The last frontier: oil industry scales back exploration

Suriname may be one of the smallest countries in Latin America, with a population of fewer than 600,000 people, but off its coast lie potentially significant oil and gas deposits that could alter the country’s future.

Two large discoveries in recent months by US oil exploration and production company Apache Corporation and French oil major Total have offered hopes for an offshore bonanza for the former Dutch colony. The country is looking to mirror its neighbour Guyana, where ExxonMobil recently started production from deepwater oil blocks.

Suriname currently produces just 16,000 barrels a day from onshore fields. But the US government estimates that the Guyana-Suriname basin may contain nearly 14bn barrels of oil — in line with the resources of Argentina — and more than 32tn cubic feet of natural gas.

The country’s ability to turn its resources into commercial oil and gas depends on exploration — the earliest stage of the production process and an activity that stands as a barometer for pressures facing the wider industry.

Oil exploration is an expensive and risky business that can take years and billions of dollars of investment. As cost pressures mount and demands on companies to act on climate change grow, this segment of the industry is coming under intense scrutiny. Once the most glamorous aspect of the oil business, exploration is now one of its most controversial.

Environmentalists and some activist investors — especially in Europe — are pushing oil companies to shrink their legacy fossil fuel businesses, stop their search for new acreage and focus instead on lower-carbon technologies and alternative sources of energy.

Suriname's former president Desi Bouterse with Rudolf Elias, director of Staatsolie, who says the country’s relatively low production costs of very light, high-quality oil will give it an advantage 'for many years to come' Suriname’s former president Desi Bouterse with Rudolf Elias, director of Staatsolie, who says the country’s relatively low production costs of very light, high-quality oil will give it an advantage ‘for many years to come’ © REUTERS

Executives must also face up to an uncertain demand outlook, despite relatively robust oil consumption patterns today. From government policy changes that disincentivise fossil fuel use to the adoption of electric cars, the future shape of oil demand in the decades to come is unclear.

And all that was the case before coronavirus sent the global economy into its worst crisis since the Depression, with the industry now wondering what the pandemic’s longer-term impact on oil demand — which stood at close to 100m barrels a day last year — will be. After a more than 8m b/d fall in 2020 the International Energy Agency expects recovery of nearly 6m b/d next year. 

While oil is likely to stay a large part of the broader energy mix for the foreseeable future, even if consumption peaks and then plateaus for a prolonged period, the industry is deeply unsure about the outlook for the exploration business.

“In 30 years’ time you will not have these new frontiers where they will look for oil,” says Rudolf Elias, head of the state-owned oil company Staatsolie Maatschappij Suriname. “In 30 years’ time we will have just the oil that is already there, and then it will be slowly phased out.”

Despite rising public and political opposition in many parts of the world, he says Suriname has attracted capital and interest at just the right time. The country’s relatively low production costs of very light, high-quality oil will give it an advantage “for many years to come”.

Chart showing that the world's recoverable oil falls by about 282bn berrels in 2020

Climate activists argue that new discoveries only perpetuate the fossil fuel era. Rather than chasing new barrels, they say, companies should focus on mitigating the economic disaster that awaits as declining longer-term demand inevitably renders vast, already discovered resources as “stranded”

“The world has 50 years of proven oil reserves,” says Kingsmill Bond, an energy strategist at think-tank Carbon Tracker. “The prospect of declining demand as a result of electric vehicle adoption and policy changes means we no longer need a huge oil exploration industry tooled up for ever-rising consumption. The talents and resources of the industry can be deployed better elsewhere.”

Public perception is turning too. While opposition to exploration deep beneath Arctic waters and in other areas with fragile ecosystems has only risen, discontent with the activity more broadly is accelerating. A poll conducted by the Kaiser Family Foundation and Washington Post last year found that more than half of those surveyed said energy exploration on US federal lands and offshore should be reduced. 

“In the past, a big discovery used to be seen as this symbol and gesture of hope and happiness for a country or a company,” says one veteran oil industry executive. “Increasingly, today, it’s seen as a liability.” 

Vessels carry supplies for an offshore oil platform operated by ExxonMobil on the Demerara river, south of Georgetown, Guyana, where the company recently started production from deepwater oil blocks Vessels carry supplies for an offshore oil platform operated by ExxonMobil on the Demerara river, south of Georgetown, Guyana, where the company recently started production from deepwater oil blocks © REUTERS

A looming production gap

After oil companies bid for blocks, the owners select a winner and enter into contractual agreements. The explorer, at their own risk and cost, then drills test wells. If a discovery is made, samples of oil are collected and appraised. The aim is to find the quality and quantity of resources necessary to produce and sell oil and gas commercially.

As part of this process, which can cost hundreds of millions of dollars and take several years, a development plan is drawn up. It is after that when a final investment decision is made. The design and execution of a field development plan can cost between $1bn and $10bn and it can take up to 10 years before any oil is produced.

About 45 countries were expected to launch lease rounds for exploration this year, with about two-thirds expected in offshore areas. While some are still due to go ahead, including in Malaysia, Trinidad and Tobago, Norway, and Canada, according to Oslo-based consultancy Rystad Energy, coronavirus is expected to put certain projects on hold — from Brazil and Colombia to Thailand.

Rystad estimates that “recoverable” oil resources — the volume that could be extracted from the earth, given constraints of technology and demand — has fallen since 2019 by 282bn barrels to 1.9tn barrels, as the pandemic prompts a longer-term shift in consumption habits and in oil demand and as companies abandon exploration plans.

At the same time, major companies such as BP and Royal Dutch Shell have reduced the value of their assets by tens of billions of dollars as they re-evaluate future oil prices which they increasingly expect to stay lower for a lot longer. Among the projects they have revised down or rendered worthless are exploration assets.

Chart showing that oil demand will decline but there could still be a supply gap

“Should any energy company in the world bet on an oil-only future? No,” says Angela Wilkinson, secretary-general at the World Energy Council. “But we have an energy demand tsunami coming towards us and we can’t grow the renewable footprint at the same pace.”

“When people say we don’t need oil, they mean we don’t need oil for power as there are alternatives in the form of gas and renewables,” she added. “But what about everything else? It’s a fantasy.”

Despite the rise of US shale oil as a new force in the market, Andrew Latham at research group Wood Mackenzie believes some exploration will still be required to meet strong demand over the next 20 years. Only about half the supply needed in the years to 2040 is guaranteed from fields already on stream, he says. The rest requires new capital investment. 

While it is true that the world’s known resources are more than enough to meet predicted demand, many of these barrels are among the most expensive and dirtiest to extract, making companies reluctant to develop them. What there is a shortage of, say analysts and investors, are so-called “advantaged” barrels that are cheaper and cleaner.

The Johan Sverdrup oil field off Norway. The country's $1tn oil fund said last year it would sell out of companies that are purely focused on exploration and production The Johan Sverdrup oilfield off Norway. The country’s $1tn oil fund said last year it would sell out of companies that are purely focused on exploration and production © EPA-EFE

In the event of no new investment into these known resources, production will fall each year by around 8 per cent for oil and 6 per cent of gas. A shortage of supplies could loom, leading to a price spike. 

Mr Latham says that if the world continues on the path it is currently on, with only modest efforts to address climate change and global temperatures rising by 3C by 2035, that would imply “more exploration and more Surinames of the future”.

“Should the world accelerate the energy transition and get to 2C, then the answer is a qualified maybe,” he adds. “In this environment, only the best assets with the lowest break-even prices will be required.”

Chart showing investment cuts to conserve cash. Estimated capital spend ($bn), 2019 and both the original and estimated forecasts for 2020, as of 23 Apr 2020

Adapting strategies

For Luca Bertelli, who heads up Italian oil major Eni’s exploration business, there is no doubt in his mind that the world requires more discoveries to meet the world’s energy needs. But he is also in no doubt that the pressures of the energy transition will only mount. “It is irreversible,” says Mr Bertelli of the shift, especially in Europe, towards cleaner fuels. 

Continuing to explore and produce oil and gas while also reducing the volume of greenhouse gas emissions a company produces is a challenge that climate activists believe is impossible to achieve. But oil industry executives say the revenues from these legacy businesses are far too significant — at least for now — to give up. Ultimately this cash will also be necessary for any investments into cleaner energies and low carbon technologies. 

“We cannot stop exploring today,” he says, “but we have to adapt our strategies and we need to shift our portfolios.” 

In determining when and where to invest in new operations, companies must take into account the carbon intensity of particular barrels, a metric that never used to be in place. It takes into account not only the energy used to extract heavier, more viscous oils, but also the associated and unwanted gas that is released and often flared.

Mr Bertelli says exploration will also move more towards gas, which is cleaner than oil, although still a fossil fuel. He adds that companies would inevitably allocate less capital to exploration, while also becoming more focused about which regions they operate in. 

“The oil industry will need to be extremely selective when choosing new initiatives and new acreage,” he says, adding that greater use of technology would enable more accurate and specific forms of exploration.

The biggest oil and gas companies have already become more picky, with “value over volume” becoming an industry mantra.

“It’s too simple to say we have just got to stop exploring,” says Bob Dudley, the former chief executive of BP. “[But] exploration capital today is going to be very focused and limited.”

Some companies already see additional exploration activity as an optional extra. Cumulative exploration spending by the majors has fallen by 40-45 per cent in past five years.

“We expect it to reduce more in the future with capital expenditure being increased towards low carbon business and alternative energy,” says Taiyab Zain Shariff, an exploration analyst at Rystad. 

Climate activists protest against Shell in Prague, Czech Republic. Oil majors have reduced the value of their assets by tens of billions of dollars as they re-evaluate long-term oil prices Climate activists protest against Shell in Prague, Czech Republic. Oil majors have reduced the value of their assets by tens of billions of dollars as they re-evaluate long-term oil prices © EPA-EFE

Eni plans to focus less on so-called “frontier” areas for exploration and instead on regions that already have production facilities — from offshore Egypt and Indonesia for gas and Angola for oil.

The aim, should they make a discovery, is to produce the resource quickly, shortening the length of time to deliver production and profits and lowering costs dramatically. “The capital we invest needs to be invested very efficiently,” says Mr Bertelli. “Most likely we will focus on proven basins and super basins where infrastructure already exists.”

The result is that many companies are keen to carry on exploring while also talking up their environmental credentials — Eni is one of a string of European oil majors that has made new emissions commitments in recent months.

“The mood in exploration in a lot of companies is not so high in the last few years,” says Mr Bertelli. “The energy transition will come but hydrocarbon consumption will stay there even until 2050 and it will cover 45-50 per cent of the global demand, which is why we cannot stop now.”

“You work in silence . . . that is the reality,” he adds. 

An oil platform at Puerto Bahia in Colombia. About 45 countries were expected to launch lease rounds for exploration this year, but coronavirus is expected to put certain projects on hold — from Brazil and Colombia to Thailand An oil platform at Puerto Bahia in Colombia. About 45 countries were expected to launch lease rounds for exploration this year, but coronavirus is expected to put certain projects on hold — from Brazil and Colombia to Thailand © EPA

Activist pressure

As some of the world’s biggest energy companies concentrate their cash and technical prowess on a smaller number of high-potential prospects, they have sold off their least efficient, unwanted assets to smaller independent producers which believe there is more cash to wring out.

“We see the majors all the time trying to sell mature assets,” says James Smith, chief financial officer at the UK’s Cairn Energy. While he conceded that companies such as Total and Eni are still aggressive and use their financial muscle to pick up the most attractive acreage in certain regions, overall they “are significantly reducing their appetite for exploration”, he says. 

“There is a powerful lobby today that sees new exploration as a crime against the planet, which is why the majors are having to do it in a low key way,” he adds.

Smaller players, which often have higher risk appetites and like to champion their more entrepreneurial spirit, have benefited from Big Oil’s pullback. Yet they are not immune to the same pressures facing their larger rivals. Shareholders are increasingly unwilling to invest in companies that conduct speculative exploration and engage in expensive production activity.

Bankers too are becoming more reluctant to lend to single-venture entities, prioritising companies that have scale and diversity in operations. Norway’s $1tn oil fund, the world’s biggest sovereign investor, said last year it would sell out of companies, such as Cairn and Tullow, that are purely focused on exploration and production. 

Angela Wilkinson of the World Energy Council: ‘Should any energy company in the world bet on an oil-only future? No’ Angela Wilkinson of the World Energy Council: ‘Should any energy company in the world bet on an oil-only future? No’ © World Energy Council
A solar farm in Egypt. Ms Wilkinson adds that 'we have an energy demand tsunami coming towards us and we can’t grow the renewable footprint at the same pace' A solar farm in Egypt. Ms Wilkinson adds that ‘we have an energy demand tsunami coming towards us and we can’t grow the renewable footprint at the same pace’ © EPA-EFE

Unlike the European oil majors, which have spent money on renewable technologies and businesses in the electricity supply chain, smaller independents do not have the balance sheet strength, expertise or even the willingness to invest in greener technologies. 

Among Cairn’s biggest challenges is understanding which entities will be a source of capital over the longer term. “Fund managers in western Europe are under a lot of pressure over the carbon intensity of their portfolios . . . This pressure is from younger people and their pension pots”. 

Growing demands from the public and regulators to change will also make it difficult for the industry. “This might well mean companies get driven into private ownership and markets where there is less transparency,” says Mr Smith.

Although he says this is not a “near-term” plan for Cairn, “if publicly listed ownership gets difficult . . . private sources of capital will step in and fund this”.