The Times West Virginian

Headline News

August 2, 2013

Higher costs push Big Oil into slump

NEW YORK — New troves of oil have been found all over the globe, and oil companies are taking in around $100 for every barrel they produce. But these seemingly prosperous conditions aren’t doing much for Big Oil: Profit and production at the world’s largest oil companies are slumping badly.

Exxon Mobil, Shell and BP all posted disappointing earnings this week. Chevron is expected to post a profit decline Friday. All of them face the same problem: The cost to get newfound oil from remote locations and tightly packed rock is high and rising. And it takes years and billions of dollars to get big new production projects up and running.

The higher extraction costs could translate to higher oil and gasoline prices for consumers.

Strong production growth at an oil company can offset higher operating costs, “but when production is flat or declining it’s a big hit,” says Brian Youngberg, an analyst at Edward Jones. “Even though oil prices are $100 or higher, the returns on investment aren’t what they used to be.”

The new oil being found and produced is in ultra-deep ocean waters, in sands that must be heated to release the hydrocarbons, or trapped in shale or other tight rock that requires constant drilling to keep production steady.

That makes this new oil far more expensive to get out of the ground than what’s known as conventional oil — large pools of oil and gas in relatively easy-to-drill locations. Those reserves have always been hard to find, but now they are all but gone outside of the Middle East.

David Vaucher, who tracks oil production operating costs at IHS CERA, says oilfield operation costs are now at a record high. “The fields are more remote and the resource conditions are more extreme,” he says.

New oil projects in the U.S. and Canada, where production is growing faster than anywhere in the world, require high oil prices to be profitable, Vaucher says.

In order to make an industry average return, a new production project in the Canadian oil sands requires a price of $81 per barrel. For an onshore U.S. field, it’s $70 per barrel, but it ranges from $45 to $95 per barrel, depending on the rate of oil flow. In the Gulf of Mexico, it’s $63. In the Middle East, just $23 per barrel.

Many oil analysts predict that relatively weak growth in world oil demand coupled with rising production from newfound fields will make for flat or lower oil prices in the years to come. But if big oil companies can’t earn strong profits at today’s oil prices, it may mean prices will have to rise higher to convince them it’s worth the risk to continue to aggressively explore new fields. If they worry they can’t make enough money, they’ll cut back.

Oswald Clint, an analyst at Bernstein Research, said in a recent report that oil prices can hold steady and even rise into 2015. Among his reasons: The growth of U.S. oil production is slowing because the best new American fields have been tapped, and the number of rigs probing new fields has flattened out.

One of the more difficult places for Big Oil lately has been onshore in the U.S., which is in the midst of a historic oil boom being driven by the new discoveries. American production is now rising faster than any time since the 1950s, putting the nation on track to become the world’s biggest oil producer.

But major oil companies such as Exxon Mobil, Chevron, Royal Dutch Shell and BP were late to get into the U.S. shale oil game, and therefore had to pay high prices to acquire promising land. And the drilling is hugely expensive, too. Because the oil is thinly dispersed and hard to squeeze out, dozens of wells must be systematically drilled over an area to get to the oil.

Drillers are making technological leaps that are reducing some costs, but those are being countered by higher costs to lease equipment, buy supplies and pay workers rise that are shrinking profits.

Smaller oil companies like EOG Resources and Continental Resources that found these troves early were able to acquire the best acreage for relatively low prices. Because oil production is rising for these smaller companies, profits can rise even if costs increase. For a major oil company like Exxon or Shell, even big increases from dozens of wells in Texas or North Dakota aren’t enough to make up for declining production in giant fields around the globe.

Royal Dutch Shell announced Thursday that oil production fell 1.3 percent from a year earlier and profit fell 57 percent, largely because of a write-down of the value of the leases on U.S. land that the company thought held large amounts of oil or other liquid hydrocarbons.

“Production curves are less productive, less positive shall we say, than we originally expected,” Shell CFO Simon Henry said on a call with investors.

Shell CEO Peter Vosser said that while U.S. shale oil production was proceeding well in general, the company plans to sell stakes in four or five of the nine regions where it has holdings because it hasn’t been able to get as much oil to flow as it thought it could.

The company also announced it was abandoning plans to boost production to 4 million barrels per day by 2018 from its current rate of 3 million barrels per day.

Exxon Mobil, the world’s biggest investor-owned company, said Thursday that profits fell 57 percent, to their lowest level in more than three years. Poor performance from the company’s refining operations was largely to blame, but oil production fell 1.9 percent, the ninth straight quarter production has declined compared with the year earlier.

The last time Exxon’s earnings fell below $7 billion in a quarter, oil prices averaged $79 per barrel. In this most recent quarter, they averaged $94.

BP reported a production decline of 1.5 percent on Tuesday and said production in the third quarter would also fall and costs would climb. Chevron, which reports results Friday, is expected to post a 17 drop in earnings per share, according to analysts polled by FactSet.

The oil majors have been investing heavily in major new projects, especially in the deep waters of the Gulf of Mexico, Brazil and East and West Africa. But the price tags are so high that the companies can’t pursue everything they want.

The projects take years to begin producing. Exxon announced in May that it will spend $4 billion to develop a giant field called Julia in the Gulf of Mexico. The field was discovered in 2007, but it won’t yield anything until 2016.

Chevron is spending $16 billion to develop three fields in the Gulf of Mexico that will begin production next year. Parts of those fields were first drilled as early as 2003.

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