thinking about big integrated oils

hedge funds attacking Big Oil?

Over the weekend I read a blog post (which I can no longer find) in the Financial Times pointing out that activist investors are getting set to attack the large integrated oils.


They persist in investing in massive long-term, risky, low-return oil exploration and development projects.  It’s what they do.  In the view of the hedge funds, this makes no sense.  The oils would be better off finding better things to do with their cash flow, returning it to shareholders if nothing else.

I doubt that this will happen   ..not that hedge funds may not try to change oil company investing plans, but I don’t think they’ll be successful.

Big Oil is important in developed countries because the companies spend a ton of money securing access to petroleum.  Nations are heavily dependent on oil to fuel industry.  The oil firms get huge tax breaks for finding and developing oil deposits because these nations are heavily dependent on oil to fuel commerce and for heating.  This is especially true in the US, which is unique among richer nations in not responding to the oil shocks of the 1970s by taxing oil to control consumption.  We do this to support our globally non-competitive, but politically powerful, auto industry (most of which went bankrupt in the Great Recession anyway).

Given the strategic importance of oil,

why are the returns to oil exploration low?

A generation ago, they weren’t.  Drilling took place mainly in the developed world, often on parcels leased to the driller by the government.    The landowner got an initial payment plus a modest percentage of any finds.  Projects that made good economic sense when oil sold for $7 a barrel are bonanzas today.  Big Oil got most of that.

In contrast, major exploratory drilling today is done in emerging economies, where the big untapped pools of oil are.  But ever since the first nationalizations of drilling projects in the Middle East in the 1970s showed how one-sidedly favorable production agreements were to the oil majors, terms have been tilted much more heavily toward the host nations.  Today’s production agreements provide little more than a specified return on capital to the oil explorer.  Price hike windfalls go to the host, not the big oil.

In the face of less favorable economics,

why continue to drill?

Three reasons:

–it’s still profitable

–it’s what the oils do best.  The last round of oil company diversifications, admittedly a long time  ago, were unmitigated disasters, and

–the home countries of the major oils need a steady supply of oil to keep industry humming and citizens warm in winter.

It’s this third reason that I don’t think activists see.   

At some point, shale oil may change the situation.  Even so, I figure it would be politically unacceptable for any big integrated to dismantle, or even substantially curtail, its exploration and development efforts.  The worry would be that in times of shot supply, oil would go solely to project developers.  In fact, Asian countries are concerned about this possibility that they’ve designated their big oils as “national champions,” whose job is to secure oils supplies for the home country.  Profits are secondary.

I don’t think Washington, or London, or Paris would allow its oil exploration firms to drop out of the race, even if short-term economic returns to the companies and their shareholders might be better if they did so.



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