WoodMac sees lots of drilling options

From left: OGFJ's Don Stowers and Wood Mackenzie's Julie Wilson and Bill Durbin.

OIL & GAS FINANCIAL JOURNAL: With the new administration in Washington, it appears that quite a few regulations - environmental, financial, and otherwise - will be swept aside. President Trump has also appointed a number of cabinet members and agency heads believed to have sympathetic views to the oil and gas business. In your view, what is the significance of this for the oil and gas industry? Will we see an immediate impact?

BILL DURBIN: Any change in political administrations is typically accompanied by quite a bit of euphoria by whoever backs that president. When you look at President Trump and the people he has appointed, it is clearly a signal that there is a shift in direction and emphasis when it comes to government policies and regulatory efforts. Through his executive orders, I think we're seeing early signs that he is looking into taking some fast actions to reduce the overall regulatory burden on the US economy. When you look at the energy industry, fewer regulations mean there likely will be less pressure on day-to-day activities. So there is probably a warranted optimism in the energy sector overall about the Trump presidency, with the possible exception of the renewables sector where he is taking a very different approach to climate change and alternative energy infrastructure. But that is where the states come into play. The regulatory environment in the various states and the federal relaxations that may occur under President Trump may very well balance each other out going forward.

JULIE WILSON: On the fiscal side, President Trump campaigned on reducing the corporate income tax from 35%, to 15% or 20%. Obviously that would have a big influence on the attractiveness of the industry from a financial standpoint. However, if the federal government reduces the tax rate, the states may see this as an opportunity to increase their taxes on the industry. I think that will be an interesting dynamic - to see what happens at the federal level and what the states do in response as well. The royalty rates in the Gulf of Mexico, for example, will be particularly interesting.

DURBIN: That's a good lead-in to what's going on with the global oil industry in general. One of the characteristics you can look at is the competition along fiscal terms. So whether it's Alaska, the Lower 48, Mexico, Brazil, Nigeria, or Australia, people are looking at the fiscal regimes to see if they are competitive with past investments. And is it attractive in this new oil price environment? There is a significant difference to companies when the oil price is $100 versus $50 or $60. But how are oil-producing countries reacting to the new price environment when they rely on taxes and royalties to fund the government? Will they still be able to compete for that investment dollar?

WILSON: Yes, I think you'll see some countries moving one way in an effort to attract more investment, while others will move the other way and increase taxes and royalty rates in order to squeeze more dollars into the government till because they have budgets to meet.

OGFJ: Getting back to the new administration's stated policy changes, President Trump has been very vocal about his views on immigration and existing trade pacts, particularly with regard to Mexico. The US oil and gas industry has a fairly good working relationship with Mexico. A number of new pipelines are being constructed to carry shale gas from Texas to Mexico, for example. In addition, Mexico has been enacting reforms in its oil and gas sector in order to attract new outside investment, particularly to its offshore sector, and US and global firms have shown a fair level of interest. How is this likely to play out? The Republican Party traditionally has been against protectionism, but the Trump administration campaigned on an anti-NAFTA, protectionist, America-first agenda.

DURBIN: That's a really difficult and delicate question on the global stage today. It involves a great deal of potential political risk. We are monitoring the many factors that shape this but right now it's so speculative. It is worth remembering there has been so little time since Donald Trump came into office, and some of this is playing out in court as well. I think we'll have to hold off on that one and see what happens over the next several weeks and months. But, rest assured, we will be coming out with a considered quantitative and qualitative analysis in due course.

"I think the reason the Lower 48 onshore unconventional space yielded very quick results (in terms of cost reductions) is that everyone was trying to keep everything alive - whether it was the oil services companies or the E&P companies themselves. Everyone was determined to lower breakeven costs in order to respond to global oil price pressures. A few companies, such as Hess, have been very focused on driving costs down in the offshore as well, and have had some success. But it’s just a different game from onshore." - Bill Durbin

OGFJ: If I can ask you to take a broad view, how would you characterize the current state of the global petroleum industry?

DURBIN: It depends on what your view is of the strengths of the Lower 48 unconventional oil base. It's clear we have billions of recoverable barrels, but there is a difference of opinion as to the geologic viability on a long-term basis for that Lower 48 supply. If you're a real bull on tight oil, you can take the position that there will be a glut for years to come. But if you take a more nuanced approach and look at that geologic play, you may admit that we're still learning quite a lot about how tight oil is produced and the degradation of reservoirs over time. This is especially true when you take into consideration different types of fracking techniques that were used in the early days that may have damaged the reservoirs, particularly the sweet spots.

There are companies looking at that scenario and saying they can manage it. They're willing to invest and to focus on these particular issues. And there are other companies that are saying they will put some investments there, but they will keep their feet in the deepwater and offshore. These are two totally different businesses with two totally different revenue and production profiles. You also have to manage price volatility in both of these environments. So, to just say that the world today is oversupplied is overly simplistic.

WILSON: Talking to our clients, I have found there more optimism out there. Even with the current oil price, they are beginning to make more investment decisions, even in the deepwater. So we think there will be an increase in Final Investment Decisions (FID)for big projects around the world. A lot of these will be incremental projects such as subsea tiebacks. But I also think we'll see work commence on the most attractive new fields in the portfolio, such as the Liza field discovered offshore Guyana, which can be developed in stages. Still, FIDs will remain well below what we had in 2014, both in the number of projects and their value.

So how would I sum this up? I think there needs to be a breakthrough in technology around the redesigning of wells for the deepwater arena to make a real comeback. There have been more technical improvements and cost reductions around wells in the Permian Basin, and the deepwater needs to catch up.

DURBIN: I think the reason that the Lower 48 onshore unconventional space yielded very quick results (in terms of cost reductions) is that everyone was trying to keep everything alive - whether it was the oil services companies or the E&P companies themselves. Everyone was determined to lower breakeven costs in order to respond to global oil price structures. A few companies, such as Hess, have been very focused on driving costs down in the offshore as well, and have had some success. But it's just a different game from onshore.

The overriding question is: Do you put all your eggs in one basket, or do you spread it around? I think we're still trying to find out what the best balanced portfolio is, and it will differ with different investors and different players. There are different interests and different strategies. For example, a Japanese financial house may put money into a Lower 48 investment to get some of that cash, but then they like to have the security of a long-term scalable investment in the offshore. The same thing is true for equity investors.

Let me come back to your original question though - What is the state of the global oil industry? Unlike 2015 and 2016, there is a strong undercurrent of optimism. What Julie and I have been talking about here is the outcome of all of these dynamics that have been unfolding over the last two years in response to the crash in oil prices. There has been a general acceptance that oil prices have settled into the mid-50s and now people are trying to get comfortable with that. So I would say there is cautious optimism.

"I think there needs to be a breakthrough in technology around the redesigning of wells for the deepwater arena to make a real comeback. There have been more technical improvements and cost reductions around wells in the Permian Basin, and the deepwater needs to catch up." - Julie Wilson

OGFJ: What do you see as OPEC's role in the world today? Is the cartel's role in setting oil prices diminishing?

DURBIN: OPEC has an outsized influence on price when OPEC is OPEC. When the members operate together and they focus together then, as we've seen in the past, they do very well at managing supplies. But the change in behavior that occurred a couple of years ago showed a divergence in what OPEC's focus was. The dependency on revenues from oil and gas for a number of OPEC countries was such that there had to be a realization as to how to manage what technology had done to the oil and gas industry. This is not a matter of how they manage large, long-term conventional oil development coming into the market. This was reasonably predictable, and OPEC knew how to deal with that. Now, the technology is such that within days we can bring oil online relatively quickly. The market has changed and will never be the same as it was. But in addition to the tight oil supplies, non-OPEC countries like Brazil and Mexico are inviting in outside investors, and that too is changing the landscape dramatically.

OGFJ: Renewable energy has been growing incrementally over the years and now accounts for a decent percentage of power generation. However, hydrocarbons remain the fuel of choice for transportation, at least for the near term. How will renewables affect the oil and gas industry going forward? Also, let me throw in a second sort of oddball question. India has embarked on an ambitious program to develop its gas hydrates. Although commercial production is still at least a decade away, the government believes this is a potential game-changer for them. What are your thoughts on this?

DURBIN: Let me answer the gas hydrate question first. The breakeven cost on that is high, and the technology barriers are relatively high as well. When you look at the ability of companies operating in shale gas plays to bring on a large volume of gas at a relatively low cost, it's difficult to see how hydrates will eventually play a role. The long-term volumes of gas that we have globally is large. That said, when you look at a country like India that is expected to import quite a bit of gas and you're comparing hydrates against LNG that creates a lot of headroom. Look at the US when gas prices were high, that spurred the technology that enabled the development of shale gas resources. I never want to turn my nose up at anything that is dependent on technology because I'm a big technology bull. So we'll see how the economics play out to make that attractive. But places like India and Japan that are currently dependent on energy imports are more willing to look at other energy options than countries with ample domestic resources. If they can overcome the technology hurdle, it may make sense to them. So it's something we like to keep an eye on, and it's gotten into some of the analysis that we've done.

On the renewables front, that is a very interesting space, particular for the hydrocarbon sector. Setting aside political considerations, the cost around renewables has fallen dramatically. Wood Mackenzie recently acquired Green-Tech Media, which is one of the preeminent research and consulting firms that focus on solar, storage, and transmission. It's not that we expect solar or any other form of energy to completely displace hydrocarbons - we don't. Hydrocarbons have a long shelf life in front of it, especially when you consider the hundreds of millions of people in China and India and elsewhere that don't consume much energy now. When you look at the scale of the world population, there is a long lead time for hydrocarbons. But with the cost reductions for renewables, they have become very competitive with hydrocarbons in the power sector. It's a very exciting space to be in, and we are watching to see what kind of impact it will have on hydrocarbons. But, the bigger question is electric vehicles. Will electric vehicles reach a point of cost reduction and market penetration that they will move in on the monopoly of gasoline and diesel vehicles? As long as the majority of Teslas sold are in the $50,000, $70,000, and $100,000 price range, that defines that sector as a niche market. But if manufacturers are able to get those vehicles down in the $16,000 to $20,000 price range with the same or similar characteristics of the higher-end vehicles, then we'll start to see market share change quickly.

OGFJ: Saudi Arabia has long been considered the "swing producer" of oil that was usually willing to adjust its production up or down when needed to stabilize oil prices. A little more than two years ago, the Saudis declined to do this in the face of an abundance of crude supplies and plummeting prices. They decided it was better to protect market share instead. Have North American shale producers become the new swing producers? And what is the role of offshore players in the Gulf of Mexico?

DURBIN: Yes, there was the expectation that shale producers couldn't weather the low prices for long - that many would go out of business. Oilfield services costs were trending upward, and the expectation was that shale producers would have a very hard fall. If they couldn't bring costs down, investments would dry up and 10,000 to 12,000 producers would start to drift away, which would restore conventional supply and demand balance. But technology continued to improve, efficiencies improved, and the dramatic cost reductions that occurred improved the economics and yielded much better breakeven costs. What that did was highlight the resiliency of the Lower 48 oil and gas industry. They did what was necessary to adjust to the new low prices. So the shale producers - those in the sweet spots, at least - became much more competitive due to those newly realized cost reductions. But, are US shale producers the new swing producers? You would need to ask about 12,000 people that question. But what we would like to put forward is that it has become a much more competitive market in terms of the availability and producibility of various supplies around the world, including offshore.

WILSON: As we talked about earlier, the smaller incremental projects are moving forward, not so much the larger-, mega-projects. That is a trend that is true globally, but especially in the Gulf of Mexico. Right now, those larger projects are not moving forward. So if they aren't moving ahead, that portends a supply crunch in a few years. You have to have long-term projects to develop a steady supply of conventional production for the future and it's simply not happening right now. Companies are not moving ahead with these because they're more focused on keeping balance sheets strong. Looking further out, global exploration groups have become smaller and leaner and are more focused on immediate value, but the bigger discoveries and value are still to come from the emerging or frontier plays. Some companies are still investing in those areas, albeit at much lower levels. When we look at the petroleum potential around the globe - in all the different basins around the world - there is a lot of oil and gas out there, but it is not being actively explored.

OGFJ: That sounds a bit gloomy from a supply perspective. Haven't there been some significant discoveries of note recently - a major field discovered offshore Guyana in South America, for instance?

WILSON: In the past couple of years, global exploration investment has declined from a peak of about $90 billion to around $40 billion. We think that will continue; exploration spend will be about the same this year. There have been a few giant discoveries - Guyana, as you mentioned, and also offshore Mauritania, a little farther north than most West African production, and offshore Egypt. However, there is still cause for concern for the longer term due to the overall lack of exploration investment. Market conditions likely will have to improve significantly before this changes. The oil discoveries will have a much easier time moving ahead than the gas projects.

OGFJ: On the subject of renewables, it is said that hydrocarbon companies are in the best position to move into this arena. Indeed, some already have, especially the majors. What is their motivation? Is there money to be made in renewable energy?

DURBIN: Initially there were political considerations, but I think the companies have moved away from that. This time, there is more of an economic interest in renewables. If you think about the offshore wind energy business, they're trying to create scale. Who is better at managing large projects than E&P companies? So on the surface it might look like a complete left turn, but you want to look at the economic element and technical side of the business to see who marries up best with renewables than the oil and gas industry. And of course it does create a position for the future - we don't want to overlook that.

OGFJ: Let's move along to Mexico. Have the energy reforms enacted by the Mexican government been sufficient to lure investment and expertise, which Mexico desperately needs, especially in the deepwater?

WILSON: I think the changes that were enacted show that the country realized it needed to change its policies on outside investment in order to secure the investment it needed, and the reforms have done just that. The early shallow water bidding rounds attracted mostly smaller investors, but the government learned from the process, was flexible enough to make adjustments, and they were very pleased with the results of the deepwater rounds.

DURBIN: I think those are very good observations about Mexico. When you open things up to private investment, as Mexico has, when you haven't allowed it for decades, you can do it right or do it wrong. I think Mexico is doing it exactly the right way. They are learning and having a high-level dialogue and building relationships, not just with investors but domestically as well. Everyone has to be happy with the pace of change and there has to be a balance between what people expect domestically and what kind of deals are struck with the investors. I think what we've seen has been very workable.

OGFJ: You mentioned Guyana earlier. Could you talk a little more about the significance of that discovery? Are the geological structures similar to West Africa?

DURBIN: That is what people are trying to prove up. We were joking about how the two continents (Africa and South America) were once joined up before continental drift, but that's exactly why the subsurface geology maps from one continent to the other. You piece all this together, but then you test out. Do you have the same level of quality as you find in West Africa? Much of this is still to be determined.

OGFJ: Do you expect this will be a very big thing for the countries in that area (off northern South America)?

WILSON: In a word, yes. ExxonMobil is fast-tracking development of Liza. There is quite a lot of gas with that discovery, and they initially won't have a means of exporting or commercializing the gas with the first phase of development. So in the next phase, they're going to have to think about how they will commercialize the gas. In Guyana, they're already talking about building an onshore base, so they can run the logistics out of Guyana. At the moment, everything is coming from Trinidad. But Guyana wants to build up its own industry, so the government is clearly engaged and motivated to use this opportunity to develop their own industry.

OGFJ: Will Suriname and French Guiana be part of this development? They are neighbors of Guyana?

WILSON: Some parts of Suriname and French Guiana will be. There is a lot to learn about the basin and we will see what the planned exploration wells in Suriname bring this year. Explorers are going to have to find the sweet spots in the basin, which is not straightforward.

OGFJ: So there is still exploration risk to consider?

DURBIN: Yes. Once you get back in the conventional plays, then you're back to the traditional exploration risk profiles.

OGFJ: Before winding up the interview, let's revisit the first question. Do you expect the Trump administration to reverse some of the decisions made by Obama regarding drilling on federal lands, drilling off the Eastern Seaboard, drilling in the Arctic regions, etc.?

DURBIN: At this early stage in the new administration, it's very hard to make any strong predictions. However, from what we've heard so far, it looks like the earlier decisions on the Dakota Access Pipeline (DAPL) and the Keystone XL pipeline extension will be reversed. As far as the other things you mentioned, I don't believe there is a great demand for drilling along the Atlantic Seaboard. There's probably not a great demand to be drilling off the coast of Florida either. These are all areas without any sort of infrastructure and with very uncertain prospectivity. These areas have been closed to drilling through a number of administrations, going back to Bush I, Clinton, and Bush II. It wasn't just Obama who closed them off. There are a ton of drilling options right now in unconventional plays where we can generate a lot of cash very quickly off any money that we invest. If we're going to balance our portfolios, we ought to put our money into areas that we know very well - not those we don't know at all.

That said, we don't want to tie our hands behind our back for the future. We might need to be able to drill in these areas in the years ahead, so that is why industry organizations like the IPAA and API want to leave those options on the table.

OGFJ: Thank you both for your time today.