Balancing the interests of producers and consumers
  from: Asian Oil & Gas
  by: John Mueller
  Thursday, August 24, 2006

Malaysian Prime Minister Dato' Seri Abdullah Bin Haji Ahmad Badawi, Saudi Aramco president Abdallah S Jum'ah and Schlumberger chief executive Andrew Gould were among the keynote speakers at the Asia Oil & Gas Conference held in Kuala Lumpur by Petronas this June. The event offered an enlightening spectrum of industry insider viewpoints, reviewed here by John Mueller.

Calling attention to the tussle for energy resources that could develop into a global energy crisis, Badawi observed that world consumption of oil was 67 million barrels per day (mmbop/d) in 1990 and is now estimated to be approaching 84mmbop/d for 2006. The figure is projected to rise to 100 mmbop/d by 2025. Gas likewise will be in great demand, the annual consumption figures for these same three years coming in at 73tcf, 95tcf and 150tcf, respectively.

Over the next 20 years in excess of $5 trillion will be required for oil and gas exploration and production and around $400 billion over the period 2001 to 2030 to construct new refineries.

Fortunately, in this era of strategic partnerships, alliances and collaboration, producers may be able to take some comfort that financial obligations and risks will have to be shared by all partners in the business chain in order to sustain the long-term viability of the oil and gas industry. In the future, even consumers might have to bear some of these obligations and risks.

Although higher oil prices are, in part, attributed to the increasing energy demand in both developing Asian countries and developed nations, holdups in the supply chain, speculative trading, geopolitical uncertainties and natural disasters also impact price trends, and worsen perceptions over energy security.

It is therefore imperative, warned Badawi, that producers and consumers examine not only the longer-term challenges, but also current constraints and bottlenecks throughout the energy chain, identifying policy frameworks to enhance efficient market operations within both government and private sectors.

The period of 'cheap oil' is effectively over, with crude prices not only unlikely to retreat but likely to advance to as high as $100 per barrel in the near future. It is therefore time to ask what is required to reconcile and balance the interests of both producers and consumers in the context of vital issues and common concerns affecting both parties.

There is probably no other area where nations are more interdependent than in the confluence of energy sustainability, environmental protection and economic development. Energy cooperation is one of the best ways for consuming countries to secure future energy supplies, entailing the pursuit of value-driven initiatives by producers and consumers based on strategic E&P alliances. To be excluded are efforts by some consuming countries to improve their security of supply through preferential oil deals and stockpiling to enhance security of supply.

The real issue is not about quantity, but rather the physical location of oil and gas reserves. Globally, more than 70% of oil and gas resources are owned by national oil companies, two thirds of which are in the Persian Gulf, making the barrier to entry even more challenging for international oil companies. This distribution highlights the need to develop new resources as fields in the North Sea, Alaska and the Gulf of Mexico, among others, reach maturity. As the rate of decline becomes more apparent, the pressure on producers to discover fresh reserves is becomes ever more urgent.

Asian potential
The greater Asian continent, encompassing West, Central and Southeast Asia is, collectively, a key energy exporting region, accounting for more than 60% of oil, and 51% of gas reserves in the world.

Central and West Asia in particular, despite geopolitical conflicts and instability, have vast unexplored potential. Southeast Asia, which also has considerable untapped hydrocarbon reserves, especially in deep and ultra-deep water where most of the future oil and gas discoveries are expected, is grossly underexplored. This potential, coupled with lower geopolitical risk, offers upstream exploratory opportunities in Southeast Asia to major consuming nations and an alternative to Middle East oil dependence.

It is important to look at attractive investment policies and fiscal terms that may allow consuming countries to take part in development activities in host countries. Globally, various locations with proven and potential reserves deemed geologically, environmentally and technologically challenging to develop include deep water areas, the arctic, tar sands and coal-bed methane deposits.

While the extraction of oil from such locations is technically difficult and expensive, it may be time for producers and consumers to engage in joint R&D to enable exploitation of these rich but difficult reserves in the longer-term.

Concerns among consumers about the security of supply are matched by the apprehensions of producers over security of demand. Already, consuming countries are seeking to diversify their energy mix while producing countries continue to diversify their economies. Together, consumers and producers can improve the mechanisms by which they seek to reconcile their interests and achieve mutually beneficial outcomes. Interdependence will drive collaborations based not only on commercial terms, but also on trust, the most important element.

Worldwide energy security involves a cluster of issues that call for ongoing dialogues not only between nations at a political level, bilaterally, regionally and globally; but also through partnerships between governments and industry.

Turning to the need to develop and deploy renewable and clean energy systems that can be maintained, Badawi stressed the importance of this initiative in making global energy more economically, socially and environmentally sustainable as well as accessible and affordable to a larger segment of the world population.

Governments, major oil corporations, automotive companies and manufacturing conglomerates have a critical role to play in accelerating this process as a matter of urgency. On their part, major oil corporations, most of which have achieved record revenues due to the high price of oil, must also be willing to reinvest a larger portion of their profits for the research, development and commercialisation of renewable energy resources, concluded Badawi.

Middle East outlook
Saudi Aramco president and CEO Abdallah S Jum'ah provided his perspectives on the critical issue of global energy security and Asia's role in the market, now and in the future. He underscored Saudi Arabia's connection with Asia, noting that the Far East is the destination for roughly 50% of his company's crude oil exports and well over half its refined product and NGL exports. Saudi Aramco also has substantial refining and marketing joint ventures in Asia, partnering in a number of domestic initiatives, including both upstream gas and downstream petrochemical sectors.

A particularly important and enduring concern in the oil industry is energy security, noted Jum'ah. This has manifested itself in anxiety arising from structural and cyclical factors.

On the structural side, there is a reduction of supply from the Organisation for Economic Cooperation & Development (OECD) countries as output from their fields continues to decline, with the result that non-Opec production is becoming increasingly concentrated in a number of non-OECD nations. A consequence is that Opec is set to play an even more central part in meeting future energy needs, where rising demand will be sharper in such fast-growing economies as China and India and the nations of Southeast Asia. As worldwide crude import volumes are also on the rise and more supply is traveling greater distances, regional and global transportation networks are strained.

Other facets of structural developments include qualitative issues such as crude quality and product specifications where crude oil supplies are becoming heavier and more sour, in particular global spare capacity. At the same time, demand for products is becoming whiter and lighter due to a proliferation of tighter refined product specifications in various markets, largely due to governmental regulations. As worldwide refining capacity is stretched and unable to handle heavy, sour crudes, markets tighten and product prices increase.

Further aggravating these structural developments are such cyclical factors as those ensuing from a generally healthy global economy, increasing hydrocarbon demand, and substantial increases in various commodity prices, which drive up costs for oil and gas infrastructure development. As a result, perceptions of energy insecurity climb markedly and are usually priced into the oil markets, giving rise to a 'fear premium'.

Although crude oil prices have gone up largely on the back of surging energy needs, Jum'ah pointed out that the security issue combined with the distorting effects of speculation, such as futures trading, are also playing a part in oil markets.

Asia's new breed
In recent year's, the Asia Pacific region's influence in global oil markets will continue to grow. Incremental demand growth is primarily outside of the OECD, with non-OECD demand estimated to grow by an annual average of 950,000bop/d over the next five years, over half of which will come from Asia. The centre of gravity for energy demand growth is moving steadily eastward in a sustained trend.

In recent years, a new breed of homegrown Asian energy companies have arisen that are both willing and able to compete globally. Most of these Asian energy enterprises are national oil companies that have adopted a strategic and long-term perspective on their new ventures, exemplified by the proactive approach of Petronas in Malaysia.

According to Jum'ah, developments in Asia have permanently changed the dynamics of the international energy market, and, because oil is fungible, measures to increase global energy security will be meaningless unless they include Asia and the Pacific.

Jum'ah echoed Malaysian PM Badawi's sentiment that all parties concerned should work together, addressing structural and cyclical challenges, considering both the supply and demand sides, relying on advanced technology to realise a clear and comprehensive vision of the energy future.

Observing that Saudi Aramco manages about 260 billion barrels of oil and has the potential to add another 200 billion barrels of reserves, Jum'ah commented that his company aims to meet these various challenges through a series of initiatives along the petroleum value chain in cooperation with global partners that include many in Asia.

In the upstream sector, Saudi Aramco is expanding its production capacity, bringing online around 3mmbop/d in the next five to six years, which, accounting for offset due to natural decline, would provide a projected rate of 12mmbop/d by end 2009. This output is planned to be in keeping with Saudi Aramco's stated purpose to maintain a surplus capacity of 1.5 to 2mmbop/d.

Downstream in Asia, Saudi Aramco is looking at the expansion of refining capacities in South Korea through S-Oil and in the Philippines using Petron. They are also working with Sinopec on downstream projects in Fujian and Shandong provinces, China. International partners are assisting in the development of two export-oriented refineries in Saudi Arabia, designed to process heavier crudes. Further downstream, construction has begun with Sumitomo Chemical on a world-class, integrated refining and petrochemical facility at Rabigh Refinery.

Jum'ah concluded by saying as Saudi Arabia considers Asia their natural market and partner, Saudi Aramco will continue to invest in Asia and work to attract additional Asian investment in Saudi Arabia in the years to come.

A service company view
Beginning with a brief historical review of the history of the oil industry, Schlumberger chairman & CEO Andrew Gould drew attention to the fact that safety and certainty in oil lie in variety. This view was recognised by the British in the years preceding the First World War when the decision was made to switch from coal to oil for its navy, and is just as valid today for the fast developing economies of China and India. The promotion of Shell and BP by the British to lock in relationships with the world's major oil producers close to a century ago is a trend that can also be seen in the development of Eastern Hemisphere natural gas resources.

The subsequent global search for oil and move by producing countries from the 1960s onward to control their domestic hydrocarbon resources caused huge shifts in the industry and had a dramatic effect on the development of technology. Technological innovations in offshore exploration, encouraged by these changes in ownership, in turn resulted in the type of reserves available to the market. At the same time, national oil companies became increasingly competent in providing their own resource and product specific requirements and more concerned with long-term sustainability rather than market demands. In addition, the post-1973 era saw the service companies start to play a greater role in developing technology to cater to the increasing range and complexity of products and services needed by their customers as oil companies reduced spending on R&D, a situation that has endured to this day.

This historical progression has led to the convergence of five factors to cause another major shift in the relationship between producers and consumers, a shift that will continue to have a powerful influence on the exploration and production industry and the technology that it develops, observed Gould.

The first of these factors is the high price of oil stemming from strong demand, lack of production base renewal over the 20-year period prices were low, and the effect of 'peak oil' theorists who amplify supply anxieties. Gould contends that hydrocarbon resources are sufficient and any viable long-term alternative is at least decades away.

The second factor is the unprecedented restriction in the flow of market capital to the ownership of reserves. Estimates show that less than 25% of oil reserves are freely available to investment by international capital and of that 25%, a considerable proportion, is currently held by new Russian companies. Major resource holders are growing more conscious of the additional value that high prices have placed on their reserves and are increasingly reluctant to share returns with international partners.

Third, a new generation of international national oil companies are scouring the world for reserves, some seeking to replace maturing domestic resources and others who are championing the energy needs of developing economies.

Fourth is the necessity to reduce CO2 emissions in the atmosphere and the contribution the burning of fossil fuels makes. Carbon capture and storage is an established technology that should be actively promoted.

Finally, the call on the industry's physical and human resources to meet the supply challenge is unparalleled. This demand is not just due to cyclical exploration, but also to attempts to achieve massive developments of natural gas production capacity and transportation infrastructure, tar sands exploitation and oil and gas projects in Africa, the Middle East and Far Eastern Russia.

Under-investment
Strains are being put on petroleum industry organisations, be they oil and gas, service or construction companies, originating from a long period of underinvestment with the result that those involved have only a limited capacity to respond.

According to Gould, these burdens can be divided into three categories.

The first is the lack of places in which to invest, caused to a large extent by access to reserves being restricted to the national oil companies. Although this is not having a major impact at the moment, it may do so in future.

The second element is the dearth in construction capacity needed for new projects. This, however, will be solved over time as the growing industrial might of China, India, Brazil and the Middle East rapidly adapts to meet the need for rigs, platforms, tankers and refineries.

Lastly, the only serious constraint Gould sees to a smooth, steady increase in new supply is in the availability of people with proper experience and sufficient technical education, a shortage that exists at almost all levels of industry. This is the result of under-investment in new talent, and the discouragement of existing talent, over the last 20 years. The number of jobs lost between 1993 and 2000 by the listed Western oil companies was more than 200,000.

The US graduated more than 1500 petroleum engineers in 1984 but by 2000 this had dropped to just 260. Even though enrollments in earth science programmes in US universities has begun to increase, this is not true everywhere, with surveys showing that the supply of technical professionals will be adequate to meet demand at a global level only if major shifts in recruitment patterns occur. Human resources will inevitably come from diverse nationality backgrounds. Attracting the best will require an acceptance that career advancement be open to all, even for nationals of countries other than the oil company's original home, something all companies in the industry need to take very seriously.

However, training sufficient new professionals in the short term is not a realistic proposition, and industry will have to increase its reliance on technology to help fill the skills gap.

Luckily, the petroleum sector has a long record of technology innovation and adaptation to fill breaches caused by under-investment, noted Gould. One solution is to more efficiently utilise expertise through data communications technology existing between the field and office, which has made remote job monitoring increasingly possible.

Schlumberger's experience has shown that remote drilling operations centres can multiply the productivity of drilling engineers by factors of two or three as measured by the number of wells they can supervise simultaneously. The final step in this evolution, still some way away, could be elimination of the professional at the well site. In future he may be able to drill, log or perform many other tasks from his office in town.

Another major effect of enhanced communications is the ability to move technology development closer to field operations. Structuring R&D in proximity to producing oil and gas fields is much more relevant to the leveraging of intellectual capital and oilfield access, rather than intellectual capital alone.

The future summed
As entrée to reserves becomes more limited, technology development will increasingly focus on the requirements of the different industry players, and on the types of reserves available to them. Some of this change can be seen in North America where many developments are concentrated on non-conventional sources of hydrocarbon such as shale-gas, coal bed methane or heavy oil. In the Middle East, geological differences are driving technology to improve recovery in carbonate reservoirs as well as for dealing with larger proportions of sour gas. Locally, deepwater technology, for example, will be increasingly developed by the companies that no longer have admission to more conventional reserves.

The challenges of lifting production will mean that industry players will become more specialised in certain areas of hydrocarbon exploration and production technology, inevitably giving rise to new leaders in these areas. Technology development will be more focused around particular types of operation, requiring staff and R&D to become more local in character.

A further consequence of this specialisation is the demographics of the likely sources of new human capital. This, together with the need for the producing nations to gain admittance to technology needed to exploit their natural resources, could well shift a large part of the technology advantage to those producers. Gould reminded skeptics who think this outcome impossible that the US automobile industry did not take the Japanese seriously until it was too late. AOG

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