the future of oil mega-projects

My friend Bruce pointed out in a comment last Friday that the shale oil explosion in the US has come very quickly, and as a surprise to most.  Could there be a similar resurgence of the mega-projects that the big international oil companies have typically launched–and are the cause of the huge cost writeoffs they are now making?

My thoughts:

oil

–I assume the current administration in Washington will encourage domestic pipeline construction and reduce/eliminate support for renewables.  This would push further into the future the time when renewables will be price competitive with, and begin to replace, fossil fuels in a widespread way.  At the same time, increased availability of fossil fuels would tend to keep a cap on their price–which pushes the changeover to renewables even further into the future.

–if the chief oil exporting nations think this way (and I believe they do), there won’t be the panicky sense of urgency to produce oil as fast as possible that would prevail if they thought renewables would begin to substitute for fossil fuels in, say, ten years.

–I have friends in the Endless Mountains of Pennsylvania (the Marcellus Shale) who sold the mineral rights to their land to an oil company several years ago.  They tell me there are seven or eight oil- or gas-bearing strata below the one being tapped now.  If this is any indication, profitable shale drilling can go on for much longer than the consensus expects.

–the onshore shale oil/gas wells that smaller independent firms drill tend to use simple equipment, take a short time to get up and running and play out in, say, two years.  If I had to make up an oil price breakeven point for the typical fracked well, I’d say $30 a barrel.

–the offshore megaprojects that the big integrateds specialize in tend to involve very deep wells that take a long time to drill, use quarter-billion dollar+ floating drilling rigs to do so, and which tend to be located in remote, inhospitable, infrastructure-poor areas controlled by potentially unstable governments.  On the other hand, they tend to produce oil/gas for twenty years or more.  Breakeven?  …a gross generalization would be $60 a barrel.

–onshore shale wells in the US tend to cost around $12 million and to produce $35 million in output before they play out.   Fields, say, in deep water offshore Africa or in the Arctic, can require billions of dollars in upfront investment.  In addition, it’s possible that terms will be renegotiated in its favor by the owning government if the wells turn out to be more prolific than expected.  So the risk profile for this type of project is far higher, and the payback period far longer, than from the type of domestic onshore drilling done by independents.  It’s also at best marginally profitable at today’s oil price.  This suggests to me that the big oils will continue to prioritize their lowest risk, but also lowest potential, projects.

–can costs for big integrateds fall from here?  Maybe.  But those for frackers would likely fall in line, too.  And the political risks + the substantial upfront costs caused by challenging physical environments will likely remain for Big Oil projects in spite of future breakthroughs in technology.  So my guess is that the barriers to greenfield mega-projects will remain high.

Of course, neither frackers nor the large integrateds can match the lifting costs for established wells in Saudi Arabia of around $2 a barrel.

Middle East

–Many Middle Eastern oil-producing countries have young, growing populations and economies that are fundamentally dependent on sales of oil.  The government is typically the main employer.  Over the past decade, government spending will typically have expanded in line with oil revenues, to the point where now, with the oil price more than 50% off its highs, substantial government budget deficits are common.  Reorientation of these economies is urgently needed, but is also, like anywhere else, typically opposed by beneficiaries of the status quo.  This is a recipe for political instability.

–the US is likely going to be energy self-sufficient within a few years.   This will lessen the economic motivation for the country to intrude into, ore even maintain an interest in, Middle Eastern politics.  Other motives for doing so will remain, but my guess is that political willingness will wane, as well.

 

 

 

 

 

 

the Lucky Country, the Dutch/Detroit disease and the Middle East

lucky countries

where is Wikipedia when you need it?

The original “Lucky Country” was Argentina.  As I googled the term before writing this post, however, I found no trace of a link between the name and the South American agricultural giant.

Still, I began my international investing career in the mid-1980s with an Australian portfolio.  In that Cro-Magnon time the Argentina/Australia comparison was common.

The idea for both nations was that they were endowed with abundant natural resources, but that this was a curse, not a blessing.  That good luck spawned its opposite–excessive reliance on food/mineral production, insularity, dysfunctional government and resultant economic misery.  In contrast, resource-poor places like Japan or Korea were blossoming as economic powerhouses.

the Dutch/Detroit disease

I stuck in the Detroit part.  For me the Michigan analogy is much more current and powerful.

The Dutch “disease” was the discovery of gigantic offshore oil deposits.  They required a lot of labor to develop–mostly strong backs and a willingness to spend long periods of time on floating oil development platforms. 

The jobs required a lot of people, however, and paid maybe 3x normal wages.  Combine that with a small national population and the result was soaring wages and, therefore, a mass migration of non-oil industries to other countries.  When oil prices peaked in December 1980 and began a swoon that would reduce them by about 3/4, the oil business collapsed.  Government finances fell apart and unemployment skyrocketed as laid-off oil workers couldn’t find new domestic jobs.

The “disease,” then, is small area and reliance on a single industry.

Detroit is the American equivalent, with automobiles instead of oil.  The domestic auto industry grew fat and lazy in the 1970s-80s behind protective barriers erected against imports.  It paid high wages that drove most other businesses out of the area.  Heavy reliance on the “Big Three” car makers, corrupt government and the arrival of foreign auto manufacturers in lower-cost areas in the US eventually combined to drive the city into bankruptcy.

the Middle East

Economically, the typical oil producing country is Detroit in the desert.

Two twists on the all-eggs-in-one-basket theme:

— very young populations, meaning an imminent threat of significant youth unemployment; and

–a reluctance to allow women into the workforce.

Both probably turn them into Detroit on steroids.

I have no idea how this all works out.  Dubai, which has no oil, is looking a lot smarter than it did six or seven years ago.  The recent Saudi announcements of a radical restructuring of its economy are just the curtain being raised on what may be a lengthy, twisty-plot drama, I think.