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Europe United Kingdom Oil & Gas
24 February 2009
Fundamental, Industry, Thematic, Thought Leading Deutsche Bank Company Research's Research Committee has deemed this work F.I.T.T for investors seeking differentiated ideas. Here our European integrated oil team provides insights into the cash and marginal costs of oil production. It concludes that against the backdrop of a faltering oil price it is not just demand that is at risk of significant disappointment; at current oil prices project deferrals and an acceleration in the 4-6% underlying pace of natural decline stand to drive a more rapid than expected correction in the supply/demand balance for crude oil. Fundamental: The risks around future oil supply have risen sharply Industry: Breaking down the global cost curve Thematic: Cash economics work; full cycle economics don’t Thought leading: Oil is a wasting asset In the short term, there is no magic bullet; non-OPEC keeps producing
Global Markets Research
European Integrated Oils
The cost of producing oil
Cash production costs 2009 (opex plus royalties) across major production regions ($/bbl)
OPEX plus royalties $/bbl 30
Average cash costs among top producers $7.70/bbl (or $12.50/bbl excluding OPEC countries) Canada Sands Algeria Mexico Libya Angola Nigeria Iraq Brazil
Iran UAE 0 0 Kuw ait Saudi Arabia
2922 5844 8766 11688 14610 17532 20454 23376 26298 29220 32142 35064 37986 40908 43830 46752 49674 52596 55518 58440 61362 Cumulative 2009 oil production kb/d
Source: Wood Mackenzie; Deutsche Bank
Lucas Herrmann, ACA
Research Analyst (44) 20 754 73636 firstname.lastname@example.org
Elaine Dunphy, ACA
Research Analyst (44) 207 545 9138 email@example.com
Adam Sieminski, CFA
Strategist (1) 202 662 1624 firstname.lastname@example.org
Deutsche Bank AG/London All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research is available to customers of DBSI in the United States at no cost. Customers can access IR at http://gm.db.com/IndependentResearch or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.
Europe United Kingdom Oil & Gas
24 February 2009
European Integrated Oils The cost of producing oil
Lucas Herrmann, ACA
Research Analyst (44) 20 754 73636 email@example.com
Total SA (TOTF.PA),EUR37.75 Royal Dutch Shell Plc (RDSb.L),GBP1,597.00 Buy Buy
m b/d 89.0 2008 Forecast 2009 Forecast
Elaine Dunphy, ACA
Research Analyst (44) 207 545 9138 firstname.lastname@example.org
Adam Sieminski, CFA
Strategist (1) 202 662 1624 email@example.com
88.5 88.0 87.5 87.0 86.5 86.0
Fundamental, Industry, Thematic, Thought Leading Deutsche Bank Company Research's Research Committee has deemed this work F.I.T.T for investors seeking differentiated ideas. Here our European integrated oil team provides insights into the cash and marginal costs of oil production. It concludes that against the backdrop of a faltering oil price it is not just demand that is at risk of significant disappointment; at current oil prices project deferrals and an acceleration in the 4-6% underlying pace of natural decline stand to drive a more rapid than expected correction in the supply/demand balance for crude oil. The abject collapse in world economies has seen the markets’ previous obsession with supply quickly switch to one which at times seems similarly myopic around demand. Yet in markets where the surge in costs and taxes in recent years have meant that the price required to extract crude oil has dramatically risen, our sense is that it is not just global demand estimates that are at risk of reduction. Industry: Breaking down the global cost curve Using Wood Mackenzie’s extensive database we have sought to obtain a better understanding of today’s cash costs of oil production as well as the oil price now required for growth investments to prove economic. In doing so we have looked not just at average cash costs by country but also the cost curves within the more mature, higher cost oil producing regions themselves. We also assess the fullcycle economics of investing in today’s growth regions. Thematic: Cash economics work; full cycle economics don’t Our analysis suggests that the current cash-breakeven cost for non-OPEC supply is c.$12/bbl rising to c.$15/bbl in the higher cost, more mature basins of the UK, Norway, Alaska and (because of extraction taxes) Russia. Unsurprisingly, Canada’s oil sands represent the high cost barrel requiring an average WTI oil price of at least $28/bbl for cash-breakeven. We estimate that, excluding the US onshore for which granular data is limited, under 1mb/d of production would be operating at a cash loss given an oil price of c.$30/bbl. Short term oil prices can fall further. Thought leading: Oil is a wasting asset Oil is, however, a wasting asset and from examination of growth provinces and indeed the impact of past cycles on production from mature basins, a supply response seems patently apparent. We estimate current costs dictate a price of at least $60/bbl is now necessary to justify growth investment in Angola, the GoM, Brazil and Nigeria’s deepwater. Moreover, at least 1mb/d of existing supply now appears at risk as decline rates accelerate over the next 1-2 years. In the short term, there is no magic bullet; non-OPEC keeps producing Overall, our conclusion is that in the short term oil prices would likely have to fall to $20/bbl and below before non-OPEC was at risk of shutting-in material supply. However, with investment now falling, not least as the financial crisis impacts a far more significant independent sector, the downside risks to supply forecasts are increasing; and not just in the medium term. Whilst this analysis is not concentrated on the corporates against the weak oil price backcloth it is clearly the lower-cost producers whose earnings should prove better protected. Amongst the majors Total and BG Group look by far the best placed. Deutsche Bank AG/London
85.5 85.0 84.5 Aug-07
Oil is a declining asset (mb/d)
Onstream Probable Reserves grow th Other discoveries Under development Yet-to-find
Fundamental: The risks around future oil supply have risen sharply
60 2008 2009 2010 2011 2012 2013 2014 2015
Source: Wood Mackenzie
UK cost curve ($/bbl)
$/bbl 100 90
UK - Average OPEX cost $14.19/bbl 132kb/d and 413m b uneconom ic below $30/bbl 70kb/d and 272mb uneconom ic below $40/bbl
132kb/d and 413m b uneconom ic below $30/bbl
70kb/d and 272m b uneconom ic below $40/bbl
Schiehallion ($12.2/bbl) Buzzard ($6.1/bbl)
0 3 73 242 457 989 1078 1321 1558 1604 1769 1821 1903 2198 2376 2622 2813 2926 3333 3368 3492 3767 3968 4117 4194 4331 4380 4693 4810 4851 5007 5112 5324 5376 5414 5459 5592 5642 5721 5778
Cum ulative resource m bbls
Source: Wood Mackenzie: Deutsche Bank estimates
Non-OPEC decline rates 2000-8E
UK US Offshore Australia Norway Non-OPEC average Middle East Africa Other Asia Canada US Onshore Latin America China FSU 0% 5% 10% 15% 20% 25%
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research is available to customers of DBSI in the United States at no cost. Customers can access IR at http://gm.db.com/IndependentResearch or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.
...................................................... 3 Oil is an asset in decline................ 30 The pressure is on… ........................................................................... 19 What drops out – at least $60/bbl is needed for a growth barrel .......................... 4 Risks ............................................................................. 16 The impact on growth in mature regions is likely negative .............. 22 Nigeria – high costs and riskier operating environment ....... ............................................ 26 Cost and the companies ............................................................................................................................................... 12 Alaska – Economics comfortable at a price down to $20/bbl ............................................................................... 30 Page 2 Deutsche Bank AG/London ............................ 13 Russia – Domestic no problem.... 8 Where is cash breakeven? .................. 19 Investment is about costs as much as price............................... 23 Angola – it simply doesn’t work at current costs and prices....................................................................................................... 7 The high level view on OPEX by country .......................................................................................... 4 Oil is a wasting asset .................................... breakeven $42/bbl (but new projects different story) ....................... 14 US Onshore – History says 1mb/d at risk already ............................................................ 5 Raiding the database... 14 Canada oil sands – simply high cost (but gas matters a lot)...... 20 Brazil – avg.............................................................. 16 The implications for growth regions ............... the more mature the higher the cost ................................24 February 2009 Oil & Gas European Integrated Oils Table of Contents Executive Summary......................................................................................................................................We see limited risk of shut-ins at prices above $30/bbl ................................................................................................ 26 Are we seeing light on the horizon?................................................................................... 11 Norway – less vulnerable than the UK but ……................................................................................................................... 5 Not only demand is pressured in falling price environment ............................................................................................................................. exports a different story.................................................................................. 24 Where to from here for costs?....... 11 Unsurprisingly..................... 4 Valuation .................. 21 Gulf of Mexico – low cash cost but growth vulnerable................................................................................................................................................................... 3 Recommendations...................................................... 15 Mature basins: Decline rates to accelerate? ............................................................................................................................................................................ 11 The UK ...............
We see this production as vulnerable to shut-in.5mb/d. are to be averted and in which costs and taxes have surged. the US Gulf of Mexico and Nigeria’s deepwater to deliver an economic return. Some simple observations Clearly in reading this report investors need to recognize that costs are dynamic. Deutsche Bank Source: Wood Mackenzie GEM.24 February 2009 Oil & Gas European Integrated Oils Executive Summary Oil is an asset in decline Faced by a collapse in global growth the focus in world oil markets has rapidly shifted from constraints on supply to the diminution of demand. With the oil price collapsing and the economics of future production deteriorating. Norway and Alaska is around $15/bbl. not least Angola. Deutsche Bank estimates Deutsche Bank AG/London US GoM 65 Page 3 Canada Sands China Alaska Kazakhstan Norw ay Russia UK . However.a. As such. With the costs of developing new fields substantially increased and new investment decisions sharply reduced we also look at what oil price would be required for projects in today’s growth markets. having said this we believe that four simple observations can be made from our analysis: On average the cash cost of extracting a barrel of oil in the mature and higher cost nonOPEC markets of Russia. the UK.7mb/d of production would be cash negative and this including 0. Brazil. Yet in an industry which needs constant investment if underlying production declines of 5-7% p. with all its implications for the crude oil price.50/bbl excluding OPEC countries) Algeria Mexico Libya Angola Nigeria Iraq Brazil 70 5 Azerbaijan Venezuela Iran 60 2008 2009 2010 2011 2012 2013 2014 2015 UAE 0 0 Kuw ait Saudi Arabia 2922 5844 8766 11688 14610 17532 20454 23376 26298 29220 32142 35064 37986 40908 43830 46752 49674 52596 55518 58440 61362 Cum ulative 2009 oil production kb/d Source: Wood Mackenzie GOSS. in this note we have used our research partner Wood Mackenzie’s country-by-country database to gain a better understanding of the potential impact of the current global turmoil on oil supply in both the short and medium term. our sense is that the risks to supply estimates both in the short and medium term have increased meaningfully as project economics have further faltered. In an effort to assess the volume of current production that may be vulnerable to falling oil prices. Finally we consider the composition and likely direction of costs going forward and which European companies look best placed to cope against a backcloth of sharply lower oil prices.70/bbl (or $12. our analysis starts with a review of the cash costs (opex plus royalties) of extracting oil within the main producing regions before reviewing the risks to current production in mature basins. data that is valid today may well prove materially different tomorrow. As such it is significantly below the current oil price. Looking at the marginal cash cost curves within these mature regions we estimate that at an oil price of US$30/bbl a modest 0. Figure 1: Oil production requires steady investment to avoid decline m b/d 95 Onstream Probable Reserves grow th Other discoveries Under developm ent Yet-to-find 25 Figure 2: Cash costs of production (opex plus royalties) in the major oil producing regions ($/bbl) OPEX plus royalties $/bbl 30 90 85 20 80 15 75 10 Average cash costs am ong top producers $7. Only in the Canadian oil sands do average cash costs of circa $28/bbl approach the prevailing $35-40/bbl WTI oil price. at a $20/bbl WTI oil price this rises towards a material 3. Nevertheless.4mb/d of oil sands production.
Whilst this is in line with our estimate of the companies’ long run planning price. Norway and Russia. on absolute basis we believe we are now at a floor. the key risk to our estimates remains the prospect for commodity prices and crude oil in particular. All told. Total SA and BG Group look especially well placed given production costs that are around 40% below the average.30/bbl are some 25% above the average. Whilst this implies a sharp decline in profitability it also suggests that the sector should trade towards the top end of its P/E range. Our forecasts are consequently vulnerable to a significant move in the price of crude about our $45/bbl oil price estimate. We target a fair sector P/E multiple on average of around 14x prospective 2009 earnings estimates. With an estimated 1mb/d of relatively low cost production due on-stream over the next 3 years we would. cash return on capital analysis (CROCI) and discounted cash flow models amongst others. after several years of steady production decline Shell is now very much the high cost producer with technical costs of $23/bbl against a sector average of $18/bbl and production costs that at $8. Page 4 Deutsche Bank AG/London . many of which are fixed price.24 February 2009 Oil & Gas European Integrated Oils Past oil price collapses have been associated with a sharp increase in the decline rates observed in mature basins. Canada. expect this trend to reverse. On the basis of our current forecasts we believe that we are now approaching the trough of the current price cycle. Recommendations Whilst this analysis is not concentrated on the corporates. against the weak oil price backcloth we would highlight that it is the low cost producers whose earnings should be better protected through this period. however. the rise in costs and taxes in recent years suggests that the average oil price necessary to achieve a 15% IRR in Angola is now $68/bbl. against the current economic backdrop it comes as little surprise that 2008 saw fewer final investment decisions (FIDs) taken than in any year since 1989 despite the surge in the oil price. should provide for greater revenue stability. $62/bbl in the US GoM. Elsewhere. the UK. dollar oriented 7% plus dividend yield we also believe that at current share prices downside is limited. As a sector whose functional currency is the US dollar. our analysis suggests that. Risks As ever. Using past production curves as a proxy we estimate that as much as 1. with the multiple placed on the sector’s capital now trading below 1x invested capital against its long run average of 1.not least assessing the impact of rising costs on business profitability at a time of falling prices and volumes. $60/bbl in deep water Nigeria and around $60/bbl in Brazil (although this depends heavily on the scale of the development considered). with the sector offering a secure.3x the shares offer significant absolute upside. Within the growth regions. forecasting for an operationally geared sector through a downturn in the cycle is fraught with difficulties . Other risks include material changes to our expectations for volume output that could arise as a consequence of a worse than anticipated demand outlook.5mb/d of supply could be lost to accelerated decline over the next two years within the US onshore. We believe that little of this is allowed for in current supply estimates. our view being that this represents a sensible 10-15% discount to past peak multiples (c16x) and thereby allowing for some potential further slippage in the crude oil price. Importantly. Alaska. Amongst the Europeans. a sharp fall in that currency would significantly undermine asset values and dividend payments. This challenge aside. These include P/E relatives. Similarly. Valuation We use a multitude of earnings and cash flow valuation techniques to value the oils. Total should also gain given its greater exposure to oil price related production taxes which we expect to be in decline whilst BG Group’s exposure to natural gas markets. on cash return (CROCI) metrics.
0 88. is far from certain. Deutsche Bank Deutsche Bank AG/London Page 5 .5 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 M ar-08 Apr-08 M ay-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 2008 Forecast 2009 Forecast Figure 4: IEA OECD data suggests 300mb excess inventory (or 3. Faced with a surge in excess capacity as demand has weakened. the price of crude oil has sunk falling by a remarkable 70% in the space of little over five months. and the market’s reasoning is all too understandable. Put simply if the market doesn’t know where the demand floor lies.0 85. Deutsche Bank Source: IEA data. With economies continuing to deteriorate. As expectations for economic growth within mature and emerging economies have dramatically deteriorated. However.5 85.0 87.5days global supply) Days 58 57 56 55 54 53 52 51 50 49 Jan Feb M ar Apr M ay Jun Jul Aug Sep Oct Nov Dec 2003-7 range 2008 2007 Source: IEA data.0 86. Glance at the pace of change in the IEA’s forecasts for demand in 2009 or the build in days of forward demand cover.9mb/d in five months m b/d 89. in the current market we believe that OPEC’s success at stabilizing the oil price. how can it sensibly regain confidence that OPEC’s supply-side actions are sufficient? Figure 3: IEA demand estimates for 2009 have fallen by 2. at times such as these efforts by OPEC to contain supply would be expected to bring the market back into balance and help to establish an oil price floor.5 86. in the absence of some firm indication that global demand is stabilizing and that stock levels are no longer building it remains unclear what level of supply OPEC actually needs to cut towards before it can bring the market back into balance.5 88. the abject collapse in world economic growth associated with the current financial crisis has understandably driven a complete reversal in market focus. so too the seven year bull market in the crude oil price has unwound. in the short term at least. as depicted in the charts below. we quite simply do not know where the demand floor lies at this time.5 87. Where is the demand floor? Given the near total lack of a visible demand floor it is of little surprise that the market should at times appear as myopic on the downside implications for the crude oil price as it was on the potential for upside implied by the earlier supply constraints. For while the member countries may endeavour to underpin crude oil markets by espousing their ambitions for the oil price and supporting their statements by curbing their collective production.24 February 2009 Oil & Gas European Integrated Oils Oil is a wasting asset Not only demand is pressured in falling price environment After five years of at times myopic concern on the ability of oil markets to meet the global economy’s steadily increasing need for crude oil. OPEC cuts – but is doing so in the dark Typically.0 84.
even if production within nonOPEC is sustained in the short term. it is OPEC that plays the key role of balancing oil supply and demand.00 5. in reality OPEC’s 36mb/d of crude oil production capacity only represents 40% of the global industry’s c. As such. Iran Undoubtedly. Yet to the extent that the oil price falls to levels at which its production is no longer economic on a cash basis. As long as non-OPEC’s production is economic on a cash basis.8m b/d of w hich 3. As illustrated in Figure 7 this is estimated by the IEA to run at around 5-7% (or 4-6mb/d) per annum.00 0. if a collapsing oil price (or escalation in costs) prohibits investment our expectation would be that.5m b/d is in S. Nigeria and Iran looks set to move towards 6mb/d on current demand/supply estimates 9.00 3. Ven. Ex VINI this suggests 7% w orld dem and is available (or 9% on a gross basis) Spare Source: IEA data. Iraq. the apparent build does little to foster a view that the prospects for crude markets are improving (as illustrated by Figure 5 below). Yet whilst substantial. faltering supply would eat into any short term build in space capacity relatively quickly.00 -1.00 1. Capacity will not be idled.00 6. the key question for non-OPEC supply reductions and with them crude oil price support this has to be ‘at what oil price is non-OPEC production at risk of shut-ins on the basis that production is no longer economic on a cash basis’? Oil is a wasting asset Yet perhaps as importantly.0m b/d. As important in determining a potential oil price floor is therefore to assess what is likely to happen to non-OPEC supply both in the near and medium term i. production of oil faces a natural rate of decline. what is the scope for non-OPEC supply to prove weaker than anticipated.00 8. Iraq. Figure 5: OPEC spare capacity excluding that in Venezuela. with the decline rates in mature regions such as the UK and Norway typically running at higher rates. At what price does non-OPEC move towards cash loss? Historically.90mb/d of gross production capacity for crude oil and natural gas liquids (NGL’s). Rather it raises the question of how long it might take for crude markets to move back into balance once economic recovery commences and provides little confidence that the spot crude price has reached its near term floor. non-OPEC producers have long perceived that it is upon OPEC that the role of balancing short-term supply and demand imbalances falls. and in contrast with many capital intensive industries. Deutsche Bank estimates Spare ex Nig. non-OPEC will not cut. In the very short term.00 4. This is well illustrated by the below aggregation of Page 6 Deutsche Bank AG/London .24 February 2009 Oil & Gas European Integrated Oils With the cuts driving an unnerving rise in spare capacity In the meantime as idled capacity rises towards past peaks. in much the same way that supply markets tightened through the start of this decade. effective spare capacity ex VINI rises to 5. action will most likely be taken.e.00 7.00 2.00 Sep-00 M ar-01 Sep-01 M ar-02 Sep-02 M ar-03 Sep-03 M ar-04 Sep-04 M ar-05 Sep-05 M ar-06 Sep-06 M ar-07 Sep-07 M ar-08 Sep-08 M ar-09 Sep-09 Spare = 11% w orld supply On current target of 25.Arabia (or 8m b/d in total).
as discussed over the following pages what is clear to us at this time is that globally. Equally. as is evident from the summary charts depicted on pages 9 & 10. Clearly. Indeed. it need be appreciated that costs are something of a moving feast. Deutsche Bank Source: IEA data on-stream assets only and excluding ramp up. the US GoM and Nigeria with a view to assessing whether or not development projects in these regions continue to deliver sensible economics at current oil prices. In doing so we have not only sought to obtain some good idea of the relative positioning of opex and other cash costs (e. royalties) within the different countries. Because much of this is known to break-even at a higher cash cost (a significant proportion of US onshore requires prices of over $50/bbl) this suggests that the vulnerability of supply to a falling oil price is probably greater than our analysis suggests. Wood Mackenzie does not have data on all sources of crude oil production. Indeed. absent investment. it would seem reasonable to assume that decline rates in mature provinces are almost certain to accelerate. against a backcloth of lower oil prices we expect taxation to decline as host nations look to encourage investment. today’s global oil production base of 84mb/d will have declined to nearer 75mb/d by 2015.24 February 2009 Oil & Gas European Integrated Oils Wood Mackenzie’s estimates for global oil production which suggest that. New developments are required for sustenance m b/d 95 Onstream Probable Reserves grow th Other discoveries Under developm ent Yet-to-find Figure 7: Non-OPEC decline rates have averaged 7% over the 2000-2008 period led by mature regions UK US Offshore 90 Australia Norw ay Non-OPEC average 85 80 M iddle East Africa 75 Other Asia Canada US Onshore Latin Am erica China 70 65 60 2008 2009 2010 2011 2012 2013 2014 2015 FSU 0% 5% 10% 15% 20% 25% Source: Wood Mackenzie GOSS. Similarly. Angola. Figure 6: Oil Production is declines naturally over time. Romania) is not available. Looking further out we have then gone on to use Wood Mackenzie’s estimates for opex and capex per barrel to assess the economics of investment in today’s growth markets of Brazil. for the more mature regions we have also attempted to look at the cost curves within the countries themselves. there are already signs of this. Assuming that the oil price remains at its current subdued level for some time and that the limited availability of credit persists we have little doubt that both capital and operating costs will fall materially. given that in recent year’s industry production in mature OECD markets has increasingly been dominated by smaller E&P companies. the disparate nature of the 1-2mb/d or so that is produced by small ‘ma & pa’ type operators in the US Onshore together with that for other typically mature provinces (for example. Either way. In particular.g. Deutsche Bank Raiding the database With these points in mind we have reviewed Wood Mackenzie’s database of global oil projects in an attempt to gain a better understanding of the cost dynamics of the industry on a country-by-country basis. be it the reduction of export taxes in Kazakhstan or proposed changes to mineral extraction taxes in Russia. many of whom are now suffering from a lack of liquidity given the credit crisis. at an oil price below Deutsche Bank AG/London Page 7 . given the dynamic nature of costs in this industry. our objective being to assess how much production may prove vulnerable to shut-ins at different oil prices. most particularly at this time.
With this in mind over the following section we have used Wood Mackenzie’s field-by-field production and cost database to build intracountry cost curves. This is to say nothing of the acceleration in decline rates that seems increasingly inevitable given that many supply projects are quite clearly uneconomic in today’s price and cost environment – not to mention the additional challenge that the credit crisis has presented for an industry that through the boom years has become increasingly dependent upon cash strapped smaller companies and NOCs for its production. median production costs in these areas including taxes would appear to run at around $15/bbl.70/bbl if OPEC members are included. As we have mentioned not least amongst these are the significant number of ‘ma & pa’ type producers in North America which whilst individually small. or our exclusion of gas dominated projects and their associated NGL production. there is no ‘silver bullet’ or single source of material oil production. Globally average cash costs in non-OPEC are around $11-12/bbl ($8/bbl cum OPEC) As to the high level results. On average. Given that Wood Mackenzie’s database captures around 82mb/d of current oil production in part this difference reflects our decision not to incorporate data for a large number of the smaller oil producing nations. Page 8 Deutsche Bank AG/London . however. Using our understanding of tax and fiscal terms we then present the same data but with the operating cash cost grossed up for any royalties. In other words industry production would appear to be robust down to much lower crude oil prices than may at first be presumed and only at an oil price of $15/bbl and below does a very significant proportion of production move into loss on a cash basis. collectively account for close to 1mb/d of ‘price sensitive’ oil production. cash opex costs per country are relatively modest. US. UK.0mb/d) production include Canada’s oil sands. The high level view on OPEX by country So what are the higher cash cost regions? Over the following two pages we depict our summary analysis of Wood Mackenzie’s country-by-country database showing both an estimate of the weighted average cash operating cost by country and the barrels of 2009 crude production that each country represents. our analysis can be seen to capture approximately 75mb/d of the world’s current 86mb/d of oil production capacity. Alaska. As such. the US-lower 48. even including the Canadian oil sands. Building a cost curve for 75mb/d of world production In total. the North Sea (UK and Norway) and Kazakhstan. it is of note that on average cash costs excluding OPEC territories average around $12. the charts thereby representing the ‘cash opex’ and ‘cash opex plus taxes’ for major and then smaller producers. the production and operating costs of which are often relatively small. About 30-40% or 4m/d of the shortfall is. severance or extraction taxes. Note that. one simple conclusion from this analysis is that.24 February 2009 Oil & Gas European Integrated Oils US$30/bbl at least 1mb/d becomes cash negative given current industry costs. with the possible exception of the oil sands. Russia. in our opinion our analysis also highlights that. because of the volume of data we have also split the countries by scale of production. Indeed. Indeed the charts suggest that on average. Russia – the high cost provinces This point aside.50/bbl or closer to $7. Alaska. the high cost production regions with material (over 1. Norway. on a cash basis including royalty and severance taxes. it is these countries whose cost curves are probably worthy of further analysis. our expectation being that this should afford us some better insight into the number of barrels of oil production that are vulnerable to ‘shut-in’ as the price of oil falls towards the $20/bbl level. the shut-in of which might support the current $35-40/bbl crude oil price. from the data that is available what is immediately clear is that. no single region suffers average cash production costs that would suggest that it is uneconomic at the current $40/bbl oil price. To the extent that production in these areas arises from a multitude of fields (which obviates Kazakhstan). reflective of production in countries or from producers that are not captured by the Wood Mackenzie data set.
24 February 2009 Oil & Gas European Integrated Oils Figure 8: Estimated OPEX cost of production ($/bbl) across major territories (where OPEX is predominantly lifting and transport) OPEX $/bbl 30 25 20 15 10 Average OPEX am ong top producers of only $6.20/bbl (or $11.50/bbl excluding OPEC countries) Canada Sands Algeria M exico Libya Angola Nigeria Iraq Brazil Brazil Iraq Saudi Arabia Venezuela Iran Alaska China Azerbaijan Venezuela Norw ay Iran UAE 0 0 Kuw ait Saudi Arabia 2922 5844 8766 11688 14610 17532 20454 23376 26298 29220 32142 35064 37986 40908 43830 46752 49674 52596 55518 58440 61362 Cum ulative 2009 oil production kb/d Source: Wood Mackenzie GEM. Deutsche Bank estimates 2922 5844 8766 11688 14610 17532 20454 23376 26298 29220 32142 35064 37986 40908 43830 46752 49674 52596 55518 58440 61362 Cum ulative 2009 oil production kb/d Figure 9: Estimated $/bbl cash cost of production across major territories (OPEX plus royalties/severance taxes) OPEX plus royalties $/bbl 30 25 20 15 10 Average cash costs am ong top producers $7.10/bbl excluding OPEC producers M exico Libya Angola Algeria Nigeria Canada Sands US GoM Azerbaijan Norw ay Russia UAE 0 0 Kuw ait Source: Wood Mackenzie GEM. Deutsche Bank esimates Deutsche Bank AG/London US GoM UK 5 Kazakhstan Russia China Alaska UK 5 Kazakhstan Page 9 .70/bbl (or $12.
GoM and c1.5mb/d unaccounted for lower 48 production Page 10 Argentina Colom bia Australia India Denm ark Equatorial CongoGuinea Brazzaville Deutsche Bank AG/London .5mb/d unaccounted for lower 48 production Figure 11: Estimated $/bbl cash cost of production across minor territories (OPEX plus royalties/severance taxes) OPEX plus royalties $/bbl 30 25 20 15 Average cash costs am ong top producers $9.24 February 2009 Oil & Gas European Integrated Oils Figure 10: Estimated OPEX cost of production ($/bbl) across minor territories (where OPEX is predominantly lifting and transport) OPEX $/bbl 30 25 20 15 10 Average cash costs am ong top producers $8.20/bbl excluding OPEC countries) 10 Equatorial Guinea CongoThailand Brazzaville Indonesia 5 Egypt Om an Qatar Gabon Brunei M alaysia Sudan Indonesia Sudan Gabon India 5 Thailand Brunei Colom bia Argentina Canada (ex Oil Sands) Ecuador 0 0 517 1035 1552 2070 2588 3104 3622 4138 4657 5173 5691 6210 6726 7244 7761 8279 Cum ulative 2009 oil production kb/d 8797 9313 9831 10348 10866 11382 11901 12419 12935 13454 Source: Wood Mackenzie GEM.90/bbl excluding OPEC countries) US (ex-GoM ) US (ex-GoM ) Australia Denm ark Canada (ex Oil Sands) Ecuador Egypt Om an Qatar M alaysia 0 0 517 1035 1552 2070 2588 3104 3622 4138 4657 5173 5691 6210 6726 7244 7761 8279 Cum ulative 2009 oil production kb/d 8797 9313 9831 10348 10866 11382 11901 12419 12935 13454 Source: Wood Mackenzie GEM. Deutsche Bank estimates Note US-excludes Alaska.55/bbl (or $10. GoM and c1. Deutsche Bank estimates Note US-excludes Alaska.30/bbl (or $8.
we have used Wood Mackenzie’s field by field analysis and our understanding of fiscal terms to build marginal cash cost curves for these separate areas. however.24 February 2009 Oil & Gas European Integrated Oils Where is cash breakeven? Unsurprisingly. Alaska and the US onshore it is in these markets that we would expect a potentially significant number of production barrels to be ‘shut-in’ through any sustained downturn in the oil price. with the exception of known high cost provinces such as Canada’s oil sands. To what extent this may encourage operators to shut down facilities for extended maintenance is obviously unclear. Undoubtedly there will be producing fields in other geographic areas whose cash costs are such that their economic viability is threatened as oil prices move towards $30/bbl.We see limited risk of shut-ins at prices above $30/bbl Given the mature. it suggests to us that the actual costs of keeping plant going at lower oil prices will be higher than figure 13 implies. However. Likely as not. given an average cash cost including production taxes of around $15/bbl in the UK. any price-induced loss in existing production is very likely to be at the margin. Having said this. Deutsche Bank AG/London Page 11 . the UK would appear at first glance to be one of the more vulnerable regions in terms of potential shut-ins. that we believe the UK would see a truly material threat to its immediate production outlook. Russia. Most likely. our analysis suggests that a modest 132kb/d of ‘09 production could be at risk of shut-ins at oil prices around $30/bbl and under 70kb/d at $40/bbl. whilst our analysis suggests that some significant number of barrels would likely become uneconomic at a price of say $20/bbl. For most other markets. riskier E&P companies now driving that production. With this in mind we have sought to look at the marginal cost curves of these areas in some more detail. Figure 12: What might be at risk in mature provinces excluding US-lower 48? Oil prices below $20/bbl UK Norway Canada oil sands Alaska Russian export Source: Deutsche Bank Oil prices below $30/bbl 132kb/d 47kb/d 460/kb/d 15kb/d NIL Oil prices below $40/bbl 70kb/d 20kb/d NIL NIL NIL 471kb/d 228kb/d 1610kb/d 18kb/d 1033kb/d The UK . Oil needs to fall well below $30/bbl before material cuts are threatened Interestingly. maintaining production is almost certain to require some notable degree of capital investment. the more mature the higher the cost Our high level analysis of the cash costs for the major producing regions clearly suggests that. As such the temptation to shut-in given an extended fall in the oil price would also inevitably be higher. Indeed. This is illustrated by the below table which summarizes the number of barrels that we believe would be at risk across the different regions at oil prices down to $20/bbl (c3mb/d) and 30/bbl (a modest 700kb/d). high cost profile of the UK North Sea and the relatively high proportion of smaller. However. for a region such as the UK with its aging infrastructure which operates in a hostile environment. truly threatened. it is typically (and unsurprisingly) the more mature oil provinces that tend to have the highest cash breakeven levels. at a WTI oil price of $30/bbl and above very little outside Canada’s oil sands is. we believe. Shown below. it is only if the price of crude oil were to fall to under $20/bbl and stay there for some extended period of time. thereby threatening the economics of larger plays such as Forties and Ninian. it should be appreciated that our estimates of the UK’s economics are limited to opex costs alone.
1/bbl) 10 0 3 73 242 457 989 1078 1321 1558 1604 1769 1821 1903 2198 2376 2622 2813 2926 3333 3368 3492 3767 3968 4117 4194 4331 4380 4693 4810 4851 5007 5112 5324 5376 5414 5459 5592 5642 5721 5778 Cum ulative resource m bbls Source: Wood Mackenzie GEM.24 February 2009 Oil & Gas European Integrated Oils Figure 13: UK cash cost curve: our analysis suggests that at prices of around $40/bbl only modest production faces an economic threat $/bbl 100 90 UK .Average OPEX cost $14. a number of key differences mean that we see less risk of shut-ins in Norway. While similar to the UK in terms of infrastructure.61/bbl 20 15 10 5 0 155 180 482 502 788 912 1115 1211 2089 2369 2473 3049 3088 3455 4803 5238 5308 5605 6191 6368 6561 6791 7019 7035 7109 7288 7354 7473 7913 7962 8018 8109 8131 Ekofisk ($9.2) 20 Schiehallion ($12.85/bbl is below the average $14.85/bbl.$10.2/bbl) Buzzard ($6.80/bbl Cum ulative resource m boes Source: Wood Mackenzie GEM. Firstly.average OPEX cost $10.20/bbl in the UK – a feature which in large part is a function of production being concentrated amongst a far lower number Figure 14: Norway cash cost curve: Our analysis suggests that prices would need to drop below $30/bbl before any material volumes of production would be at risk $/bbl 50 45 40 35 30 25 Grane $20.50/bbl) Norw ay .19/bbl 132kb/d and 413m b uneconom ic below $30/bbl 70kb/d and 272m b uneconom ic below $40/bbl 80 70 132kb/d and 413mb uneconom ic below $30/bbl 70kb/d and 272m b uneconomic below $40/bbl 60 50 40 30 Forties ($22. Deutsche Bank estimates Page 12 Deutsche Bank AG/London . Norway’s lower maturity means that average OPEX/bbl at c.45/bbl Asgard $8. 47kb/d and 169m b uneconom ic below $30/bbl 20kb/d and 43m b uneconom ic below $40/bbl 20kb/d and 43m b uneconom ic below $40/bbl 47kb/d and 169m b uneconom ic below $30/bbl Snorre $11. Deutsche Bank estimates Norway – less vulnerable than the UK but …….
In reality. oil prices would need to fall some considerable way before production would truly be at risk of material shut ins. Deutsche Bank estimates Having said this.24 February 2009 Oil & Gas European Integrated Oils of facilities than it is of structurally lower costs (forecast oil production in 2009 is 1. Figure 15: Alaskan cost curve suggests that nearly all fields have a cash breakeven excluding capex of around US$18/bbl $/bbl 40 35 30 25 20 15 10 5 0 23 24 260 295 436 2138 2257 3149 3256 3546 3693 4054 4192 4268 OPEX Royalty 12.5% PPT M ajor fields Prudoe Bay and Kuparuk both appear to have a cash break-even of $17/bbl Cum ulative resources m bbls Source: Wood Mackenzie GEM. 2. at $30/bbl only 47kb/d looks uneconomic.9mb/d in the UK from over 300 facilities vs. companies which are likely to suffer less financial stress at this time than the smaller E&P companies in the UK. This should ensure that the pace of decline in a deteriorating price environment is more modest than that likely in the UK. a 12.5mb/d from around 70 in Norway). however. harsh operating environment our analysis suggests that even if oil prices were to fall below $30/bbl all but one field remains economic (and this field is forecast to produce only 15kb/d of oil in 2009).5% royalty which we include in our calculations and some modest expected charges for petroleum production tax or PPT (we assume between 0-4% depending upon opex costs). Deutsche Bank AG/London Page 13 . also apparent from our analysis of Wood Mackenzie’s database is that nearly all fields are expected to incur capex costs of around $2-3/bbl through the course of 2009. This compares with the aforementioned UK exposure of nearer 471kb/d or (25% of total UK output) at $20/bbl and 132kb/d at $30/bbl. whilst Alaska may be a relatively high cost and mature region. As a consequence our analysis suggests that whilst the economics of almost 228kb/d or 10% of Norwegian production would be challenged at an oil price of $20/bbl. Relative to the UK Norway thus certainly looks better placed. even if we were to do so the cash breakeven level would be unlikely to move much beyond the $20/bbl level suggesting that. Secondly. Finally the fiscal regime in Norway is such that it encourages exploration (78% tax relief on exploration) and development (generous capital allowances) on projects. Given the consistency with which this seems to be applied it is debatable whether such charges should not be treated as cash costs of continuing production. Norway has a higher proportion of large cap major oil companies operating projects. This is despite the existence of high transit costs. Alaska – Economics comfortable at a price down to $20/bbl Despite its reputation as a high cost.
Moves to reduce the level of MET should provide some near term support for profits and investment. however. to the extent that the bitumen extracted is not upgraded. average cash cost inc M ET on a WTI basis $18.45/bbl.50/bbl to remain in profit.44/bbl Sam otlor $18. mean that Canada’s oil sands sit very much towards the top of the oil cost curve.8bn bbls resources uneconom ic if price falls to $20/bbl Vankorskoye $20. This suggests that at a current domestic price of $20/bbl Russian production remains in profit albeit not by much. Canada oil sands – simply high cost (but gas matters a lot) Clearly to describe the oils sands as mature would be inaccurate. Admittedly. Sales into export markets do attract higher prices and even allowing for export tax should contribute more significantly to profits (although the absolute profit per barrel is less than compelling).5/bbl 20 15 10 5 0 544 1488 4584 5153 6070 6778 7815 9183 10044 10390 10775 12101 12646 15428 17211 18002 21722 25892 26682 29980 33331 37448 38510 43426 44883 46128 48665 56681 58039 62920 64839 67128 Cum ulative resources m bbls Source: Wood Mackenzie GEM. however. At this time. The sheer scale of Athabasca’s reserves suggests substantial growth potential. The cost of extracting the bitumen and converting it to synthetic crude does. however. We estimate that the cash costs of operating a mining and upgrading facility akin to Suncor. This is particularly true for crude oil exports given that. However.24 February 2009 Oil & Gas European Integrated Oils Russia – Domestic no problem. conducive for investment and in many ways it comes as little surprise that with investment in the industry falling away Russian production should now be in decline (see later). our impression is that more will need to be ceded by the tax authorities if Russian companies are to invest meaningfully for growth. AOSP or Syncrude in 2008 were around US$28/bbl. production of bitumen from SAGD is considerably lower at nearer $13-15/bbl. None of this is. Deutsche Bank estiamtes Allowing for MET of around $8/bbl currently (our estimate) and encompassing a normalized urals discount to Brent of about $3/bbl we estimate that Russian producers need a Brent oil price of around US$18.average OPEX $7. Figure 16: Russian cost curve suggests that cash breakeven for OPEX and transport averages $7. largely as a consequence of the country’s punitive levels of taxation. Russia is now almost certainly one of the most expensive provinces in the world in which to produce crude oil.45/bbl $/bbl 30 Russia . the Page 14 Deutsche Bank AG/London . the authorities have levied tax at a rate of 65% on the difference between the realized export price and $25/bbl.45/bbl 25 Export Tax 65% M ET Urals discount OPEX 1033kb/d '09 oil production and 12. if we were to solely consider OPEX costs it would also be wholly untrue – we estimate that stand-alone opex and transit costs are little more than $7-8/bbl. since 2004. exports a different story Given the scale of the fields and the resource base it seems a little ironic to label Russia a high cost producer. However. Indeed.45/bbl but adding taxes/Urals discount this rises to $18.
however. adding back bitumen discount) $/bbl 40 35 30 25 20 15 10 5 0 4043 8041 11041 17596 20936 22484 22554 22874 23094 22404 23264 23344 25244 26644 26944 27294 27789 27977 28877 29886 30501 31502 31542 33392 Suncor. Moreover. This in large part reflects the very fragmented nature of a substantial portion of US onshore production. as recently stated by RDS it is not easy to shut down and then restart an oil sands operation. Given limited data it is obviously not possible for us to sensibly create or analyze a cost curve for this region. we see US stripper well production as being one of the most vulnerable to shut-ins. Figure 17: Estimated operating costs for both synthetic oil and bitumen oil sands projects on a WTI equivalent basis (i. Companies would almost certainly be prepared to continue to run production even if the contribution achieved became modestly cash negative. observed at some further length when considering supply growth over the following pages. The lower-48’s production history is. Syncrude and AOSP Bitum en discount Production cost Joslyn Cum ulative reserves (m b) Source: Wood Mackenzie GEM. on-shore US production is a major region for which material data is not available. not least due to the fact that during the oil price crash of the 1990’s US oil production fell by some 500kb/d as.e. US Onshore – History says 1mb/d at risk already We should emphasise that where Wood Mac’s database covers a very substantial proportion of global oil supply. cash costs should be retreating and fairly significantly. No surprise then that the 1. Equally. namely natural gas. low productivity wells were shut in. these high-cost.17% of total US oil production is significantly higher than it has been for much of the past two decades. Deutsche Bank AG/London Page 15 . Push the oil price below $25-30/bbl for any extended period of time and the theory is that Canada’s sands will ultimately shut-in. not least because that way they are immediately positioned to take advantage of any up-tick in price once it comes.2mb/d of bitumen based oil that Canada now produces is seen as a key to determining the marginal cash cost of oil. As such.24 February 2009 Oil & Gas European Integrated Oils discount to WTI of say $20-25/bbl means that production economics are quickly destroyed. Deutsche Bank estimates Having said this it should be appreciated that in recent years at least $10-12/bbl of cash cost has represented expenditure on energy. amongst others. Our understanding of US onshore stripper well production is that it is high cost (estimates range between $55/bbl . production from stripper wells in the US at around c.$70/bbl cash costs including royalties) not least due to the modest number of barrels produced per day (c2kb/d) and the very high water cut. with gas prices now in reverse in North American markets. given the strength of the oil price in recent years. If past cycles are anything to go by.
Referring again to Wood Mackenzie’s estimate of the components of supply growth over the next six years suggests that total production on-stream as at the end of 2008 will suffer an annual decline in the region of 2%. Russia serves perhaps as a more recent example of what could potentially happen to growth in mature regions should investment in the maintenance and development of existing and new opportunities stagnate to decline. our analysis of the threat to non-OPEC supply from current low oil prices suggests that in aggregate any lost production will most likely be modest and at the margin. This does. the pace of delivery here must also be under question given the economics which prevail today.24 February 2009 Oil & Gas European Integrated Oils Mature basins: Decline rates to accelerate? The impact on growth in mature regions is likely negative Evidently. It is of note that the Page 16 Deutsche Bank AG/London . however. the UK. something which past experience suggests can certainly not be taken for granted at this time. However. given recent company announcements indicating that capital and exploration spend will be reined back and portfolios high-graded with projects deferred where companies have the flexibility to do so. m b/d 95 Onstream Probable Reserves grow th Other discoveries Under developm ent Yet-to-find 90 85 80 75 70 65 60 2008 2009 2010 2011 2012 2013 2014 2015 Source: Wood Mackenzie GOSS. Deutsche Bank Production risks increasingly appear to be to the downside … Indeed. Figure 18: Contribution of future elements of supply – without investment on-stream production suffers a CAGR decline of 2% 2008-2015. And whilst the below chart depicts a far more modest production decline of an annual 1% or so if we include reserves growth and resources under development. we believe the risk to this production profile is now very much to the downside. This seems particularly true given what we know of regions like Canada. Alaska and the US where production growth has slowed dramatically in past cycles following cuts in investment spend. assume the continued steady investment in existing facilities. as emphasized in our introductory comments oil is a wasting asset and the oil supply industry one which requires consistent investment if production levels are to be maintained.
7-1mb/d of existing production. however. Nowhere is this more obvious than in the US where in recent months rig activity has plummeted (see figure 44). decline rates appear set to accelerate with production falling on average by at least 10%. This seems particularly relevant in light of the very difficult credit markets that persist at present and that look likely to continue to do so over the course of 2009 and. Deutsche Bank AG/London Page 17 .50 15. Quite simply.00 17. Yet.0% 14.8mb/d at present to an expected 9mb/d by 2015 i.0% 1. absent an improvement in the investment climate there will be a supply response in the longer term. 2010. Whether it is the UK. Given that these regions alone account for around 7mb/d of annual production the implication must be the loss of around 0.e. Alaska and the US onshore through past downturns in the crude oil price and the trends are all too apparent. difficult to determine. Figure 19: High cost US stripper wells now account for almost 20% of US oil production bbl/d 2. and the impact upon price is likely to be all the more significant. perhaps. … with that risk augmented in mature basins by its corporate source Perhaps more striking through this downturn is also the increased dependence of the future growth of the industry on smaller to mid-sized companies. Deutsche Bank Past history suggests that mature regions will see decline rates accelerate to c10% Clearly sitting here today our strong impression is that the stage is now set for an acceleration in the pace of decline in mature basins.a. if not improve.0% 1. Quite how sharp this decline might be is. From our perspective what this suggests is that although the loss in supply in the very short term from mature production centers due to shut-ins may be relatively modest.50 12. In short. if returns come under pressure the supply response would appear to be relatively consistent. one look at the charts overleaf which depict production profiles for the UK. US or modern day Russia. Assume decline rates in Russia hold at the recent rate of around 2-3% and a further 300kb/d of production looks vulnerable. with drilling activity in mature provinces already slowing sharply this is now inevitable. Deutsche Bank estimates Source: Wood Mackenzie.0% 16. With an increasing proportion of production from mature basins now concentrated in the hands of smaller companies rather than the majors (something that we believe is well illustrated by the shift in UK production towards the independents since 2000 or the increased proportion of US production arising from stripper wells) our simple impression is that growth in these regions is likely to suffer especially significantly over the coming years.00 13.24 February 2009 Oil & Gas European Integrated Oils Russian Oil Ministry have recently suggested that Russian oil production will decline from around 9. Canada.00 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 10.0% 0.0% 2. by an average of c.1-2% p.0% 0.50 Average production per well (bbl/d) % stripper production % US production 19.0% 11.0% 18. Assuming that this arises at a time when demand for crude oil starts to stabilize.0% Figure 20: Make up of UK production: The share of the majors in the UK has near halved since 2000 80% 75% 70% 65% 60% 55% 50% 45% 40% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 % UK production delivered by the m ajors Source: US EIA/DOE data.
Deutsche Bank estimates Figure 25: Canada: Akin to the lower-48.24 February 2009 Oil & Gas European Integrated Oils Figure 21: UK oil production growth year-on-year 19962002 – the impact of underinvestment is clear 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% Jan-96 15% 10% 5% 0% -5% -10% -15% -20% Jan-94 20% 15% 10% 5% 0% -5% -10% -15% -20% Jan-95 M ay-95 Sep-95 Jan-96 M ay-96 Sep-96 Jan-97 M ay-97 Sep-97 Jan-98 M ay-98 Sep-98 Jan-99 M ay-99 Sep-99 Jan-00 M ay-00 Sep-00 Jan-01 M ay-01 Sep-01 Jan-02 M ay-02 Sep-02 M ay-94 Sep-94 Jan-95 M ay-95 Sep-95 Jan-96 M ay-96 Sep-96 Jan-97 M ay-97 Sep-97 Jan-98 M ay-98 Sep-98 Jan-99 M ay-99 Sep-99 Jan-00 M ay-00 Sep-00 Jan-01 M ay-01 Sep-01 Jan-02 M ay-02 Sep-02 Figure 22: Russian oil production is also starting to show the effect of underinvestment in the industry 5% 4% Im pact of low er investm ent throughout the price crash of the late 90's: -9% com pound decline in production 3% 2% 1% 0% -1% -2% -3% Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Russian declines accelerate Source: UK BERR data. Deutsche Bank estimates Figure 26: … with Canadian light oil production suffering similarly over the same period Source: Statistics Canada data. Deutsche Bank estimates Figure 23: Alaskan oil production follows a similar trend with production decline resulting from underinvestment Source: EIA/DOE data. And turned negative again in 2002 . Source: Statistics Canada data. Interfax. Canadian heavy declined sharply during the price crash of the late 90's …. Deutsche Bank estimates Page 18 M ay-96 Sep-96 Jan-97 M ay-97 Sep-97 Jan-98 M ay-98 Im pact of low er investm ent leads to period of negative grow th?? Sep-98 Jan-99 M ay-99 Sep-99 Jan-00 M ay-00 Sep-00 Jan-01 …. the 1990s price collapse drove a 15% production decline … Akin to light oil.possibly as a result of delayed investm ent in the late 90's M ay-01 Sep-01 Jan-02 M ay-02 Sep-02 Source: Reuters. Deutsche Bank estimates M ay-95 Sep-95 Jan-96 M ay-96 Sep-96 Jan-97 M ay-97 Sep-97 Jan-98 M ay-98 Sep-98 Jan-99 M ay-99 Deutsche Bank AG/London Sep-99 Jan-00 M ay-00 Sep-00 Jan-01 M ay-01 Sep-01 Jan-02 M ay-02 . Deutsche Bank estimates Figure 24: US lower 48: The decline in prices in the late 1990s drove a short 500kb/d fall in onshore production 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% -12% Jan-95 20% Production in light crude in Canada declined sharply during the price crash of the late 90's declining by 13% y-o-y at its peak 15% 10% 5% 0% -5% -10% -15% -20% Jan-95 M ay-95 Sep-95 Jan-96 M ay-96 Sep-96 Jan-97 M ay-97 Sep-97 Jan-98 M ay-98 Sep-98 Jan-99 M ay-99 Sep-99 Jan-00 M ay-00 Sep-00 Jan-01 M ay-01 Sep-01 Jan-02 M ay-02 Sep-02 US shut-ins take dow n c500kb/d in 1998/9 Source: EIA/DOE data.
even before oil prices collapsed through the second half of last year. This is particularly true in ultradeepwater and complex developments which are inherently more costly to develop and for which a tight deepwater (5000metres plus) rig market suggests that. we should first highlight that fundamentally. Bloomberg. US GoM. In our opinion. Our analysis unsurprisingly suggests that the growth regions are much more vulnerable to project delays and/or cancellations. FID has fallen in every other downturn – which has resulted in falling or flattening of F&D costs $/bbl oil price & No. Angola and Nigeria). Companies thus began to postpone sanctioning projects until such a time as costs cooled so rendering projects economic at these planning price levels. than mature regions are to production shut-ins. the very simple reason for the dearth of FID in 2008 was costs. costs were simply too prohibitive to guarantee a return. even in the face of a fall in crude prices.24 February 2009 Oil & Gas European Integrated Oils The implications for growth regions Investment is about costs as much as price Turning now to growth regions and what the current environment means for future developments. As the figure below highlights. the number of final investment decisions (FIDs) taken in the first six months of 2008 was a very modest eighteen. costs are unlikely to come back quickly. it is not solely the oil price which determines whether or not a project will be sanctioned. At the typical planning price for crude oil of $60-$80/bbl that we believe is used by the major oil companies. FID taken F& D costs 100 H2 08 FID Oil Price (nom inal) 25 $/bbl F& D 30 80 20 60 15 40 10 20 5 0 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 0 Source: Wood Mackenzie Pathfinder. Figure 27: Average no. This is despite the fact that most projects would have been more than economic should the oil price experienced through to the middle of the year have prevailed. FID 120 No. Deutsche Bank AG/London Page 19 . Deutsche Bank Using our understanding of costs and Wood Mackenzie’s forecasts for OPEX and CAPEX we have calculated the average breakeven oil price required for development of future projects in four key growth regions (Brazil.
Taking Wood Mackenzie’s generally well informed cost estimate for full cycle CAPEX per barrel.3 4. so as to state everything on a ‘WTI equivalent basis’ we have adjusted this price for to ensure any price discount or premium is captured. StatoilHydro’s Leismer up-grader project. What drops out – at least $60/bbl is needed for a growth barrel As to the findings our analysis suggests that. Nigeria DW $60/bbl and Brazil around $60/bbl (although this depends upon the size of the field and special petroleum tax) most projects in the growth regions fail to wash their face at the lower end of companies’ price planning ranges. A number of Canadian oil sands projects (Total’s Northern Lights. whilst elsewhere Saudi Aramco’s cancellation of a $10bn service contract for the development of the Manifa project. In reality the rate will vary dependent upon field size 7. are just some of the headlines we’re seen over the last few months. Hess’s recent guidance that is intends to spend 33% less in 2009 on exploration than in 2008 and 26% less on production and development spend. the breakeven oil price for projects to achieve company investment objectives is in line. given an average breakeven on new projects in Angola of around $68/bbl. Shell’s Jackpine development at AOSP. More importantly.0 Taken from Wood Mackenzie GEM database 2. Figure 28: Methodology by which we calculated our estimated breakeven oil prices within the growth regions Roncador Capex 15% return CAPEX plus return Corporation Tax Special Participation TaxT OPEX Royalty WTI discount Total Cost Source: Deutsche Bank $/bbl Comments 7. barring a few exceptions. we have assumed that the industry requires a 15% return and grossed up to give us a required ‘cash flow per barrel number’ for the project to wash its face. GoM $62/bbl.7 Royalty of 10% applied to CAPEX plus return plus taxes plus OPEX plus discount to Brent 9. in the absence of a very significant shift in taxation or capital and operating costs. very few of the development projects mooted would deliver an economic return at current oil prices. Page 20 Deutsche Bank AG/London . Finally. cut backs in CAPEX and canceling bid rounds for rigs. Using Wood Mackenzie’s database to assess project economics In order to build regional cost curves and gain a stronger understanding of how the full cycle economics for growth regions have shifted in recent years we have again fallen back on Wood Mackenzie’s database of capital and operating costs. Sense checking our breakeven estimates against the outputs from Wood Mackenzie’s sophisticated fiscal models to calculate NPV’s suggests however that.3 Taken from Wood Mackenzie GEM database 1.6 Clearly we recognize that this method fails to take into account the time value of money and certain other fiscal elements such as capital allowances.8 Reflects an estimated 25% discount to Brent give API in the high 20’s 37. Petro-Canada’s Fort Hills) have delayed FID.3 Whilst SPT rates varies between 10-40% we have used 25% for this example.5 Corporate Tax rate in Brazil of 35% applied to CAPEX plus return 4. Back-calculating further we have then used our understanding of the different regions fiscal regimes and Wood Mackenzie’s estimates for per barrel operating costs to estimate the oil price required to justify investment.24 February 2009 Oil & Gas European Integrated Oils Indeed we are already seeing this profile of poor project economics translate to the real world. with an ever increasing number of companies (both IOCs and NOCs) announcing project postponements.1 Reflects our use of 15% as minimum return sought on project 8.
Overall we estimate that at oil prices below $40/bbl some 8. the giant oil field in Brazil’s sub-salt Santos basin.5mbbls (or 74% of total resources included within the Wood Mackenzie database) at oil prices below $30/bbl.24 February 2009 Oil & Gas European Integrated Oils Brazil – avg. requiring significant capital outlay. However. we note that other factors are also likely to impact the development of projects such as the fact that the government could initially favor developing gas fields in order to reduce the country’s gas imports from Bolivia. under the existing fiscal regime in Brazil our analysis would suggest that the average breakeven oil price required for new developments is a more modest $51/bbl. Another factor which could impact development is the requirement for c. unlike future developments in growth PSC regimes in Africa which require oil prices nearer $70/bbl. Deutsche Bank AG/London Page 21 . Deutsche Bank estimates What do the Wood Mac models say? Below we present a number of key future developments in Brazil which highlights our calculated breakeven oil price compared to Wood Mackenzie’s calculated NPV10 at both $40/bbl and at $60/bbl. Even Tupi. breakeven $42/bbl (but new projects different story) While the overall average breakeven oil price required in Brazil is a modest $42/bbl. This would imply a breakeven oil price of near $60/bbl for Tupi in the current cost environment (again on the basis of a development that will ultimately produce 1mb/d and thus attract SPT at 40%). the local market (particularly the rig market) is not sufficiently developed as yet to be able to cope with the potential demand from the development of all Brazil’s recent sub-salt discoveries. this figure includes a number of existing fields such as Roncador ($38/bbl) or Albacora ($20/bbl) for which FID was taken in a lower cost environment and which have significantly lower breakeven points. The projects that underpin future production growth in Brazil are in ultradeepwater and are technologically complex.30-40% local content in the development of projects. Figure 29: Brazil Concession – we estimate that an average oil price of $42/bbl is required $/bbl 70 Capex Opex Return Tax Royalty SPT Discount to WTI Tupi $60/bbl 60 Parque das Conchas $55/bbl 50 Average beakeven oil price required in Brazil of $42/bbl 40 Roncador $38/bbl M arlim Sul $43/bbl 30 20 10 0 342 463 903 1362 2003 3591 3899 4021 4195 4447 4834 4892 5324 7888 8686 9097 9792 11715 12415 12416 12824 13469 18371 Cum ulative resources m boes Source: Wood Mackenzie GEM. However. only requires an oil price of $60/bbl (compared with the $40/bbl breakeven oil price indicated by BG Group) to break even on our estimates (we suspect the difference reflects BG commenting on TUPI as a single 100kb/d development rather than the first in a series thereby driving up special production tax (SPT) rates).6mbbls of reserves are no longer economic and this increases to 13.
Thus where the relatively modest operating (we estimate $7/bbl) and royalty (we estimate $4/bbl) costs in the GoM suggest that the region should remain cash positive on existing production at oil prices down to $11/bbl.5bn bbls at oil prices below $30/bbl. Deutsche Bank Indeed.45 56. Wood Mackenzie GEM Gulf of Mexico – low cash cost but growth vulnerable With its concessionary fiscal regime. In total our analysis indicates that at oil prices below $40/bbl some 6bn bbls (64% of total cumulative resources considered) would potentially become uneconomic. Figure 31: Deepwater Gulf of Mexico – we estimate that an average oil price of $46/bbl is required to breakeven $/bbl 100 Capex 90 80 70 Tahiti $53/bbl 60 Shenzi $46/bbl 50 40 30 20 10 0 0 10 199 589 819 906 974 1040 1195 1261 1293 1447 1522 1708 1787 1906 2014 2682 3002 3181 3246 4177 4324 5060 5501 5639 6411 7165 7534 8772 9010 Average breakeven oil price required in US Deepw ater GoM of $46/bbl Thunderhorse $41/bbl Atlantis $36/bbl Opex Return Tax 35% Royalty M ars Differential Cum ulative resources m bbls Source: Wood Mackenzie GEM.25 55. published December 2008) which estimated that as a consequence of the surge in development costs. only three relatively small fields with aggregate 2P reserves of just 42mboe received project sanction in 2008 compared with nearer 10 projects containing 600mboe in 2007. looking at projects where production has not yet started the average breakeven oil price required increases to $52/bbl. Projects such as Shenzi or Tahiti which have taken FID and are nearing production start-up have breakeven oil prices of $46/bbl and $53/bbl respectively. however this increases again for projects that are less far along the development path such as Jack ($67/bbl) or Knotty Head ($70/bbl). that future developments in US GoM could suffer in the current environment was also highlighted in a recent Wood Mackenzie Insight article (‘Probables in deepwater Gulf of Mexico 2008’. the US GoM has been one of the key growth regions for major IOCs over the last decade. This correlates well with the below Wood Mac NPV estimates. additions to the list of probable reserves for development slowed sharply with reserve adds of just 214mboe compared with over 1500mboe in 2007. the outlook for medium term growth should oil prices remain at current levels looks certain to continue to deteriorate.24 February 2009 Oil & Gas European Integrated Oils Figure 30: Brazil key development projects Project Baleia Franca Peregrino Parque das Conchas Papa Terra Tupi Operator Petrobras StatoilHydro Shell Petrobras Petrobras Reserves mbbls 298 450 382 609 4654 Peak prod’n kb/d 65 95 98 160 868 DB B/E oil price $/bbl 39. low geopolitical risk profile and a modest average breakeven oil price of only $46/bbl. increasing to 7. However. Secondly.16 59.05 43. Page 22 Deutsche Bank AG/London .59 WM NPV10 $40/bbl 157 295 -344 -2202 -12768 WM NPV10 $60/bbl 988 1908 1618 140 444 Source: Deutsche Bank.
10 53. Add to this Nigeria’s riskier operating environment (given military and social unrest) and Nigeria would appear to lend itself to potential delays in project development. Wood Mackenzie GEM Nigeria – high costs and riskier operating environment Our cost-build analysis of Nigerian PSC’s indicates that akin to Angola. however. Deutsche Bank AG/London Page 23 . Figure 33: Nigeria PSC – we estimate that an average oil price of $46/bbl is required to breakeven $/bbl 90 Capex Return Governm ent OPEX Royalty 80 Average breakeven oil price of $46/bbl required for Nigeria PSC developm ents 70 Bolia-Chota $71/bbl 60 Usan $60/bbl Akpo $44/bbl Erha $43/bbl Agbam i $30/bbl Bonga $46/bbl 50 40 30 20 10 0 36 344 917 1738 2559 3149 3188 4325 4935 5005 5085 5285 5425 5680 Cumulative resources m bbls Source: Wood Mackenzie GEM.51 59.24 February 2009 Oil & Gas European Integrated Oils Figure 32: US Gulf of Mexico key development projects Project Shenzi Great White Tahiti (GC 640) St Malo (WR 678) Jack (WR 759) Knotty Head (GC 512) Tubular Bells (MC 725) Operator BHP Shell Chevron Chevron Chevron Nexen BP Reserves mbbls 345 435 450 400 375 300 274 Peak prod’n kb/d 86 72 106 85 64 80 77 DB B/E oil price $/bbl 46. at $60/bbl Nigeria has one of the highest breakeven oil prices for new projects in the growth regions that we have considered.27 50. mainly due in our opinion to the generous capital allowances and other tax offsets available on deepwater PSC’s in Nigeria which our simple calculation does not attempt to account for. Having said this. Aparo and Usan. such as Bolia-Chota.67 Wood Mac NPV $40/bbl -323 -1140 -708 -2028 -2379 -1761 -1190 WoodMac NPV $60/bbl 1566 895 1642 -460 -838 -487 351 Source: Deutsche Bank. Digging a little deeper our analysis indicates that the breakeven oil price required for future deepwater developments. Deutsche Bank Below we present a number of key future developments in Nigeria which highlights our calculated breakeven oil price compared to Wood Mackenzie’s calculated NPV10 at both $40/bbl and at $60/bbl. In other words. circa 69% of cumulative deepwater reserves in Nigeria considered in our analysis are not economically viable in the current high cost environment at $40/bbl.42 63. none appear economic at $40/bbl with most requisite of an oil price comfortably north of $50/bbl to achieve breakeven. Nsiko.29 69. increases to near $70/bbl.35 67. The more sophisticated Wood Mackenzie model indicates breakeven oil prices somewhat lower than we calculate.
at lower oil prices it is the government that absorbs most of the impact (at a LT oil price of $150/bbl the government would have taken 54% of revenues. Figure 35: Angola PSC – we estimate that an average oil price of $41/bbl is required to breakeven $/bbl 100 90 80 70 60 50 Average breakeven oil price required in Angola PSC regim e is $41/bbl 40 Totals's Dalia $25/bbl 30 20 10 0 1254 1274 1324 1329 1390 1419 1419 1430 1918 1947 2305 2889 3251 3254 3254 4123 4124 5047 5653 5669 5735 6320 6475 7696 7900 8754 9754 10455 Girassol $20/bbl Kizom ba C $32/bbl Total's Pazflor c.$53/bbl Capex Opex Return Governm ent Discount to Brent Block 31 c. Consequently. Wood Mackenzie GEM Angola – it simply doesn’t work at current costs and prices The chart below paints a none too rosy picture in a region that was once mooted as being a new growth engine for IOCs. The table below which shows Wood Mackenzie’s NPV10 estimates at both $40/bbl and at $60/bbl suggests that our estimates are not unreasonable – with all projects excepting Pazflor requiring an oil price north of $60/bbl.$70/bbl Cumulative resources m bbls Source: Wood Mackenzie GEM. with our analysis suggesting an average breakeven oil price for new developments in Angola of $69/bbl (compared to the average breakeven of $41/bbl for all projects in the region). Total’s Block 32 or BP’s Block 18 West require something nearer $80/bbl suggesting FID on these projects will not be forthcoming in the current environment. at a LT oil price of $100/bbl this falls to 42%). Page 24 Deutsche Bank AG/London .24 February 2009 Oil & Gas European Integrated Oils Figure 34: Nigeria key development projects Project Usan Aparo Oyo Bolia-Chota Nsiko & Aparo Operator Total Chevron Eni COP/Shell Chevron Reserves mbbls 610 70 80 340 255 Peak prod’n kb/d 180 20 30 102 83 B/E oil price $/bbl 57. with costs running high and eating heavily into the government’s share of cash flows it is possible that obtaining project sanction will prove increasingly difficult in the current environment. Deutsche Bank Wood Mac NPV’s confirm that north of $60/bbl required given current costs In total our analysis suggests that some 5bn bbls (48% total cumulative PSC resources in Angola) are not economic at oil prices below $40/bbl and that with the exception of the Kizomba satellites no future developments (including Pazflor. Clov.44 NPV $40/bbl -1809 -295 -333 -308 -1454 NPV $60/bbl 1580 158 521 376 -426 Source: Deutsche Bank. Furthermore.91 83. Malange or Blocks 31.75 69.65 61. as highlighted in a recent Wood Mackenzie publication.69 70. 32 & 18) are commercially viable. Within this we note that key growth projects such as BP’s Block 31.
79 55.55 83.02 81.40 NPV $40/bbl -4110 -4396 -5699 -5025 -5537 -5604 -6437 -2322 NPV $60/bbl 1390 -1069 -2252 -2224 -3148 -3044 -3646 -1251 Source: Deutsche Bank.24 February 2009 Oil & Gas European Integrated Oils Figure 36: Angola key development projects Project Pazflor Clov Block 31 PSVM Block 31 SE Block 31 Mid Block 32 Central Block 32 SE Block 18W Operator Total Total BP BP BP Total Total BP Reserves mbbls 720 604 500 500 500 499 498 203 Peak prod’n kb/d 200 170 150 150 150 150 150 80 B/E oil price $/bbl 53. Wood Mackenzie GEM Deutsche Bank AG/London Page 25 .33 80.50 60.15 81.20 73.
24 February 2009 Oil & Gas European Integrated Oils Where to from here for costs? Are we seeing light on the horizon? Over the preceding pages we have discussed at some length the likely impact of both cash and capital costs on production and investment levels. Evident from this is that we are very much of the view (unsurprisingly) that. Deutsche Bank estimates Source: Deutsche Bank estiamtes. The below charts depict the seemingly inexorable rise in costs over the last few years. whilst on a cash basis the threat to existing supply is likely at the margin. partly as a consequence of limited company disclosure but more significantly as a result of the very disparate nature of oil production. In an ideal world we would of course have a good idea of what exactly comprises operating costs and capital costs. shallow water vs. so too costs must be expected to fall. while our analysis of company reported technical costs would suggest a similar 11% growth rate in a number of major oil companies over the same period. onshore etc). Middle East) and terrain (deepwater vs. this industry is not one that lends itself to ready analysis. Figure 37: IHS/CERA Upstream Capital costs Index Index (2000=100) 240 220 200 180 160 140 120 100 80 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Q1 2008: 210 Q3 2008: 230 Figure 38: Average technical costs 11% CAGR 2000-07 $/boe 20 18 16 14 12 10 8 6 4 2 0 2000 2001 2002 2003 2004 2005 2006 2007 CAGR 11% increase 2000-2007 Big Six Average DB Oil Co. Company data What goes up must come down – it’s just the timing and extent that’s unclear Costs are. As illustrated by the figures overleaf which are derived from data proffered by RDS and CERA. given the disparate nature of costs both by geography (Nigeria vs. that we are starting to see companies reassess their development portfolios and delay FID on certain projects. US GoM vs. However. dynamic and in much the same way that inflation has accelerated as the oil price has appreciated. That costs have increased markedly over the past few years has been only too apparent. with oil prices collapsing the escalation of costs in recent years now threatens to undermine the industry’s willingness to invest to maintain existing capacity let alone develop the capacity necessary to meet expected future demand growth. Little wonder then. our strong expectation is that if the demand and price environment remains depressed. Consequently we would be relatively well placed to assess by how much costs would increase/decrease given movements in the various components. More challenging however is to try to assess by how much and how quickly. that with costs at current record highs and an oil price that has plummeted to levels not seen (in real terms) since 2003 when costs were almost half that of today’s level. CERA estimates that upstream capital costs have increased by a compound 11% since 2000. however. trying to assess what kind of reduction one could expect in costs is nigh on impossible. Page 26 Deutsche Bank AG/London . Source: CERA data.
given the significance of steel in many other cost categories not least equipment and vessels. com pressors) 40% Figure 41: Average OPEX split in US Offshore Rigs (Day rates) 10% Figure 42: CERA Upstream Capital Costs Index 2500 Steel Equipm ent 2000 Bulk M aterials Land Rigs 1500 Construction Labour Offshore Rigs Yards -fabrication Offshore installation vessels Engineering & PM Subsea Other (labour. equipm ent rental. Deutsche Bank estimates Source: CERA data. The tightness in the labour market within the oil industry has led to salaries soaring in recent years. Overall. Deutsche Bank estimates Some flavour on the major inputs – steel and rigs are key Looking at the above it is only too clear that the make up of operating and capital costs can vary dramatically. having said this we can make the following observations On the capital side of the equation both steel. in overheated markets the productivity of labour has Deutsche Bank AG/London Page 27 . gas separators. m aterials. However. freight. Deutsche Bank estimates Source: RDS. catering. Moreover. Deutsche Bank estimates M aterials (Generators. fuel) 26% Sub-sea kit 6% Logistics 8% Fabrication yards 10% Steel casings 40% 1000 500 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: RDS. logistics 23% Rigs (Day rates) 20% Labour costs 20% Others (including fuel. and the rally in steel prices can be assumed to have had an even more significant impact on overall costs.24 February 2009 Oil & Gas European Integrated Oils Figure 39: Average OPEX split in Europe Figure 40: Average OPEX split in US onshore Labour. i. the greatest compound growth in costs has arisen in sub-sea markets something which akin to the growth in deepwater rigs also reflects the shift in the industry towards deepwater plays. and offshore rig rates have accounted for the lion’s share of the cost increases in recent years if the CERA index is to be believed. strip out the inflation seen in these two components and industry inflation would have been nearer 8% per annum than the 12% actually observed. not least for pipe casings. with the American Association of Petroleum Geologists recently indicating that the average annual salary for a geologist with 20-24 years experience went from $113k in 2005 to $167k in 2008. One profile does not fit all. annual growth of 14%. Similar to steel its contribution to total cost is in reality much greater than that initially indicated above given labour costs will also drive rig rates and logistics. Steel and rig rates aside. Indeed. Moreover.e. raw m aterials) 30% Logistics 15% Steel Casings 17% M aintenance 35% Source: RDS. labour costs have proven a significant driver of costs.
As shown in Figure 45 the industry entered a 5-year period of lower costs on a per barrel basis following the ‘price crash’ of 1980s. Fuel costs have naturally increased in line with rising oil and natural gas prices something which again has been particularly pertinent for costs in the oil sands. in particular steel which fell 50% in little more than 5 months. the structure of contracts will have a role to play here. the fact that costs had already been pared to levels at which the service providers were under significant stress. Deutsche Bank estimates The past suggests costs will come back The message of past cycles is also that industry costs fall following oil price crashes. lump sum contracts during the boom years in an attempt to control its costs. execution or quality clauses in order to reduce costs where possible. however. is that the majors will be far tougher on contract terms focusing intensely on any key performance indicators (KPIs) in place. now stands to potentially have to wait longer to benefit from lower priced raw materials (renegotiation of contract aside).e. F&D spend). Figure 43: The surge in steel prices is now firmly in reverse US$/t 1400 1200 1000 800 600 400 500 1500 Figure 44: US Rig Count has collapsed since the end of 2008 total rigs 2500 Rigs 4-week change 4-week change 100 US HRC Japan HRC China HRC 50 2000 0 -50 1000 -100 -150 200 0 Aug-03 Dec-04 Apr-06 Aug-07 Dec-08 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 -200 -250 Source: CRU. two of the most significant sources of cost inflation now appear to be in reverse. Shell for example recently commented that it estimates the productivity of often unskilled labour in Canada’s Athabasca region at only 60% of that achieved by its employees in Houston. amongst others. No doubt the paucity of the period of oil price falls also played its role.70/boe in 1990. Most companies state that cost fluctuations typically take circa 12-18 months to work their way into the cost structure of the majors.24 February 2009 Oil & Gas European Integrated Oils also been an issue. with costs falling by a CAGR of 13% from 1985 to their trough of c. What we do expect however.$3. regardless of type of contract. Page 28 Deutsche Bank AG/London . certain costs have already started to subside and rapidly. as the following charts illustrate. Although the oil price decline of the late 1990s was not met with a similar fall in costs. with reductions being more marked in both exploration spend and CAPEX (i. In other words little was left to be had. Any company that favored fixed. Direction is easy…it is timing and scale that seem very difficult to quantify So what is the outlook for the individual cost components and how quickly might we expect them to decline? With steel prices now in decline and rig utilization in many onshore and offshore markets softening. Evidently. Conversely a cost-plus contract base should theoretically result in a more immediate benefit to the major. Deutsche Bank estiamtes Source: Bloomberg. this reflects. Indeed. Our expectation would be that costs will now start to see a meaningful reduction. highlight the scope for significant cost deflation in the near future. While this will not immediately be evident in the operating or capital costs of the majors it does.
BP 5year moving average industry F&D cost estimates. By deferring projects. That these efforts are being made at a time when the demand for engineering services from all quarters of the global economy are under pressure suggests that they are likely to be more effective than not. The location of the resources that underpin future production. Today’s marginal barrel. Costs are set to fall and judging by the extent to which they rose. be it located in Brazil’s deepwater or Kazakhstan’s icy seas is more difficult. asking for EPC companies to re-quote on contracts and reviewing expenditures on everything from catering services to helicopter-transport providers. This certainly appears to be the level anticipated by both Total. however. and Shell whose CEO has indicated he would expect the CERA index to be at least 40 points lower by the end of this year. technically challenging and costly to extract. savings are being sought. the likelihood is that the risk is to the downside. clear. however.24 February 2009 Oil & Gas European Integrated Oils Figure 45: F&D costs have risen over three fold over the past four years F& D $/boe 28 Oil Price (real) 23 60 50 40 13 30 20 8 10 3 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 0 F& D costs 70 WTI $/bbl 80 18 Source: Bloomberg. Deutsche Bank AG/London Page 29 . The build time and contract length of much of the work undertaken for this industry suggests. that. With the forward order books of the service industry starting to reflect the deteriorating trends the bargaining position of the oil producers is certainly better than it was. To the extent that the world economy does not rapidly recover the trend is. What is very clear. in the same way that it took time for the inflation in costs to explode. which is targeting a $800m or c20% reduction in OPEX costs by end 2009. not to changes in mention environmental regulation in many regions argues that costs will certainly not return to the levels seen but five years ago. our impression is that cost reductions in OPEX of at least around 20% in twelve months time ought to be achievable. however. is that in today’s demand-forsaken world the major oil companies are certainly making considerable effort to place service providers under increased pressure. so too cost deflation will not occur overnight. Listening to company guidance. Deutsche Bank estimates It is not possible to assess the extent of the decline As to the extent of the decline in costs and the timing of any reductions we can only say that at this stage it is extremely difficult to quantify not least given the dynamic nature of costs within this industry and their evident sensitivity to activity levels.
however we note this is due not only to cost inflation but also to increased activity levels.16% since 2002. we would expect this negative trend to reverse. A number of factors have likely contributed to this fact namely that with production declining by 8% p. With BG this is likely a reflection of it’s predominantly gas biased portfolio (c.5% in 2002 to 18. Sector technical costs (production costs + production taxes + DD&A + exploration expense) which averaged $18/boe in 2007 have increased by an average 16% since 2002. Page 30 Deutsche Bank AG/London .24 February 2009 Oil & Gas European Integrated Oils Cost and the companies The pressure is on… With margins being squeezed by lower oil prices and costs which are essentially ‘stuck’ at higher rates in the short term. this suggests Shells’ operational gearing is higher than its peers.330 in 2002 to 380 in 2007 RDS has the highest per unit production ($8. Based on our estimates the total number of wells drilled within the companies considered has increased from c.a. Production taxes (i. with over 1mb/d of new. Those on cost-plus type contracts stand to benefit sooner than those on fixed-cost lump-sum type contracts. over the last 5 years. a fact very much stressed throughout the Q4 08 reporting season where the majority of companies highlighted various cost optimisation. the pressure is on companies to cut costs. This effect will be less important at Chevron (18% lifting costs are production taxes) and BG (18%).90/boe and $4. lifting costs in 2009 will decline on lower production taxes. Given production taxes are calculated on revenues. In the interim. Total and BG Group with production costs of $4. Exploration spend has also increased significantly since 2002 across the entire peer group (up 12% on average). cost absorption has worsened. As emphasised earlier.a. however. having witnessed average annual cost inflation of c. since 2002.75% in 2007) DD&A which we use as a proxy for CAPEX spend has risen by 11% p. Excluding production taxes. essentially in-line with the estimated growth rates seen in upstream CAPEX per CERA data. royalties etc) have risen by an average 25% CAGR since 2002 – which is greater than the growth rate in annual average crude prices i.e. However. 72% compared to group average nearer 45%). Lifting costs (which comprise both unit production costs plus production taxes) averaged just under $10/boe in 2007 with a similar 5-year CAGR of 18%.70/boe in 2007.e. particularly at companies such as Total and BP where 47% and 38% of their respective lifting costs are related to production taxes. relatively low OPEX cost production due on-stream over the next 3 years.17/boe respectively are the low-cost producers. cost efficiency or just plain outright cost cutting programmes they plan to implement. this would imply increased government take over the same period (e. looking at the various cost stacks of each of the majors as at the end 2007 we note the following: Average operating production costs for the majors were $6. the US has increased the royalty rate in deepwater GoM from 12. while Total’s low cost base reflects its non-OECD bias and relatively young portfolio. sector technical costs fall to near $15/boe with corresponding 5-year growth of 14%.g. and given the fall in crude oil prices.30/bbl in 2007) and technical costs ($24/boe) within the peer group. the pace at which the IOCs can see these lower costs feed through to the bottom line depends very much on what type of service contracts they have signed. However.
20/boe excluding taxes $/bbl 25 Production costs DDA Exploration Expense 20 20 15 15 10 10 5 5 0 Shell BP Exxon Eni Sector average Chevron Total BG 0 Shell Eni Chevron BP Sector average Exxon Total BG Source: Company data. 5-year CAGR 11% $/bbl 12 10 8 6 4 2 0 Shell Eni BP Sector Chevron Average Exxon Total BG DDA (USD per bbl) 5-yr CAGR 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Figure 49: Exploration spend in 2007 averaged $1.3bn. Deutsche Bank estimates. Deutsche Bank estimates * Unit production costs = FAS 69 production expense/annual production Source: Company data. 16% 5 year CAGR 2002-2007 $/boe 9 8 7 6 5 4 3 2 1 0 Shell Chevron BP Exxon Sector Average Eni Total BG 0% 10% 5% 20% 15% Production cost 5-yr CAGR 30% 25% Figure 47: Lifting costs ‘07 – production taxes have been a key driver of lifting costs at a number of companies $/bbl 12 10 8 6 4 2 0 Exxon BP Shell Sector average Total Chevron Eni BG Production cost Production Taxes 5-year CAGR 26% 24% 22% 20% 18% 16% 14% 12% 10% Source: Company data. Deutsche Bank estimates Deutsche Bank AG/London Page 31 .24 February 2009 Oil & Gas European Integrated Oils Figure 46: Unit production costs – average of $6. Deutsche Bank estimates Figure 50: Technical costs – breakdown by company in 2007 – sector average $18/boe including taxes $/bbl 25 Production costs Production Taxes DDA Exploration Expense Figure 51: Technical costs – breakdown by company in 2007 – sector average $15. Depletion and Amortisation charge/annual production Source: Company data. Deutsche Bank estimates * DD&A = FAS 69 Depreciation.70/bbl in 2007. * Lifting costs = (FAS 69 production expense plus production taxes)/annual production Figure 48: DD&A costs used as indication of CAPEX – sector average in ’07 $7. 5year CAGR of 12% $m ln 2000 1800 1600 1400 1200 1000 800 600 400 200 0 Shell Eni XOM Chevron Sector Average Total BP BG Exploration spend 5-year CAGR 40% 35% 30% 25% 20% 15% 10% 5% 0% Source: Company data.50/bbl. Deutsche Bank estimates *Technical costs = (Production expense + production taxes + DD&A + exploration expense)/ annual production Source: Company data.
0 7.0 6.0 4.0 10.0 23.0 2.0 17.0 6.0 15.24 February 2009 Oil & Gas European Integrated Oils Figure 52: Production costs per boe on a company by company basis. Deutsche Bank estimates Source: Company data.5 4.0 0.0 2.0 10.0 5.5 2.0 3. 2000-2007 $/boe 5.0 7.5 0.0 13.0 4.0 11.0 8.0 0.0 6. 2000-2007 $/boe 9.5 1.0 3.0 2000 2001 2002 2003 2004 2005 2006 2007 Shell Chevron BP Total Exxon BG Eni Source: Company data.0 8. Deutsche Bank estimates Source: Company data. Deutsche Bank estimates Page 32 Deutsche Bank AG/London .0 21.5 3.0 0.0 4. 2000-2007 $/boe 12.0 8. Deutsche Bank estimates Figure 56: DD&A costs per boe on a company basis.0 4.0 1.0 2000 2001 2002 2003 2004 2005 2006 2007 Shell Eni Chevron Total BP BG Exxon Figure 53: Production taxes per boe on a company basis.0 5. 2000-2007 $/boe 12. Deutsche Bank estimates Figure 54: Lifting costs per boe on a company basis.0 2.0 1. Deutsche Bank estimates Source: Company data.0 9.0 2000 2001 2002 2003 2004 2005 2006 2007 Shell Exxon Eni Total BP BG Chevron Figure 57: Technical costs per boe on a company basis 2000-2007 $/boe 25.0 19.0 2000 2001 2002 2003 2004 2005 2006 2007 Exxon Eni BP Chevron Total BG Shell Source: Company data.0 2. 2000-2007 60% Total Shell 50% Exxon BG BP Chevron Eni 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 2005 2006 2007 Source: Company data.0 2000 2001 2002 2003 2004 2005 2006 2007 Exxon Chevron BP Eni Shell BG Total Figure 55: Production taxes as a percentage of lifting costs on a company basis.0 0.
14. Important Disclosures Required by U.com/ger/disclosure/DisclosureDirectory.75 (EUR) 20 Feb 09 1629.eqsr. Deutsche Bank and/or its affiliate(s) makes a market in securities issued by this company.SD11 *Prices are sourced from local exchanges via Reuters.db.S. please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm. Deutsche Bank and/or its affiliate(s) owns one percent or more of any class of common equity securities of this company calculated under computational methods required by US law. Data is sourced from Deutsche Bank and subject companies.8. Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst about the subject issuers and the securities of those issuers. or intends to seek.17. In addition. Deutsche Bank and/or its affiliate(s) has received non-investment banking related compensation from this company within the past year. or issuer(s) group. Deutsche Bank and/or its affiliate(s) expects to receive. 2.L Recent price* 37. is more than 25m Euros. 17. Regulators Please also refer to disclosures in the “Important Disclosures Required by US Regulators” and the Explanatory Notes. See “Important Disclosures Required by Non-US Regulators” and Explanatory Notes. Regulators Disclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States.97 (GBp) 20 Feb 09 Disclosure 2. 8. Deutsche Bank and/or its affiliate(s) owns one percent or more of any class of common equity securities of this company calculated under computational methods required by US law. 15.24 February 2009 Oil & Gas European Integrated Oils Appendix 1 Important Disclosures Additional information available upon request Disclosure checklist Company Total SA Royal Dutch Shell Plc Ticker TOTF. during which time it received noninvestment banking securities-related services. This company has been a client of Deutsche Bank Securities Inc. 2. 14. Bloomberg and other vendors.8.15 2. within the past year. Deutsche Bank and or/its affiliate(s) has a significant Non-Equity financial interest (this can include Bonds. 6.6. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research. Lucas Herrmann Deutsche Bank AG/London Page 33 . Convertible Bonds. Credit Derivatives and Traded Loans) where the aggregate net exposure to the following issuer(s). compensation for investment banking services from this company in the next three months.6. The Chairman of Deutsche Bank's Management Board and Group Executive Committee serves on the Supervisory Board of this company.PA RDSb. Special Disclosures 11. 6. the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report.S. Deutsche Bank and/or its affiliate(s) makes a market in securities issued by this company. Important Disclosures Required by Non-U.
GBP1. Target Price Change GBP2.00 8 3 4 56 9 10 11 12 S ec ur it y P r ic e 1 .00 Buy.00 Buy.00 Upgrade to Buy.00 Buy.00 Buy. 2. 4. 5.00 3 4 5 6 7 89 0.PA) (as of 20/02/2009) 250.000.620.950. Target Price Change GBP1. 11/4/2006: 22/5/2006: 13/7/2006: 8/1/2007: 6/7/2007: Buy.00 1 00.50 Buy. 2.500.00 Buy.00 Buy.00 S ec ur it y P r ic e 1 50. 11. 2002 200.00 7.00 Buy.375. 6/7/2007: 14/1/2008: 24/6/2008: 7/7/2008: 30/9/2008: 4/11/2008: Upgrade to Buy. 8. Target Price Change EUR74. Target Price Change EUR69.180.00 0. Target Price Change EUR62. 9.00 Buy.00 Historical recommendations and target price: Royal Dutch Shell Plc (RDSb. 2002 1 .100. Target Price Change GBP2.00 Feb 06 May 06 Aug 06 Nov 06 Feb 07 May 07 Aug 07 Nov 07 Feb 08 May 08 Aug 08 Nov 08 Da t e 1. 3. Target Price Change GBP2.750.00 Buy. Target Price Change GBP2.00 Downgrade to Hold.000.00 Buy. Target Price Change GBP2. Target Price Change EUR250.500. 4. Target Price Change EUR65. Target Price Change GBP1. 10.00 Previous Recommendations 7 12 2.L) (as of 20/02/2009) 2.00 6. Target Price Change EUR61. 12. Target Price Change GBP2.500. Target Price Change EUR71.24 February 2009 Oil & Gas European Integrated Oils Historical recommendations and target price: Total SA (TOTF.000. 9. 7.700. 6.00 Feb 06 May 06 Aug 06 Nov 06 Feb 07 May 07 Aug 07 Nov 07 Feb 08 May 08 Aug 08 Nov 08 Da t e 1. 8. Target Price Change GBP2. Target Price Change EUR50.00 Buy. Target Price Change EUR76.950.00 1 Previous Recommendations Strong Buy Buy Market Perform Underperform Not Rated Suspended Rating Current Recommendations Buy Hold Sell Not Rated Suspended Rating *New Recommendation Structure as of September 9. 11/4/2006: 8/5/2006: 23/6/2006: 18/8/2006: 23/1/2007: 2/2/2007: Hold.00 Hold.100. 5. Target Price Change GBP2.00 Page 34 Deutsche Bank AG/London .00 Buy.00 500.925.00 2 50.00 Strong Buy Buy Market Perform Underperform Not Rated Suspended Rating Current Recommendations Buy Hold Sell Not Rated Suspended Rating *New Recommendation Structure as of September 9.00 Buy. 16/11/2007: 7/7/2008: 30/9/2008: 20/10/2008: Buy. 3. Target Price Change GBP2.
Sell: Based on a current 12-month view of total shareholder return. do not recommend either a Buy or Sell.month view of total shareholder return (TSR = percentage change in share price from current price to projected target price plus projected dividend yield ) . Notes: 1.24 February 2009 Oil & Gas European Integrated Oils Equity rating key Buy: Based on a current 12. 2007 were: Buy: Expected total return (including dividends) of 10% or more over a 12-month period Hold: Expected total return (including dividends) between -10% and 10% over a 12-month period Sell: Expected total return (including dividends) of 10% or worse over a 12-month period Equity rating dispersion and banking relationships 400 300 200 100 0 Buy Companies Covered 50% 37% 28% 28% 14% 26% Hold Sell Cos. 2. w/ Banking Relationship European Universe Deutsche Bank AG/London Page 35 . we recommend that investors buy the stock. based on this time horizon. we recommend that investors sell the stock Hold: We take a neutral view on the stock 12-months out and. Newly issued research recommendations and target prices always supersede previously published research. Ratings definitions prior to 27 January.
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