Oil majors' output growth hinges on strategy shift

LONDON Fri Aug 1, 2008 10:26am EDT

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LONDON (Reuters) - Western oil majors need to speed up a strategic shift into more complex oil and gas projects if they wish to return to consistent production growth after another quarter of disappointing output.

The world's largest fully public-traded oil company by market capitalization, Exxon Mobil, on Thursday reported an 8 percent fall in oil and gas production, compared to the same period in 2007.

Industry No 2 Royal Dutch Shell said output dropped 1.6 percent while No 3 BP Plc's was flat.

The results follow a trend of falling output and ditched or scaled back growth targets across the sector in recent years.

"The track record of delivering on production growth has been poor," said Gary Hobbs, senior analyst at Fortis Private Banking.

Investors' focus on production explains why record profits, driven by oil prices that hit an all-time high above $147/barrel on July 11, have failed to lift the companies' shares.

The DJ Stoxx European oil and gas sector index trades at the same level now, as oil hovers around $125/barrel, as it did when oil was under $30/barrel in 2001.

The weak production figures reflect a sea-change in the oil industry in recent decades, as resource holders increasingly reserve their richest fields for their state oil companies.

"Access to new resources is constrained," BP's chief executive told reporters earlier this week.

In response, oil companies are being forced to look at projects which they would previously not have considered due to the high costs and technical challenges involved. Yet, analysts say some, including Exxon and BP, could do more.

STRATEGIC SHIFT

Traditionally, oil companies drilled for oil and gas in large, easy-to-access reservoirs. But today, for western oil companies at least, the era of easy oil is over.

Now, the industry must increasingly squeeze crude from bitumen-drenched soil in Canada and crack open shale deposits in North America, coal seams in Australia and "tight" sandstone reservoirs across the globe to unlock natural gas.

"These are the main plays the supermajors are investing in," Derek Butter, corporate analyst at industry consultants, Wood Mackenzie said.

The supermajors is the industry term for the five largest fully publicly traded oil companies, Exxon, Shell, BP, France's Total and California-based Chevron.

Where these companies are invited in to develop more traditional gas reservoirs, it is normally on the basis they build multi-billion dollar facilities to freeze the gas to liquid or to convert it to motor fuel.

The downside of unconventional oil and gas assets is that they are expensive to develop. Shell, the most whole-hearted follower of the shift to alternative oil and gas resources, on Thursday said it was lifting its capital investment budget to over $40 billion for 2008.

However, these projects often have lower depletion rates than traditional oil fields and are located in countries which allow companies to keep most of the upside from high oil prices, whereas countries with big traditional resources such as Russia and Nigeria do not.

"These projects have a high upfront capital expenditure but once they are in production, they have attractive cashflow characteristics," Ivor Pether, fund manager at Royal London Asset Management, said.

RETURN TO CONSISTENT GROWTH

Shell was forced into alternative oil and gas as a way to repair its asset base, after it admitted in 2004 that it had massively overstated its proven reserves, analysts said.

Since then, the Anglo-Dutch company's oil and gas production has fallen but investors, including Pether, expect a return to consistent growth from 2010.

Butter said that BP's relative dearth of long-life unconventional projects left a question over growth in the next decade.

For years, as rivals ploughed billions into Canada's oil sands, BP dismissed the industry as "high cost" before doing a U-turn last year, much to many investors' relief.

Exxon has long been active in oil sands but some investors think the company could do more. Butter said Exxon's capital investment per barrel was the lowest among the supermajors.

One concern limiting investment in alternative oil and gas is a fear that crude prices will collapse and make such projects unprofitable. Exxon has been vociferous in reminding the market that price spikes have traditionally been followed by falls.

But if, as many analysts and executives predict, oil prices have risen to structurally higher levels, those limiting their investments in alternative oil and gas could regret it.

"In the high oil price environment, the big spenders will win," Butter said.

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