(Most of the data points/comments are extracted from a Primer published in Oct 2016 by Bank of America Merrill Lynch. Comments and financial data at the end are my own).
After a number of underperforming years, European oil & gas companies have been staging their comeback: they have cut into capex and opex to generate more cash flow or reduce debt and be able to maintain their payout/dividend payment.
The market has bearly started to notice, but oil & gas companies are leaner and in better shape to leave in a world where oil price would stand around 40-60$/barrel.
Yet, as the past decade has shown us, when oil price tend to reach high levels, capex shoot up and oil & gas companies create too much capacity, leading to lower returns. The previous capital cycle has probably ended now, but a new one could soon rise if oil prices continue to raise.
Unless industry disruption, and changing habits towards transportation and the pressure to reduce emission gases are strong enough to bring about a change in business model.
Stoxx Europe 600 Oil & Gas
Before digging into business models, how they might evolve and which companies are better preparing themselves, I thought it might be useful for me and you to get a fresh reminder of what oil & gas is all about, or at least some of a flavor of what it is.
World oil consumption by sectors (2015 estimates, rounded figures)
Transport : 54% of which road 42%, air 6%, sea 5%
Petrochems : 12%
Industry : 7%
Power : 7%
Chemical composition of oil & gas
Oil: 85-87% Carbon, 11-14% Hydrogen, 0.05-2% Sulphur, 0.1-2% Nitrogen, 0.1-2% Oxygen
Gas: 65-80% Carbon, 1-25% Hydrogen, 0-0.02% Sulphur, 1-15% Nitrogen, 0% Oxygen
4 types of hydrocarbons: paraffin, naphthene, aromatics (benzene), asphalt
Crude classification criteria
American Petroleum Institute (API) Gravity (density of oil): heavy/light (relative to water, which API is 10°). Light crude has an API gravity above 31.1°, while heavy crude’s API gravity is below 22.3°. Below 10°, it’s extra heavy (bitumen).
Viscosity refers to the ability to flow.
Sweet/Sour refers to the level of sulphur. Sweet oil is low sulphur (<1%) and is higher quality since it releases fewer emissions and requires less refining.
Brent (stands for “Broom, Rannoch, Etive, Ness and Tarbert”), has 0.37% of sulphur and API gravity of c38.06; is light sweet crude produced in the North Sea.
WTI (West Texas Intermediate) is lighter and sweeter than Brent, with 0.24% sulphyr and API gravity of c39.6, which explains its premium to Brent (in general).
Dubai/Oman: medium gravity and sour, and is the reference used by Saudi Aramco, world’s largest oil producer, to determine the price of its crude oil delivered to Asia.
Main participants in the value chain of oil & gas production are International Oil Companies (ExxonMobil, Chevron, Total, Royal Dutch Shell, BP), National Oil Companies (Saudi Aramco, Rosneft, PDVSA, Petrochina, Petronas) and independent oil producers (usually smaller companies).
-Geology: identification and acquisition of licences before starting exploration for hydrocarbons.
-Seismic: help determine how attractive specific areas or blocks are in terms of extraction potential, done by shooting sound waves through the rocks and analysing feedback when those waves echo back. Companies in this field include Schlumberger, CGG, PGS, TGS.
-Drilling: this involves various types of actors, from rig companies (Transocean, Seadrill, Helmerich & Payne) to well service providers (Schlumberger, Baker Hughes, Halliburton). The purpose is to make proof of hydrocarbon presence, then evaluate the economic viability of a well/block, to full operational exploitation and drilling of production/injection wells.
-Concept selection/Final Investment Decision.
-Engineering (Front End Engineering and Design): before building a production system for hydrocarbons, details engineering work is done by companies like Worley Parsons, Wood Group, Amec Foster Wheeler. At this stage, the type of oil will determine the appropriate extraction method.
-Procurement: this stage involves suppliers of equipment (Technip-FMC, National Oil Well Varco, Dresser Rand, Weir, Tenaris, Vallourec, Aker Solutions).
-Construction: involves the production/processing solution, which will vary depending on the type of project (onshore/offshore), environment or type of project. This will lead to the production of a Floating Production Storage and Offloading vessel (FPSO) and involves companies like Saipem, Technip-FMC, McDermott International, SBM Offshore.
-Installation: typically bringing the facilities on site for offshore project.
-Pipelines: they are typically built by IOCs and NOCs as they involve large capex and relationship management with local governments and communities/environmental groups. In the US, a specific market has emerged with dedicated financial vehicles (Master Limited Partnerships or MLPs).
-Tankers are used to move hydrocarbons around the world, with ships such as crude oil tankers of varying sizes (VLCCs), LNG shippers or LPG shippers.
-Refining: this stage turns crude oil into different products depending on their uses.
-Marketing: this is the last step in the value chain and a relatively low contributor to earnings of integrated oil & gas companies
Global Oil Reserves
World oil reserves are estimated at 1,707 billion barrels, equivalent to 50.6 years of global production at 2016 level, according to BP, a major oil producer. 43% are conventional offshore oil, 20% are shallow water, 10% heavy oil, 6% LNG, 5% oil sands, 5% deepwater.
Production Cost Curve
This graph gives an estimate of the production cost of one barrel of oil in USD for different types of resource (both conventional and unconventional oils, such as shale oil).
Economics of Oil & Gas
It takes a very long time from discovery of hydrocarbon resources to their full exploitation by oil & gas companies. Here are the key steps:
-Prospect identification and well drilling.
-Cost estimates (Engineering/Procurement/Construction/Installation costs)
Accounting at Oil & Gas Companies
Reserves are segmented in 3 levels: 1P are proven reserves, ie the asset has the highest probability of existence (90%); 2P are proven and probable reserves (these are reserves in development). 3P are 2P + possible reserves.
The reserve life of an oil & gas company is determined by the ratio between 1P reserves and production in a given year.
Reserve Requirement Ratio (RRR) divides organic resources addition by annual production.
Finding & development costs are usually considered as capex. Over the last 20 years, capex have represented c9% of oil & gas revenues (data based on a number of integrated oil companies in the US and Europe).
Opex (operational expenditures) recover a number of items: operations & production (25% of opex), maintenance (15%), technical costs/G&A (14%), transportation (11%), well services (10%), logistics (7%), insurance (4%) (this is based on ENI’s data via BofAML).
Taxes are another important point in consideration as most of the oil companies exploit the national resources of a country. Contracts can take the form of concessions, production sharing agreements, service contracts or joint ventures.
When you compile some of the financial indicators for some of the largest public oil & gas companies, results are rather disappointing.
Revenue has tended to follow the evolution of oil price, but the most interesting part is that higher oil prices have