eismic serene amidst recession rumblings
  from: Offshore Engineer
  by: Andrews McBarnet
  Thursday, April 03, 2008

No market thrives on economic uncertainty, but up to now the marine seismic community remains super confident amid US recession talk. Andrew McBarnet ponders the paradox.

US presidential candidates on the stomp have all been vying for the title of ‘agent of change’. In reality the wind of change is already blowing quite gustily without any help from politicians. And the impact is likely to be far more wide ranging than the US which is just one of the drivers, albeit significant, in the workings of the global economy.

Looking at the big picture, some kind of correction, if not outright recession in the US and beyond, looks to be upon us. The markets have certainly gone beyond nervous in their volatile reaction to the ‘numbers’ and last month’s sizeable interest rate cut in the US has probably just served to confirm traders’ worst fears.

It seems illogical to believe that the E&P business and the seismic community in particular can remain totally insulated from the fall-out of an economic downturn and thrive in a climate of uncertainty. Yet, perversely it seems, there is a virtually unanimous belief among seismic contractors and service companies that the current boom is good for at least another year and probably more.

Staying with the big picture, it is possible to see how they may well be right in still feeling comfortable. Historically oil price has been the main determinant of investment in oil and gas exploration and production. Nothing complicated here, if the oil companies had plenty of cash, E&P spending went up and vice versa. But that dynamic appears to be in the process of what may be a profound change. On an optimistic scenario this could be beneficial to the continuing health of the seismic business. In a nutshell, if the price of oil does decline somewhat because of reduced demand caused by recessionary pressures, the seismic business need not necessarily expect the usual cutbacks.

The moving parts of this evolving model are superbly expounded in a recent paper on the international oil companies (IOCs) published by the James A Baker III Institute for Public Policy, Rice University, Houston*. In some respects the message is scarily subversive, among other things even questioning the future of their Big Five (ExxonMobil, BP, Shell, Chevron and ConocoPhillips) as well as Total and Eni, who make up the numbers in the supermajor category. What is made clear is that the pattern of E&P;expenditure, and by extension decisions on seismic budgets and schedules, is changing.

If we go back to 1973 and the first energy crisis that most of us can remember or know about, this was the first time that a group of the world’s oil producers organised themselves sufficiently to affect global oil supply and demand. In those dark days in the early 1970s (literally in the case of the UK which had to promulgate energy saving measures including a three day working week and reduced use of electricity), the newly empowered Organisation of Oil Exporting Countries (Opec) was suddenly on everyone’s radar along with Sheikh Yamani, the charismatic Omar Sharif-like Saudi oil minister who did much to calm the crisis.

The reaction of Big Oil and others to the 1973 oil price hike engineered by Opec and to a number of nationalisations of oil assets without adequate compensation to oil companies previously responsible for exploration and production was unusually strategic. The publicly traded companies focused on developing non- Opec oil and gas resources. Happily this process coincided with the discovery of oil and gas off northwest Europe and inspired the revival of interest in the Gulf of Mexico. The Opec ‘threat’ was effectively neutralised for a generation.

Now, however, the North Sea and the Gulf of Mexico are mature provinces and in a sense the nightmare of dependence on imported oil is coming back to haunt many industrialised nations along with ‘peak oil’ concerns. Everyone is aware that 77% of the world’s remaining proven oil reserves of 1148 billion barrels is under the control of national oil companies (NOCs) with no equity participation by IOCs. Less than 10% of the world’s reserves is controlled by the IOCs, the players in the global private sector oil industry who have traditionally dominated E&P activity.

What interests the Baker Institute is that the IOCs as industry leaders have not taken advantage of the escalation in oil prices of recent years to significantly increase their exploration spending. It points out that the five largest IOCs have in effect cut spending levels in real terms over the past 10 years although budgets were up by 50% in 2006 from 2005. As we shall see, this scenario could be a source of comfort to suppliers of seismic services and equipment. It means that a boom market can be sustained without aggressive participation by the Big Five.

The Baker Institute paper advances a number of reasons why the Big Five have not committed resources to exploration on a larger scale. It points out that in 2006 these companies used 56% of their increased operating cash flow on share repurchases and dividends. They have also increased spending on developed resources. In the marine seismic business, for example, strategies to maximise production from existing reservoirs, typically using 4D and ‘life of field seismic’ monitoring, have been largely the province of the Big Five, Statoil being the notable exception. A presumption here is that companies prefer to monetize these assets quickly and effectively while oil prices are high. It is also true that enhanced oil recovery is a cheaper, lower risk option than exploration for new resources.

A more heretical view is that the large increases in dividends and buybacks suggest that the companies are, in effect, ‘beginning the process of partial liquidation, accepting a smaller role in the future energy world in return for larger cash payouts now’. It has also often been pointed out that accountability to shareholders leads managements to focus on being able to report short term quarterly gains as opposed to possible returns on long term exploration investment strategies. The Baker Institute report also alludes to a phenomenon not exclusive to big oil companies, namely that managements benefit from stock appreciation since compensation and value of stock options are tied to profits and stock price. This sets up an inherent conflict of interest between the long-term interest of shareholders and a combination of stock traders (short-term investors) and management.

Reduced urgency

There are plenty of other deep-seated reasons that may be in play. It is argued that the consolidations in Big Oil during the 1990s have reduced competition and hence the urgency to bring in new reserves. For example, in terms of production, the largest five firms in 1993 produced about 45% of total output of the top 25 major oil companies, whereas in 2005 the current Big Five produced 88%. It is also suggested that the bigger oil companies are less able to ramp up for new projects as the result of consolidations and cutbacks in the face of the $10 oil price in 1999. Staff to initiate and supervise projects were laid off who cannot easily be won back; fewer recruits with geoscience and engineering qualifications are joining companies with a reputation for laying off skilled workers; and of course suppliers of seismic and drilling services suffered from a period of reduced exploration budgets and are constrained in what they can supply. Shortages have of course put prices up, which is another disincentive to investing in exploration if there are other options.

Even more fundamentally, there is the problem of access and economic opportunity for companies the size of the Big Five. Most of the countries with the largest fields are off limits, and Russia and Venezuela may be setting a trend of oil rich countries becoming less welcoming to foreign oil industry investment in their resources. What we have been seeing in recent years is oil rich, exporting nations and their NOCs taking more responsibility for the development of their own resources. In addition, the Baker Institute paper suggests that giant cost overruns in major projects in places like Kazakhstan, Sakhalin Island and the Middle East may cause NOCs to question the supposed project management benefits offered by IOCs.

Adding insult to injury, the paper notes that some NOCs are aggressively competing in the open market for exploration prospects around the world. Since 1994, the nine NOCs which actively participate in international exploration invested more than $66 billion abroad in upstream activities. Chinese firms alone announced foreign projects worth $9 billion in 2006, most of which was in the form of access to oil fields in Russia, Nigeria and Kazakhstan. This compares to the total amount spent by the Big Five oil companies on exploration that year but is still quite small compared to the $59.4 billion spent by the same Big Five on exploration and development combined. Judging by the markets, investors have been more impressed by the NOCs which can be traded. Share prices of a group of 12 NOCs rose 531% between 2002 and 2007, compared with 113% for the oil majors selected for the study.

The Baker Institute contrasts the activity or lack of it by the IOCs with the next 20 largest privately traded American oil firms. It finds that they have steadily been increasing exploration spending since 1998, and their exploration spending levels are now equal to that of the five largest IOCs. ‘This differing pattern comes despite the fact that the five largest IOCs have access to operating cash flow that is three times the size of the next 20 largely traded American oil firms. This exploration spending trend would indicate that these 20 next largest privately traded American firms will control an increasing portion of non-Opec oil production in the coming years.

‘The oil production of the five largest oil companies has in fact declined since the mid-1990s. Oil production for the five largest oil companies fell from 10.25 million b/d in 1996 to 9.45 million b/d in 2005 before rebounding to 9.7 million b/d in 2006. By contrast, for the next 20 American independent oil firms, their oil production has risen since 1996, from 1.55 million b/d in 1996 to about 2.13 million b/d in 2005 and 2006.’

The conclusion to be drawn from these observations is that many independents and pure play exploration companies are better equipped and more nimble for the job of exploiting the smaller potential reserves likely to be on offer in many of the non-exclusive hydrocarbon regions of the world. An obvious example is the UK government’s management of its offshore assets. The introduction of the Promote licensing initiative and a stricter relinquishment policy a few years ago was explicit recognition that the smaller accumulations of producible hydrocarbons likely to be found in the North Sea were not a viable proposition for the IOCs of this world. The smaller pickings have attracted a plethora of smaller companies able to raise the money to invest in licence opportunities with some surprisingly successful results. IOCs have actually tapped into the trend by selling off some of their older producing assets for cash in hand rather than make any further investment to recover what reserves are left.

Spend trend

Coming back to customers for seismic surveys, the fundamentals of demand may well outweigh any recessionary worries. The Baker Institute paper does not discount the biggest players catching up on their exploration spending which can only be good for the seismic business. More disappointing would be IOCs buying smaller companies which have attractive assets as an alternative to exploration. This is a likely scenario for cash rich companies able to make acquisitions in a weak stock market and would reduce the customer base for seismic surveys.

More encouragingly, the competition to acquire and produce smaller prospects around the world seems intense partly because the investment in seismic as a first step in the exploration process is not prohibitive. Even a cursory look at the current client lists of marine seismic survey contractors shows that independents of various sizes and experience as well as a raft of newcomers are helping to fuel demand.

In the long run, apart from the basic requirement to find more oil to meet global requirements, the nationalised oil countries will dictate the pace and scale of seismic activity because they have the vast majority of the world’s potential resources. How this can work to the advantage of the seismic business has been seen in India where the government has orchestrated an unprecedented move to saturate the country’s offshore with seismic coverage mainly under the aegis of the ONGC national oil company. Importantly, as the Baker Institute has observed in previous studies, NOCs do not dance to the tune of the oil price as E&P decisions may often be dictated by non-energy political considerations. This may be frustrating for seismic contractors but at least they know that the business will come their way at some stage, maybe in the middle of recession.

The point is that for the time being in the marine seismic sector at least, there is no country deliberately excluding contracts with foreign seismic contractors. Arguably Russia and China have some potential in this respect, but there is more upside for them in contracting out their own expertise such as it is especially to those countries where westernised private enterprise companies are not welcome. Chinese land crews have been remarkably successful around the world in doing this and are by far the biggest entity in the market. However marine seismic is still very much the preserve of the big names (WesternGeco, CGGVeritas, Petroleum Geo-Services, Fugro) mainly because the technology is a lot more complex, capital intensive, and rapidly evolving.

The interesting question, then, is whether the marine seismic business worldwide will be able to meet future demand without courting the peril of over-capacity. OE

*The International Oil Companies by Amy Myers Jaffe & Ronald Soligo. Prepared in conjunction with an energy study sponsored by Japan Petroleum Energy Center and the James A Baker III Institute for Public Policy, November 2007.

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