The Majors Look West, Again
In Parachute, Colo., they still talk about their Black Sunday, in May, 1982, when Exxon pulled the plug on a billion-dollar project to produce oil from shale rock. The move eliminated more than 2,000 jobs and sent the local economy into a tailspin. Now the renamed Exxon�Mobil (XOM) is drilling again, even pursuing those hard-to-extract shale deposits that some believe hold oil reserves rivaling those of Saudi Arabia. "It has changed the landscape and improved our economic structure" says Robert Knight, Parachute's town administrator.
It also represents a major strategic shift for Big Oil. After years of shunning North America and Europe in favor of exotic locales that promised oil in far greater quantities at a much lower cost, the industry's largest players have come crawling back. The reason? Those big projects have been difficult to pull off and haven't made up for declining production in more mature regions like the U.S. Last year the five largest U.S. and British oil companies—ExxonMobil, Royal Dutch Shell (RDSA), BP (BP), Chevron (CVX), and ConocoPhillips (COP), which together account for 11% of worldwide output—saw their oil production slide 3%, to 10 million barrels per day. Those shrinking supplies are one reason that oil now tops $125 a barrel.
Certainly, the bulk of the world's future production will come from resource-rich regions such as the Middle East and recent discoveries like those off the coast of Brazil. But any additional investments in the U.S. will help reverse the two-decade-long slide in the country's oil production, and will do so at a critical time for the world's energy supplies. After falling as much as 4% a year in the past decade, U.S. crude production is expected to climb 4.2%, to 5.3 million bbl. a day in 2009, according to the U.S. Energy Information Administration. It remains to be seen, though, how much the renewed production will affect prices.
For much of the past two decades, the major oil companies beat a retreat from North America and Europe. When oil prices were low, they merged with each other, cut costs, and sold to smaller rivals thousands of wells in the U.S. and the North Sea, where the easy and cheap oil had long since been found. To replace those resources, big players hunted what the industry calls "elephants," outsize fields in Africa, South America, and the former Soviet Union—projects with tantalizing prospects seemingly at a fraction of the cost.
But those elephants have proved tough to catch. Large endeavors, including Shell's $20 billion venture to find oil in the deep water off the coast of Russia's frigid Sakhalin Island, have faced massive delays and cost overruns. Meanwhile, the political winds have shifted. Emboldened by their new oil wealth, governments from Kazakhstan to Venezuela have toughened the terms of their contracts with foreign companies—including taking a larger share of production as prices rise—or have kicked them out entirely.
Beating the Bigs
Big companies have also husbanded their capital, plowing their buckets of profits into buying back shares rather than using them to invest in new exploration and drilling. Capital expenditures as a percentage of revenues at the five largest players remained relatively unchanged between 2000 and 2007. As a result of all this, Big Oil is struggling to increase its output.
That stands in stark contrast to smaller, nimbler companies, many of which focus on natural gas drilling in the U.S. Last year, the 129 publicly traded energy companies, excluding the five biggest ones, more than doubled their overall spending, according to energy research firm John S. Herold. Those companies increased their oil production during that time by 16%.
In some cases, these smaller players capitalized on Big Oil's castoffs. In 2000, Occidental Petroleum (OXY) spent $3.6 billion to buy reserves in the aging Permian Basin in West Texas from BP and Shell. Wall Street didn't like the deal, cutting Oxy's stock price in half after the announcement. By taking advantage of latest technologies, Oxy has boosted production in those fields by 40%, to 200,000 bbl. per day. The company now stands as the largest oil producer in Texas.
Bound for North America
Big Oil seems to be wising up. To help cope with declining output, ExxonMobil will hike capital spending to as much as $30 billion a year, up from $16 billion for much of this decade. In addition to the operations in Colorado, ExxonMobil is investing more in Canadian oil sands—huge, unconventional fields where petroleum is mined like coal—as well as in the Barnett Shale, one of the largest new natural gas fields in the U.S. Ironically, the Barnett Shale was discovered by much smaller players just a few miles from ExxonMobil's suburban Dallas headquarters. "There is a strategic error that has been at work for the majors for far too long," says Richard Gordon, an energy analyst with Gordon Energy Solutions. "They've missed the boat on some very important opportunities."
Now the majors are playing catch-up. A senior executive at BP concedes that the company made a mistake by selling off older fields in the U.S. and the North Sea. BP has stepped up its spending in North America recently, as has rival Shell. And after years of dickering with Alaskan officials over potential tax rates on a new natural gas pipeline in the state, BP and ConocoPhillips announced in April that they would proceed with the $30 billion project. ExxonMobil is expected to join them. "They found North America's not such a bad place to be after all," says Arthur L. Smith, a longtime energy analyst who now runs a money management firm in Houston.
Whether the new love of North America from the major oil companies will translate into lower prices is the $200-a-barrel question. Back in the 1970s, new production from Alaska and the North Sea helped lower prices. But even if the added production today only affects prices marginally, there are other benefits, notes Ernst & Young Managing Partner Charles Swanson, like reducing U.S. reliance on foreign oil suppliers and invigorating local economies. Says Swanson: "It's a win-win."