THE WALL STREET JOURNAL: Oil Giants Face New Competition For Future Supply (ShellNews.net) Posted 20 April 05

Big Players Focus on Returns

As Rivals Undercut Them;

Limping Away From Libya

By BHUSHAN BAHREE and JEFFREY BALL

Staff Reporters of THE WALL STREET JOURNAL

April 19, 2005; Page A1

The surge in oil prices and continued high global demand are helping Big Oil reap record profits.

But they also are luring a host of smaller competitors who often are beating their bigger rivals in the race for fresh fields, snagging new exploration-and-production contracts in places rich in oil and natural gas like Libya and Saudi Arabia.

The interlopers undercutting the U.S. and European oil giants, known as the "super majors," include smaller Western oil producers looking to make it big, state-controlled companies from countries like China and India that are venturing beyond their borders for oil and ambitious companies from major oil-exporting countries such as Algeria, Russia and the United Arab Emirates.

The trend underscores a long-term problem for Big Oil: Finding enough new oil and gas each year to replace what they're producing -- let alone grow. The five largest publicly traded oil companies -- Exxon Mobil Corp., BP PLC, Royal Dutch/Shell Group, ChevronTexaco Corp. and Total SA -- have gotten so big, so sophisticated and so beholden to shareholders that their bargaining power in the scramble for future assets is threatened.

A Bigger Share

Big Oil's current big profits are coming from sales of oil and gas that is being produced from fields acquired on the cheap long ago, when prices were far lower. Crude-oil prices have nearly doubled since 2001, and early this month hit a record, when oil for May delivery rose to more than $58 a barrel on the New York Mercantile Exchange. Yesterday, U.S. crude settled at $50.37 a barrel, down 12 cents. When adjusted for inflation, that remains well short of the price during the oil shock of the early 1980s.

Despite the jump in profits, the surge has created a dilemma for the big companies. To avoid shrinking, publicly traded oil companies need to discover or buy enough new stores of fossil fuel each year to at least replenish what they're pumping out of the ground. But the cost of replenishment is going up with oil prices. The governments that control the big remaining pools of easy-to-tap fossil fuel are eyeing the windfall from today's prices and deciding they want a bigger share of profit for themselves.

Some of those governments -- including Venezuela, Nigeria and Kazakhstan -- are trying to retroactively boost their take from existing contracts. Virtually all are driving harder bargains in negotiations over access to their fields.

Financial Disadvantage

So far, the big oil companies have balked at such terms, pushing to maintain their current high returns on new investments. But smaller competitors have had no such reservations.

"They're prepared to bid away more of the return than we're prepared to bid away," says John Browne, chief executive of BP, which lost out in recent auctions in Libya and Algeria, though most recently it won the rights to several gas fields in Algeria. 

The big companies are demanding such high returns that they often are at a financial disadvantage in competing for anything but the most technologically challenging projects -- those in very deep water, for instance, or in "unconventional" areas such as Canada's tar sands.

Much of the world's remaining oil reserves, however, are in areas that are geologically easy to exploit. That gives a leg up to operators willing to charge less and take a slimmer profit. Western oil companies also are grappling with a broader political reality: The world increasingly is relying for its fossil fuel on areas such as the Middle East and Central Asia, where the political situation remains volatile and where government policies sometimes clash with Western interests.

Government officials in many oil-rich countries are warning the Western giants they will have to pay more if they hope to continue to grow. "The days of 12% to 18% returns are gone," says Nordine Ait-Laoussine, a former Algerian oil minister who was instrumental in opening his country's oil sector to foreign investment. "Perhaps they should lower their expectations on earnings."

David O'Reilly, chief executive of ChevronTexaco, says these are sobering times. "The era of easy access to energy is over," he said in a recent interview. "There is more competition for energy resources all over the world."

Last year, for instance, when sanctions against Libya were lifted and the country opened its rich oil fields to foreign investment, the super majors were widely expected to be a shoo-in for big pieces of the prize. Libya has proven reserves of nearly 40 billion barrels of light, low-sulfur oil, putting it in eighth place in the reserves rankings, after Russia. It is lightly explored and is widely seen as having great potential for more discoveries.

But in January, when Libya announced the outcome of an auction for rights to explore and produce its oil, almost all the super majors limped home empty-handed.

Only one of 15 oil-field "blocks" up for bidding went to a member of the Big Oil fraternity, ChevronTexaco. The rest went to smaller players willing to invest in the fields for a smaller cut of profits.

The biggest prize, five blocks, went to a U.S. company, Occidental Petroleum Corp., which submitted its bids in partnership with Liwa, owned by the U.A.E. Occidental, which has decades-old ties to Libya, also may have had a leg up in the bidding because of its knowledge of the country's petroleum geology. Other blocks went to players including Australia's Woodside Petroleum, American independent Amerada Hess Corp., Brazil's Petróleo Brasileiro SA, Algeria's Sonatrach and a pair of allied Indian oil firms.

India's motivation was simple: a desperate need to secure more oil to fuel its economy. "Everybody's running like mad for energy security," said V.K. Sibal, director general of hydrocarbons for India's oil and gas ministry, in an interview. "We need it desperately, so we may buy at higher prices."

After the results were announced, Libyan Prime Minister Shokri Ghanem said he would like to get winning bids from the super majors in future auctions. But smaller oil companies had been more aggressive, Mr. Ghanem said. As for the big companies, he said: "Power corrupts. It makes them arrogant."

To be sure, the Western super majors haven't lost the game yet. Qatar recently chose Exxon as its biggest partner to commercialize the country's massive quantities of natural gas, and Abu Dhabi has chosen Exxon as the sole company it is negotiating with to boost development of its Upper Zakum oil field.

Moreover, the Western oil companies have shown a remarkable ability to reinvent themselves, sometimes by swallowing the weaker among their ranks. This month, ChevronTexaco announced that it will buy Unocal Corp. in a cash-and-stock deal valued at about $16.8 billion. If commodity prices tumble, the super majors could swoop in and take over some of the smaller rivals that have begun to snap up contracts -- though that might only delay a day of reckoning rather than solve the underlying problem, which is that oil and gas are getting harder to obtain.

The super majors also could redouble efforts to ferret out the oil that others find hard to produce. Meanwhile, they say, they can afford to wait out the cycle.

But concern about the future prospects for the big oil companies is spreading to Wall Street. In a recent study, Credit Suisse First Boston noted that the percentage of cash flow from exploration and production activities that a group of 13 major oil companies reinvested in their business dropped to around 50% in 2004 from 75% in the 1990s. Investment grew only slightly as profit soared, and CSFB forecasts that the ratio won't rise significantly through 2007.

"If integrated oils do not start spending more soon, we believe they run the risk of missing opportunities and ultimately missing production-growth targets," CSFB said.

Exxon, the industry's leader, illustrates the challenges. For years, the company has forecast average annual growth in production capacity of about 3%. But according to its filings with the Securities and Exchange Commission, Exxon's actual production declined in three of the past four years. The company's output last year was slightly lower than in 1998.

Exxon executives say they haven't reneged on any promise. They say they have made conscious decisions that have the effect of limiting its output at today's high oil prices. For instance, Exxon is selling off more aging fields because it's getting what it regards as top-dollar offers from other companies. In addition, under agreements that are becoming increasingly common in the oil industry, Exxon, like others, gets fewer barrels of oil when prices soar. These agreements allow governments owning the oil to give fewer barrels to companies producing it as the market price rises.

"If we wanted to just add more volume, we could do that," said Lee Raymond, Exxon's chairman and chief executive, in a recent interview. "That's not the objective of the exercise."

What is the objective? "Make more money," Rex Tillerson, Exxon's president, said in the same interview. "You give me a choice of producing more barrels, or making more money, I am going to make more money every time."

The focus on profits among the big players was a direct response to events of the 1970s, when members of the Organization of Petroleum Exporting Countries raised prices and nationalized oil fields, throwing Western oil companies out after decades. Exxon led the way in developing a business model that focused intensely on profits rather than oil-output growth, an approach later adopted by BP, Shell and Total. All felt pressured to compete in financial markets by slashing costs and delivering ever-juicier profits.

By the late 1990s, the big oil fields in Alaska and the North Sea, where Western companies had invested heavily, were declining. Oil-rich nations were inching open their doors to new investment. But the super majors didn't win as big as expected.

Saudi Arabia was a notable example. In 1998, while on a trip to Washington, Crown Prince Abdullah, Saudi Arabia's de facto ruler, convened a meeting of Western oil executives and invited them to develop plans to find and extract natural gas in the kingdom to help produce electricity and chemicals and to desalinate water.

Most of the super majors ended up bidding on the Saudi projects. A consortium led by Exxon, for instance, sought returns of more than 16% in negotiations for the largest project, which would have involved an investment of some $15 billion, according to people familiar with the negotiations. Talks dragged on for years.

Finally, in spring 2003, Saudi oil minister Ali Naimi issued an ultimatum: Either the Exxon-led consortium would accept the much-lower terms being offered by the kingdom by June 15, or the kingdom would end the talks.

Exxon's Mr. Raymond penned a letter to Saudi Crown Prince Abdullah asking whether Mr. Naimi's notice of termination represented the Crown Prince's desire, according to a copy of the letter seen by The Wall Street Journal.

The answer wasn't long in coming. Mr. Naimi ended the talks and broke up the project into smaller bits, which he proceeded to put out for open bidding. Within months, smaller companies, including ones from Russia and China, walked away with the contracts. (Shell and Total separately reached a compromise with the Saudis, accepting a scaled-down project to only explore for gas.)

Exxon officials say the Saudi deal wasn't a huge loss. "We remain the largest outside investor in Saudi Arabia and have an excellent working relationship with the country's leadership," a company spokesman said. "We look forward to future investments there."

Still, Saudi Arabia has continued to play tough with Big Oil. Concluding that the recent rise in global oil demand is lasting, the kingdom has embarked on a plan to raise its oil-producing capacity, currently 11 million barrels, to 12.5 million barrels a day by 2009. But the national oil company, Saudi Aramco, is leading the projects itself, and hiring oil-service companies to handle key aspects of the work, instead of inviting Big Oil to manage it all.

Core Laboratories, an Amsterdam-based company that helps clients recover more oil and gas from aging fields, has set up an office in Saudi Arabia and, at the request of the Saudi government, is expanding it, says David Demshur, the chief executive, who is based in Houston. While about 85% of Core Lab's business is still with big Western oil companies, that number is down from 95% a decade ago and likely to continue falling, Mr. Demshur says.

"We will have more interaction directly with the national oil companies rather than through the Western oil companies," he predicts.

--Chip Cummins contributed to this article.

Write to Bhushan Bahree at bhushan.bahree@wsj.com

and Jeffrey Ball at jeffrey.ball@wsj.com

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