Business | Oil & Gas
Big oil players choose to neglect exploration
Imagine if Pfizer stopped researching and developing new drugs. Or if Warner Bros stopped bankrolling new movies, filling its cinemas entirely with re-runs.
- Financial Times
- Published: 00:04 July 21, 2008
Imagine if Pfizer stopped researching and developing new drugs. Or if Warner Bros stopped bankrolling new movies, filling its cinemas entirely with re-runs.
That, in effect, is what the oil majors have done during the last decade or so. Rather than invest in actually finding the stuff, they have increasingly left it to specialist explorers and start-ups. Analysis by SEB Enskilda shows the absolute amount spent on exploration by the 25 largest international oil companies increased from $13 billion in 1994 to about $28 billion last year, thanks largely to spiralling costs. But as a proportion of total upstream capital expenditure, spending on exploration has fallen from 26 to 18 per cent.
This approach is partly a legacy of the late 1990s, when a suddenly low oil price led to cost-cutting and big mergers. With little incentive to go out and explore, majors sacked many seismic engineers. As the oil price has soared, they have focused on stemming declines at maturing fields while converting resources as quickly as possible, on the basis that cash now is worth more than it is five to 10 years down the line.
But those decisions are coming back to bite them. Average reserve replacement ratios among the top 25 have weakened, picking up only slightly last year. Meantime, who has been finding all the hydrocarbons? Recent successes have been mostly limited to small E&P specialists and national oil companies, which now control three-quarters of worldwide reserves, according to PFC Energy.
To some extent, the majors can buy themselves production growth, but E&P stocks do not come cheaply, as ENI's bid for the UK's Burren Energy showed last year. Other than that, the strategy seems to be to trust in a mean-reverting oil price: when prices eventually correct, a procession of capital-constrained groups will be desperate to sell licences. Yet at the same time, the majors are pouring funds into huge unconventional projects - such as oil sands and liquefied natural gas - that cannot be justified without higher long-term prices. They cannot have it both ways.
Too Chinese to fail
Fannie Mae and Freddie Mac may not have many friends these days, but they should be able to count on a certain loyalty in Beijing. China is the biggest foreign holder of debt issued by the troubled enterprises and a relatively captive buyer of the paper.
US Treasury data shows that mainland Chinese investors owned $376 billion of agency long-term debt at the end of June last year, almost one-third of total foreign holdings of the agencies. Virtually all of this is probably held by an agency under the central bank. Extrapolating on the basis of China's growth in foreign assets, economist Brad Setser reckons the country now holds $500 billion-$600 billion worth of agency paper, or about a 10th of the outstanding stock of agency debt.
Rather than sticking with straight debt, SAFE has been shovelling up the agencies' asset-backed securities - at the end of June last year, China held $206 billion. That may well be harder to dump. Even in more normal times, commercial banks - the other natural buyers - often have balance sheet constraints. Pricing is also more sensitive to changes in market rates.
In future, switching into different instruments could also prove a struggle for China given the volumes involved. Replacing annual purchases of $150 billion or so of agencies with alternatives is tough. Buying more Treasuries would impact yields, while moving into corporate bonds would ratchet up risk. That is something which China, still smarting from big paper losses in Blackstone and Morgan Stanley, is presumably keen to avoid. These US investments were both, in a roundabout way, funded by foreign exchange reserves. None of this makes GSE debt especially compelling, but it does make China's central bank a very attractive buyer.
The People's Bank of China as America's lender of last resort? Now that really would give Paulson and Bernanke food for thought.
As the oil price has soared, the big firms have focused on stemming declines at maturing fields while converting resources as quickly as possible.
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