the
market, and at what price? China would seem to be a likely buyer, if one is to be
found. But when several companies want to sell assets at the same time, a person
wonders what prices will be available.

The new strategy is, in effect, maintaining dividends by returning part of capital. It is
clearly not a very sustainable strategy.

It will take a while for these cut-backs in Capex expenditures to find their way

through to oil output, but it could very well start in a year or two. This is disturbing.

What we are seeing now is a cutback in what companies consider economically
extractable oilsomething that isnt exactly reported by companies. I expect that
what is being sold off is mostly not proven reserves.

In this talk, it looks like lack of sufficient investment is poised to bring the system
down. That is basically the expected limit under Limits to Growth.

In theory, if an expansion of Chinas oil demand does bring oil prices up again, it
could in theory encourage an increase in drilling activity. But it is doubtful that
economies could withstand the high pricesthey are already having problems at
current price levels, considering the continued need for Quantitative Easing to keep
interest rates low.

A recent news item was titled, G20 Finance Ministers Agree to Lift Global Growth
Target. According to that article,

Mr Hockey said reaching the goal would require increasing investment but that it
could create tens of millions of new jobs.

The cutback in investment by oil companies is working precisely in the wrong
direction. If these cutbacks act to cut future oil extraction, it will bring down growth
further.

Our Finite World

OilVoice Magazine - April 2014

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Edition Twenty Five April 2014

US shale oil production costs on the rise

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