Will The Petroleum Industry Actually Change How It Works?

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Allen Brooks
posted 12 days ago

Page 1 of 8

business-trends

oil-prices

finance
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Will The Petroleum Industry Actually

Change How It Works?
One of the most dangerous phrases in the investment business is: This time is
different. We are wondering whether that phrase has meaning for the petroleum
industry as it struggles to deal with the collapse in global oil prices. An interesting
exchange we were part of on the Oilpro.com website was about the price decline. One

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ABOUT THE AUTHOR

Allen Brooks
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A distinguished professional with a 40plus year in the energy and investment
industry. A consultant to multiple
oilfield services companies.

writer mentioned that few people recognize that the current industry fall is less a
collapse and more a reflection of the industry coming down from an extended boom. As
shown in the track of futures prices since 1983, current oil prices in the $60-a-barrel
range are essentially back to levels experienced in 2005. At that price, oil is trading at
slightly more than twice the level it was during most of the early years of this century.
But, at $60 a barrel, current prices are about three times the level they traded at during
much of the 1990s. The response from the industry is that we need a higher oil price
because the cost of finding and developing new reserves has increased, especially in
due to the revolution in unconventional oil and gas resources.

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Utilizing oil price data from BP plc (BP-NYSE), we decided to examine how oil prices
moved following the previous most significant boom the 1970s. Conditions during
that period were driven by structural changes in the industry that predated the
explosion in oil prices but set-up the industry for that explosion. The decline in domestic
output made America vulnerable to outside forces manipulating the oil market. When oil
prices exploded, an industry boom was kicked off, although the U.S. and global

http://oilpro.com/post/14742/petroleum-industry-actually-change-works

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7/4/2015

Will The Petroleum Industry Actually Change How It Works? - Oilpro

economies saw oil demand fall. The demand drop was missed by petroleum industry
planners, managers and analysts. The 1970s boom, which lasted seven years, was
followed by a five-year bust whose full impact was not overcome for another half
decade. The 1980 oil price peak was 2 times higher than the oil price base established

Page 2 of 8

More Thoughts On The Restructuring

Of The Oil Industry
3 months ago
More

over the 1980s and 1990s.

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It is interesting that the 1985 average oil price became a floor despite a brief excursion
below that floor during the 1997-1998 Asian currency crisis. As the worlds economy

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recovered and enjoyed the ebullient economic and stock market environment
associated with the dot com bubble, oil prices climbed back to a level twice the 20-year
floor price level. As Exhibit 5 shows, the oil price, after declining during the 2001
recession, began climbing and then exploded higher in response to the dramatic 2004
global oil demand increase, which was driven by Chinese consumption as it prepared for
hosting the upcoming Olympics.
The 1970s boom and bust produced many complaints about the high cost of oilfield
equipment and services that drove finding and development costs up squeezing the
operating margins of the oil and gas producers. Beating down service costs was the
initial reaction of producers, but when oil prices collapsed in 1985, everyone but energy
consumers suffered. Cost pressures in the energy sector forced producers to reconsider
how they operated. The most significant change emerging from that re-examination
was Royal Dutch Shells (RDS.A-NYSE) Drilling in the 90s program. Shell and others
wanted the service industry to consolidate (a strange focus since they had successfully
used competition from start-ups, often sponsored by petroleum companies, to beat
down prices during the boom) so one company could offer more products and services
at lower costs. For those service companies with limited offerings, they were forced to
often align with other service companies to be able to bid the full range of products and
services the oil and gas companies required in their bid documents.
In the case of contract drillers, Shells approach called for them to secure the drill bits,
drilling fluids and directional drilling services needed to successfully drill wells. During a
late 1980s conference of the International Association of Drilling Contractors (IADC) at
which we were speaking, the program morphed into a discussion of the Drilling in the
90s program. After much back-and-forth discussion, we remember one crusty West
Texas driller speaking up and saying that the industry had always been doing this it
was called turn-key drilling. The drilling contractor was responsible for choosing the
best drill bits and drilling fluids in order to drill wells because he was responsible for
delivering a competed well to the producer for a fixed cost. All the risk of drilling was

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assumed by the contractor in contrast to day rate drilling in which the producer
assumes all the risk and pays a contractor by the day to use his drilling crew and rig.
Since most of the drilling industry had gotten away from turnkey work, which requires
that the contractor be highly confident in his understanding of the geological
formations he would be drilling into, this comment ended the discussion of the Shell
plan.
Throughout the 1990s and 2000s, every time the industry suffered a price and activity
downturn, producers decried the high cost of oilfield products and services. Those
comments were besides the fact that technological improvements in the business were
contributing to reduced drilling costs usually in the form of greater footage per rig per
day.

In Exhibit 6 we show the BP oil price data from 1990 to now, using a $60-a-barrel price
for 2015. We would note that BPs oil price is an average for each year meaning we dont
see the $147-a-barrel price spike in 2007. That said the current oil price essentially
matches the average of the 2008-2009 decline during the financial crisis. The $60 price
is back to a level experienced in 2005 as we were heading toward that 2007 spike. If $60
is a new floor, it is 4x the 20-year floor. It is important to note that if we measure the
current oil price decline from the peak U.S. futures price on June 20, 2014, of $107.26 a
barrel, a 50% reduction suggests a floor of $53.63 a barrel. Oil prices in this downturn
have traded at that level and lower, but prices have rebounded in recent weeks as
confidence within commodity markets has grown that U.S. oil shale production is about
to fall leading to a future elimination of the worlds glut.
Our question of Is 4x enough? raises the issue of how high oil prices must be to sustain
current production and eventually grow it. Discovering that mysterious price level has
been the quest of analysts and forecasters ever since Saudi Arabia orchestrated an
agreement among the members of the Organization of Petroleum Exporting Countries
(OPEC) to sustain their high output. Sustained high output has created the global oil
glut, which will only be corrected by less output and/or greater consumption. OPEC
perceives lower prices as the medicine to create both outcomes, and despite the
financial pain, most producers are cheering for those forces to work, and soon!
Although producers can do little about commodity prices other than take advantage of
upward blips to hedge future production, providing them greater financial flexibility and
cash flow visibility, they can and are attacking their cost structures. Most readers of the
Musings are aware of various efforts by producers to force oilfield service companies to
roll back their prices and for equipment companies to drop their sales prices. This is the

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7/4/2015

Will The Petroleum Industry Actually Change How It Works? - Oilpro

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traditional producer/service company ying and yang that occurs at every industry
turning point. What may prove more challenging this time is producers belief that oil
prices will stay lower for longer. It means structural changes become more important
than temporary price rollbacks.
While producers are calling for further service cost relief, are they doing much to help?
In contrast to past downturns, there is a recognition that energy companies need to
streamline their business operations since they cannot assume ever-higher commodity
prices will bail them out. Many producer actions in recent years have been in response
to strategic business decisions. Examples include ConocoPhillips (COP-NYSE) decision
to split off the companys downstream refining business; ExxonMobils (XOM-NYSE)
purchase of XTO Energy and then allowing that unit to absorb Exxons shale drilling
operations and continue to operate as a separate company; and BPs reorganization of
its onshore U.S. operations into a separate unit operating outside of the existing
corporate structure.
Each move, and those of other producers, was done in response to perceived structural
shortcomings in their operations impacting their financial performance. ConocoPhillips
move forced its exploration and production managers to rationalize their assets
following a history of mistimed asset purchases. Exxons move was to compensate for
its planning groups failure to foresee the shale revolution. BPs restructuring hopes to
enable its onshore E&P business to mimic the successes of independent producers.
While petroleum corporations have made strategic moves, they are also working to
lower finding and development costs through boosting their operational productivity.
Everyone who has lived through this boom environment allowed their organizations to
become bloated by adding staff, aggressively bidding up salaries of new employees that
puts upward pressure on the entire corporate salary structure, adding benefits and
building new corporate facilities. Some of these splurges are being rectified through
layoffs and salary reductions. The most powerful cost reductions will be to cut drilling,
project development and production costs in ways that are longer lasting than the
immediate benefits from cutting staff.
The impact of the industry boom since the early 2000s is reflected in the IHS upstream
capital cost index that exploded from 115 in 2005 to 230 in Q3 2013 and has essentially
remained there through 2014. That cost explosion has been particularly devastating for
offshore projects and other long-term projects such as oil sands developments and the
construction of LNG export terminals. The cost problems of many of these projects
reflect oil companies desires for complete control over projects and treating each of
them as unique. Unfortunately, that approach rejects standardization in favor of
uniqueness. Every time companies elect uniqueness, unless there is a physical necessity,
costs escalate. Many in the industry question this approach, but it appears we are seeing
early signs of rejecting uniqueness in response to the need to cut costs.

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Will The Petroleum Industry Actually Change How It Works? - Oilpro

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The most recent example of this new thinking is Chevron Corporations (CVX-NYSE)
announcement that it will accept two bids from contractors for its projects one based
on Chevrons specifications and the other based on the service companys design. In the
early 2000s, ExxonMobil created a Design One, Build Many plan for its Angola
deepwater development in Block 15. The plan involved building two tension leg
platforms and five of the worlds largest floating production, storage and offloading
vessels. The plans success brought the field into production earlier than expected and
within budget. The program was recognized with an award from the Offshore
Technology Conference in 2011. One wonders how extensive these efforts are in the
industry today because deepwater costs continue to rise. There are still many examples
of uniqueness dominating standardization.
With the advent of the manufacturing process of drilling and completing shale wells, the
operating philosophy has become that every well should be the best well in the field.
That philosophy has forced rethinking all aspects of the work process. We have covered
some of these successes in previous articles, but this is an area for further research and
investigation. How successful these efforts are and how much they are embraced will
shape the future of the petroleum industry.

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What Is Oil Prices

Future As Industry
Is Just Now
Adjusting?

The Petroleum
Industrys New
Scourge
Political
Elections!

Falling Rig Counts Has Saudi Arabia

But Sustained
Already Won The
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More Thoughts
On The
Restructuring Of
The Oil Industry

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Comments (11)
Terry O'Donnell 12d ago Reply Like 3
On top of this, I'd also say that the industry is particularly pressed to adapt Geo-politically as
well.
With increasing demand for hydrocarbons on one hand and criticism of how we deliver it on
the other, I'd say the ball is very rarely dropped by the industry at large.
William Edwards 12d ago Reply Like 2
Fine article, Allen. The perspective that you provide might be instructive to those whose world
began in the the year 2000 and who look at today's action as a radical transformation. I agree
with the implied advice that without identifying a reason for a step-function higher price level
the current price level is suspect.
TJ Dillingham 10d ago Reply Like 2
If you don't know who Michael Porter is - you should. More importantly - read the recently
released Harvard Business/Boston Consulting Report on the win-win approach for US
Unconventional O&G and a greener environment. Though I agree that the transformation in
the last decade is noble; it's far from adequate. Adjacent industries and market sectors move
exponentially faster - the excuses are wearing thing.
Look, I get it - i'm O&G all the way; but capital-intensive and high risk are not exclusive to
O&G.
The focus is on oil price - but you're looking at a lagging indicator. You don't have to be an
engineer to be a systems thinker - so look at the contributing factors to the production.
Bottom line - the industry will have to change. The window of opportunity is coming to a
close, stop thinking internally - get engaged with the call to educate the public in the
misunderstandings concerning the oil and gas industry.
The link to the study is here: http://hbswk.hbs.edu/item/7821.html
Paul Parsons 12d ago Reply Like 1
Interesting title considering that the industry has gone through its most radical transformation
ever over the last decade -- technologically, organizationally, geographically and financially.
Some of your hipshot criticisms of the industry just don't make sense.
Paul Jackson 11d ago Reply Like
So, we are victims of our own success? I think not....
James Davidson 9d ago Reply Like 1
I don t think any of the new or old oil exec s, will take heed of the boom/bust lessons
that history clearly shows in the article above. When the oil price goes up, they will revert to
type..... The voices across the office tables in Aberdeen, will be heard saying, "how much?,
never mind, I need it, just get it" ! The companymen on the rigs will be heard saying, " I know it
does not work" "but the boss in town says, we have to use it" The drilling superintendant, he
will note his objection in an email, that will reach the furthest parts of his company. Service
companies will fill their pockets, men and women will be in demand. So begins a small but
routine part of the next boom, when it happens. Sadly at the moment we are wallowing in the
mire of history, telling each other, "its ok, we have been through this before, good times are
around the corner, they won`t make that mistake again" !!!!
Ron Wilson 6d ago Reply Like 1
Very well written article. One of your last comments states that a philosophy coming out of
the manufacturing process of shale development is that each new well is supposed to be the
best well drilled in the field. I would change that and say that the real philosophy is that each
new well should be the cheapest well in the field. I have seen much more effort and time
spent on dropping the "manufacturing " cost of the well and less on making it more
productive. If you investigate the EUR distribution in a large development you find a MOL
normal distribution from low to high. Unfortunately you can find the same distribution in the
multi well pads. Our industry drills great wells next to poor wells on the same pad, sometimes

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only a few hhundred feet away, and we don't seem to care. As long as the well cost is in line
with projections. Our pendulum has swung from the "best well" regardless the cost to "any
well" as long as the cost is in line with estimate. CHEAPER is not always better. It is just
cheaper.
John C. Milne 10d ago Reply Like
Another fine contribution. My only complaint is that you include so much history and in such
fine detail that it is difficult to add further comment. Nevertheless this has whetted my
appetite. I have already commented (to some incredulity) that that the late 70's "boom" which
led to the Majors over-stocking on just about everything also led to some unforeseen
problems in the immature offshore drilling market with premature retirals and imaginative
diversification. Some of the equipment shortages encouraged some suppliers into fanciful
expansion plans and the liberal exploitation of expense accounts that would make "Madmen"
appear mundane. There has been a lot of heat generated over the current recession but your
all encompassing summary puts it all into perspective. There have been more successes than
failures in our industry over the past fifty years and those who have learned from the lessons
of the various downturns will provide the resilience to rebound to further prosperity.
Robert Mathes 9d ago Reply Like
At each of these downturns the industry always responds the same way: first they squeeze the
suppliers, then they shed personnel and only if the downturn lasts longer than the 12 to 18
months where the standard two responses stop being effective, that is when we see bigger
and more trascendental change happening: in the eighties, oil companies got rid of all their in
house services and pushed them out to the service companies, later (with few exceptions)
they dumped their R&D allowing the big service companies like Schlumberger and Halliburton
to pick that up and become a dominant force. In the late 90's came the mergers to make
IOC's big enough to compete with the big NOCs from OPEC. During the short downturns in
97-98 and 2008-9 no major changes to the industry took place. This time we see the advent
of Shale and its "Well Manufacturing Process" and the changes that is bringing to the industry.
If geopolitics doesn't throw a big spanner in the works causing price spikes, we could see
offshore and deep water finally embracing standardization and collaboration between
competitors to ensure that those assets get developed in a highly competitive commodity
market. There will be market forces controlling what happens to the industry as every
producer in the world (all 162 of them) will try to sell as much as they can at the best price
they can get. This will mean a paradigm change for the industry: the end of the Era of
unlimited and endless profits to enter the world of highly competitive players, like most other
industries. It will be very interesting to see who survives this transition
Allen Brooks 6d ago Reply Like
Thanks for you comment Ron. Maybe my word choice was poor. I did not say the cheapest
well in the field, but the best, which to me and most of the people with whom I have
discussed this issue, it means the least costly in relation to the most EUR and production. If
only cost was considered, it might lead to drilling only marginal areas of the formation. Your
point is correct that "CHEAPER is not always better."
Nestor Sanchez 2d ago Reply Like
This time is different? I do not believe that is the actual base case question. Because, the oil
industry has always been the same independently of the oil price, it is a cycle process, starting
for exploration, going through production, refining, and oil and products commercialization.
Every new project has to demonstrate its economical success at any particular
conceptualization time, in order to become a business case for an oil production company. It
is true, the cost of finding new reserves has increased a lot, but, there are a lot of mature giant
oil reservoirs all over the world, with cumulative oil production bellow 35 % of its initial oil in
place. Therefore, what the variations in oil price really does, is to reduce investment in high oil
price economically evaluate projects, and practically cancel new exploration ventures,
unconventional oil, and enhance oil recovery application in mature fields, because of the poor
visualization of some oil company managers. I believe that oil companies should focus into
increase oil production from several very well known mature depleted oil reservoirs, with
millions of barrels of remaining oil in place at very well known locations, that only need the
use of multidisciplinary integrated team technology application approach in order to identify
poorly drained regions, and opportunities to increase oil recovery with very low investment,
only using front end loading integrated teams reservoir reinterpretation to develop alternative
exploitation strategies using existing production-injection facilities. That is what the whole
thing is about, focus in what you got, and maximize known reservoirs oil reserves
recuperation economically.
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