Big Oil Has Big Problems

Some of the world’s largest oil companies are reporting pretty ugly earnings. Profits at Exxon Mobil, the biggest U.S. oil company, are down 27 percent off its worst fourth-quarter earnings in four years. Royal Dutch Shell, Europe’s biggest oil major, saw its profits tumble 48 percent.

Chevron reports on Friday, but given some of the issues it has faced maintaining production levels, there’s not a lot of optimism out there. ConocoPhillips reported a 74 percent jump in fourth-quarter net income, mostly from all the “non-core”assets it has unloaded recently. Production from continued operations is well below where it was a year ago.

In a way, the world’s major oil companies all suffer from some version of the same problem: They’re spending more money to produce less oil. The world’s cheap, easy-to-find reserves are basically gone; the low-hanging fruit was picked decades ago. Not only is the new stuff harder to find, but the older stuff is running out faster and faster.

Just to maintain production rates, oil companies have to race to find new reserves faster than the old ones dry up. That essentially puts them on a treadmill at which they must run faster just to keep pace—a horrible problem in any business. “It’s like feeding an elephant,” says Fadel Gheit, an energy analyst at Oppenheimer. “You can’t just give him a couple bags of peanuts. You have to find a truck load every day, just to keep him happy.”

As a result, oil majors are throwing massive amounts of cash at super-expensive mega-projects such as Shell’s LNG-producing “Monster ship” the Prelude, estimated to cost upwards of $12 billion. It takes years, if not a decade, for these kinds of projects to start producing, which leaves billions of dollars of invested capital not producing a return. The alternative is not investing at all and having the pipeline dry up—along with current production.

Part of the problem for the biggest oil companies is that they came late to America’s shale revolution. Many have bought in, but the timing hasn’t been great for a lot of those deals, as when Exxon bought natural gas producer XTO Energy for $41 billion in 2010, just before gas prices crashed. Gheit traces the problem back decades, to when companies like Exxon and Chevron pulled out of the U.S. in search of what turned out to be higher-cost oil in such places as Africa and Asia.

That left smaller companies trying to solve the problem of how to coax more oil from the U.S. When horizontal drilling methods started bearing fruit, the smaller independents were in shape to snatch up assets on the cheap, all over North America.