Point of View: Marathon focuses on development of integrated natural gas projects

Development of integrated natural gas projects to link stranded natural gas resources with key markets in areas where production is declining is "a new part of our business" and an "exciting area for us," said Clarence P. Cazalot Jr., CEO and president of Marathon Oil Corp., Houston.

"We had a strategic view several years ago that the US and UK and other key consuming markets were going to be short of supply in the coming years. That seems to be happening a little faster than we originally thought," Cazalot said at a recent meeting of the Texas Alliance of Energy Producers and the Houston Wildcatters in Houston.

"We saw the opportunity to access undeveloped but discovered major gas resources in the international arena, commercialize that either through LNG or gas-to-liquids-type technologies, and supply the developed markets, particularly the US," he said. "We just sanctioned, brought to final investment decision, and have construction under way on a major LNG project in Equatorial Guinea."

That project involves "about 3.4 million tons/year of LNG that will be exported from there—gas utilized out of our Alba field," Cazalot said. Most of that LNG will be shipped to Lake Charles, La., "through [BG Group PLC's] regasification facility, where it can access the major trunklines and be used all the way up to the Northeast US," he said.

Marathon "brought that project on in about 21/2 years from the time we acquired that asset, which is just an outstanding performance," he said. "Our efforts now are under way to find even more gas, both through successful exploration or [acquisition of] gas that has already been discovered out there or is being flared." Marathon will "take that gas, run it through our facility, extend the life, run it at a higher rate, and even look at the expansion through a second train," said Cazalot.

Upstream change afoot

Although Cazalot pointed out that Marathon at 117 years old is "a company with a great history, a long history, a successful history, and the future is even brighter for us," he acknowledged that the company has not always performed at its highest possible level.

"Over the years, there were those who claimed that we couldn't find oil in a service station," he said. However, Cazalot claimed, "That is no longer the case" under Philip G. Behrman, the company's senior vice-president of worldwide exploration.

"One of the changes that has taken place at Marathon is a blend of experience, taking the best of what Marathon has groomed and developed over the many years and complementing that with the expertise from throughout the industry," said Cazalot, who formerly served as vice-president of Texaco Inc. and president of Texaco Exploration & Production Inc. prior to joining Marathon. "That has allowed us to see the difference, to take an objective view of our strategies and our company and of the challenges we face and make the hard choices and make the changes that were needed," he said.

Marathon's exploration and production operation remains an important element, active in nine countries. "A major transformation of that business is under way," Cazalot said. "A big part of that was the turnaround of our exploration program.

"Another part was the rationalization of our asset base. We have divested about $2 billion of assets over the last 4 years. That created the capital we needed to reinvest in profitable new growth, which we are now doing in new places like Norway and Russia and West Africa, in particular Equatorial Guinea and in deepwater Angola. Our E&P business is an important piece, a growing piece, a profitable piece, and a big, big part of our future."

Growing downstream emphasis

He said, "Another part of our successful past and [one that] will be an even bigger part of our future is our downstream business. We are a major player in the MidwestU. We have [the] No. 1 market share in four Midwest cities, No. 3 in one, and No. 4 in another. We are the fifth largest refiner in the US, the largest Midwest refiner. We have about 1 million b/d of refining capacity."

Marathon also claims to be the No. 2 marketer of hot dogs in the US, through the convenience stores at its branded stations. "I hate to tell you we make more money off those hot dogs and some of the other things in those c-stores than we make off of gasoline or diesel," said Cazalot.

However, he said, "What used to be a pretty lousy refining business for the industry as a whole has suddenly gotten a lot better as we recognize [that while] the demand for refined products has gone up, the refining capacity has not kept pace. So those of us who have invested a lot of money in maintaining top-quality refineries and being able to refine some of the heavier sour crudes are now finding the same margins that are justifying the investments we made."

Speaking to reporters after his remarks, Cazalot said that future additions to refining capacity will be through expansions of existing refineries, since it "would take high margins for a long period of time for someone to build a grassroots" refinery.

Price prospects

Cazalot noted continued market concerns as to whether heating oil supplies would be adequate this winter, coupled with concerns as to whether prices would remain high for alternative natural gas supplies.

"So much [of the market] moves not on supply-and-demand fundamentals that we can talk about, but it moves on perception, it moves on rumors. When we plan projects, we plan around much more modest [price] projections; you can't plan around where prices and margins are today," he said.

He said, "We're not doing LNG based on $5-6[/Mcf] gas. We think the [Equatorial Guinea] project is one of the lowest-cost greenfield projects in the Atlantic Basin," with a "tailgate" cost of $1/MMbtu. "That's a very low cost of LNG," prior to transportation and regasification, he said.

"Even in a lower-price environment in the US, which could happen in 2010-12 or whatever, we've got a very good project. People who need $5-6[/Mcf] gas to make LNG work had better ask themselves questions about what is the gas price today and what will be the gas price in the time frame when that thing is in its prime."

Projects at Marathon are planned around flat spot market prices of $21.50/bbl for West Texas Intermediate and $3.50/Mcf for Henry Hub natural gas. "When you look at that today vs. the [New York Mercantile Exchange crude and natural gas futures] strip, it looks pretty conservative," Cazalot acknowledged. "But my view is that is a good test. If projects make sense at that level, if your portfolio is viable at that level, you're not running off cash, then the investment makes sense. And if prices do better than that, then you're just that much better off."

He said, "I think we will all continue to test our projects at pretty conservative prices, and I think that's why you don't see the magnitude of capital increases that you would expect from companies [at the current high price levels for oil and gas]. All of us have been through this cycle before, and in the past what has happened is that when prices were high, everyone would run out and spend a lot of money putting in capacity, and by the time that capacity comes on stream, prices would be down. We've all been burned, and we need to be cognizant of the fact that we have to invest wisely, particularly a company our size."

At Marathon, he said, "We treat our capital as very precious. We are unique in that we have a multitude of investment opportunities, more than we can or want to fund, and that's where I want to be. Because by having more opportunities than you can fund, you can be selective and pick only the best."

Russia

Although he would not comment on specific negotiations for Marathon projects in Russia, Cazalot noted, "Russia is just too large a resource opportunity for the industry not to participate. I think that's why you see a lot of companies continuing to make calls over there, to figure out what projects, what businesses they can participate in. We've staked out our piece of business in Western Siberia with the acquisition we made last year."

He said, "One of the things that we are trying to work toward is some improvement in the fiscal terms, because the fiscal terms, if you are not a refiner, are difficult. We are engaged in discussions of how the proper fiscal incentive can be created to allow nonintegrated companies in Russia to invest, because creating a diversified production base, increasing the reserve base, and increasing production are in their best interest. And it [investment] shouldn't all be from the big companies."

In Russia, he said, "Export duties apply to everyone; mineral taxes apply to everyone. Our view is that the overall Russian terms that apply in our existing business and other businesses need to be improved. High prices have created a view that some of the tax issues, export duties needed to be increased, and it had just a disproportionate impact."

Reserves concerns

On the issue of booking oil and gas reserves," Cazalot said, "We have had for some time a process where we use third parties to evaluate a portion of our reserves. Last year, 35% of our proved reserve base was evaluated and reviewed by third-party, independent reserve auditors. This year [it] will be about 20%. We have a policy now that 20%/year, on a rolling basis, gets reviewed by an outside party."

He said, "People keep going to that as the be-all, end-all, but it's not. The be-all, end-all is that you really have to have a solid process internally. We have a separate group that reports to our chief financial officer, just as our auditors do; they don't report to the operating groups. And we put our qualified reserve estimators through a training process. They have a manual of 'here's how you do it;' in a given situation, this is what you book, this is what you don't book. And their results are reviewed by someone above them, and those numbers are reviewed up the line."

Cazalot claims "zero tolerance" for discrepancies in booking Marathon's reserves. "It's a shame that a few companies had a problem, because now it seems to be creating a lot of momentum and subcommittee hearings in Washington. A lot of people are wanting to solve a problem that is not nearly as widespread as some believe and is a more complex issue," he said. "This isn't accounting. It's not something that current audit firms are geared up to do; it's not their area of expertise."

He said, "Oil and gas reserve estimates start down there at the asset team level, where you've got a geoscientist and a reservoir engineer drawing maps of that field based on a lot of data. There's no auditor alive who can check that. It all starts with that fundamental work product. If that fundamental work product gets flawed, than everything else will be, too. You've got to start with the quality of the technical data. There's got to be a culture of integrity and ethics built into that every step of the way, a culture that says, 'let the chips fall where they may.' The vast majority of the industry out there has done it right for a long period of time. We'll do whatever is required in the end."

Career highlights
Clarence P. Cazalot Jr. is president and CEO of Marathon Oil Corp., a member of the board of directors, and a member of the Marathon Ashland Petroleum LLC board of managers.