For Big Oil, a Day of Reckoning
Most of us are elated with gasoline prices, especially those driving to see relatives. We are down on the Chesapeake shore, and filled up the mini-van for $1.49 a gallon. But if you are an oil company, these aren't happy times.
Chiefly, if you are a petro-state or an oilman, you've probably got whiplash. Last summer, customers were paying you up to a whopping $147 a barrel for your oil, and though few except perhaps Arjun Murti over at Goldman Sachs thought those prices would stick around, it was equally so that almost no one expected to be paid as little as $32 a barrel just a few months later (and $36 today). Russia, Venezuela, Iran and most of the rest of the oil producing states simply cannot balance their budgets.
But, focusing for now on oil companies big and small, matters are about to get worse. As others are pointing out, that will become clear in just a few days -- on Dec. 31 to be precise. One might call it the day of reckoning. The Wall Street Journal's Ben Casselman was ahead of the pack in writing about this.
But what these reports aren't pointing out is that, if projections are anywhere near correct, this isn't a one-year matter. The companies may be in for trouble for at least the next couple of years. (After alarming the skittish market in the summer by forecasting $200-a-barrel oil, Goldman Sachs is now predicting average $45-a-barrel oil next year. The World Bank expects an average of $75 a barrel oil over the next two years.)
Here's why: It's the price of oil on Dec. 31 that all oil companies -- at least those that sell shares to the public -- must use as a measuring stick of just just how much in the way of proven oil and gas reserves they own. The most important factor in this calibration is how much it costs a company to drill a barrel of oil in, say, Canada, or the Gulf of Mexico. If they cannot drill that barrel economically at $40 a barrel (presuming that's about the price five days from now), it must be stricken from the books. Along with that number, the companies report their so-called "reserve replacement" -- to what degree managed to replenish the oil and natural gas they drilled during the year.
Those numbers must be reported to the Securities and Exchange Commission on a company's 10-K statement. That's where the trouble begins: When the companies go public with their reports in February and March, Wall Street will use the numbers to help calculate how much their share price is worth; and banks and venture capitalists will do the same to determine whether to lend to oil drillers in this tight financial environment, and if so at what interest rate.
Even for 2007 -- when oil ended the year at about $95 a barrel -- the struggle for some of the companies to replace reserves was already apparent. By the SEC rules, Exxon replaced just 76% of its reserves (though by its own internal methods it said it replaced 101%). Chevron replaced just 10%-15% of the oil and gas it drilled. BP said it replaced more than 100%.
But at $35 or $40 a barrel, those percentages are going to be far lower. Stay tuned for some news-spinning from Big Oil's public relations arms in the coming weeks and months. The companies' share prices have already been pummeled this year by Wall Street.
Some say that a focus on reserve reports is something for "unsavvy investors" and commentators -- "the resources are still there for a price," said this fellow calling others unsavvy.
That view is correct to a point -- Dec. 31 is an arbitrary date to judge one's reserves. But it's a narrowly drawn view, concentrating only on the presence of fossil fuels in the ground. It ignores that that oil and gas is becoming far harder and more expensive to drill; it's situated in smaller and smaller reservoirs, requiring the drilling of more and more wells to produce the same volume of oil; and it's largely controlled by petro-states that, even if low oil prices drive petro-states to be friendlier toward international oil companies, are still likely to demand far tougher terms than they did, say, in the 1990s.
In short, company reserves are becoming smaller, and the focus on reserves reporting is demonstrably relevant.
Some good news for the companies is that the SEC is going to change the reporting rule starting in 2010 -- companies will be able to use an average of the annual price rather than the year-end price.
But that's a slender reed of hope if trends and oil forecasts for an average $40-$60 a-barrel oil next year are accurate.
According to inflationdata.com, the average oil price in 2007 was $66.40; so far this year, it's about $98. So that if the current trajectory holds, the price on which the companies will report their 2009 reserves will be relatively low, too.
Chiefly, if you are a petro-state or an oilman, you've probably got whiplash. Last summer, customers were paying you up to a whopping $147 a barrel for your oil, and though few except perhaps Arjun Murti over at Goldman Sachs thought those prices would stick around, it was equally so that almost no one expected to be paid as little as $32 a barrel just a few months later (and $36 today). Russia, Venezuela, Iran and most of the rest of the oil producing states simply cannot balance their budgets.
But, focusing for now on oil companies big and small, matters are about to get worse. As others are pointing out, that will become clear in just a few days -- on Dec. 31 to be precise. One might call it the day of reckoning. The Wall Street Journal's Ben Casselman was ahead of the pack in writing about this.
But what these reports aren't pointing out is that, if projections are anywhere near correct, this isn't a one-year matter. The companies may be in for trouble for at least the next couple of years. (After alarming the skittish market in the summer by forecasting $200-a-barrel oil, Goldman Sachs is now predicting average $45-a-barrel oil next year. The World Bank expects an average of $75 a barrel oil over the next two years.)
Here's why: It's the price of oil on Dec. 31 that all oil companies -- at least those that sell shares to the public -- must use as a measuring stick of just just how much in the way of proven oil and gas reserves they own. The most important factor in this calibration is how much it costs a company to drill a barrel of oil in, say, Canada, or the Gulf of Mexico. If they cannot drill that barrel economically at $40 a barrel (presuming that's about the price five days from now), it must be stricken from the books. Along with that number, the companies report their so-called "reserve replacement" -- to what degree managed to replenish the oil and natural gas they drilled during the year.
Those numbers must be reported to the Securities and Exchange Commission on a company's 10-K statement. That's where the trouble begins: When the companies go public with their reports in February and March, Wall Street will use the numbers to help calculate how much their share price is worth; and banks and venture capitalists will do the same to determine whether to lend to oil drillers in this tight financial environment, and if so at what interest rate.
Even for 2007 -- when oil ended the year at about $95 a barrel -- the struggle for some of the companies to replace reserves was already apparent. By the SEC rules, Exxon replaced just 76% of its reserves (though by its own internal methods it said it replaced 101%). Chevron replaced just 10%-15% of the oil and gas it drilled. BP said it replaced more than 100%.
But at $35 or $40 a barrel, those percentages are going to be far lower. Stay tuned for some news-spinning from Big Oil's public relations arms in the coming weeks and months. The companies' share prices have already been pummeled this year by Wall Street.
Some say that a focus on reserve reports is something for "unsavvy investors" and commentators -- "the resources are still there for a price," said this fellow calling others unsavvy.
That view is correct to a point -- Dec. 31 is an arbitrary date to judge one's reserves. But it's a narrowly drawn view, concentrating only on the presence of fossil fuels in the ground. It ignores that that oil and gas is becoming far harder and more expensive to drill; it's situated in smaller and smaller reservoirs, requiring the drilling of more and more wells to produce the same volume of oil; and it's largely controlled by petro-states that, even if low oil prices drive petro-states to be friendlier toward international oil companies, are still likely to demand far tougher terms than they did, say, in the 1990s.
In short, company reserves are becoming smaller, and the focus on reserves reporting is demonstrably relevant.
Some good news for the companies is that the SEC is going to change the reporting rule starting in 2010 -- companies will be able to use an average of the annual price rather than the year-end price.
But that's a slender reed of hope if trends and oil forecasts for an average $40-$60 a-barrel oil next year are accurate.
According to inflationdata.com, the average oil price in 2007 was $66.40; so far this year, it's about $98. So that if the current trajectory holds, the price on which the companies will report their 2009 reserves will be relatively low, too.
Labels: big oil, oil prices, reserve replacement
7 Comments:
If a low POO leads to less reserves being reported and less being replaced (owing to unavailability of funding) then surely the RR ratio will remain much the same.
I accept that the absolute amount of oil replaced with have decreased but I'm not sure that the RRR would be "far lower" as you suggest.
I lived and worked in the Caspian Region for more than 10 years; quite close to the hydrocarbon business. Much of the observaiations I have gathered over this period have been truly clarified after reading LeVine's book.
Ibrahim Fawzy
Lloyd's Register of Shipping-Kazakhstan
I wouldn't feel too sorry for Big Oil, Steve. If you had told them five years ago the price of oil today would be around $35, most would think of that as a fair price. None of them invested as if they believed in $100 oil, given lessons learned from oil price collapses in mid 80s and late 90s.
So, today they are sitting on cash piles with a more inviting investment climate, host governments desperate for investment and contractors with spare capacity looking for work.
Some of us have been waiting for a major correction in oil markets for a long time. Management had been unjustifiably rewarded for performance under market conditions that they had nothing to do with creating. Now they have to return to long-term industry fundamentals to achieve results.
Save your pity for Vladimir Putin and Hugo Chavez, who behaved as if they truly believed that high oil prices will be with us forever, and your concern for consuming country policies that do not repeat the same mistakes that led to the market of recent years.
Welcome.
Nick W: reported reserves for 2007 were based on $95-a-barrel oil. Reported reserves for this year will most likely be based on $40 oil. "Far lower" is a subjective term, and we will have to wait until February to be certain how much of Big Oil's reserves are based on $40+ oil. But since that is the lowest price of oil since 2004, it seems to me highly likely that we will see a plunge of reserves for most of major oil companies and Big Oil alike.
ECC: You are right that, in the larger scheme of things, lower reserve replacement deserves no tears. As Warren Buffet is famous for saying, one can't know who is wearing a bathing suit until the tide rolls out. The coming year or two will reveal who those skinny-dippers among the oil companies are. Your final point -- on the mistakes of consuming countries -- seems to me the most relevant. We know now that $4-a-gallon gasoline was the inflection point at which motorists seriously cut back driving. So what is the other-end inflection point -- at what price on the low end do motorists return to their serious gas guzzling? It's anyone's guess, and perhaps Americans have learned their lesson, but I wouldn't count on it. What's your best guess?
Best Steve
Anyone who thinks that the current price is indicitave of the true value of oil, or that this price is here to stay for very long need to get a firm grasp on their hat! The next shock wave will blow it completely off the map. One cannot look at prices based on short term demand, we must look at price based on both demand and supply. The two are tracking very close to each other right now, with demand running slightly low to supply. In the not too distant future, they will start to diverge drastically with supply dropping and demand either growing or staying level (which I doubt). Anyone who thinks there is some magical cure for this, i.e. new technology or incfreased production, needs to get a grip. Else I have some ocean front property in Oklahoma I would like to sell them. I hope oilk stocks do take a dive next year, i will buy every share I can afford!
Glenn Parry
Granbury, Texas
Russia and the other petro-states were so drunk on high oil prices they didn’t see the bottom falling out of the global economy.
The United States is still the world’s largest consumer of oil and oil products. Given the outlook for 2009, the Goldman Sachs $45/barrel doesn’t surprise me, but they will never tell you how they came to that number. Furthermore, are we to believe banks like Goldman who tried to sell the world on all of this phony “financial innovation” like mortgage backed securities?
A more reliable source of information, at least for the U.S. economy, is the UCLA Anderson Forecast. In its fourth quarterly report, it states the national economy will feature four quarters of negative growth in 2009 followed by very tepid growth rates for 2010. It also notes that the global economy is in its first synchronized recession since the early 90s, which will continue to depress oil demand from industrialized and emerging economies alike.
Getting back to Russia and the CIS, Andrew Kramer’s article in the NYT (Dec. 30) is a sign of Russia’s fall and the false sense of security it had developed during the oil boom. This is the trap Kazakhstan fell into as well: the market for financial services, oil, mining and real estate, all central to economic growth in Kazakhstan have all collapsed putting the country’s budget, reserves and national wealth fund under tremendous pressure. Gazprom has been getting itself into also sort of areas that it has no understanding of: media and agriculture? Of course they will find a way to blame it all on the Americans, but you know what? Russia played they game too, borrowing heavily in international markets to fund corporate acquisitions.
BIG OIL has to maintain there growth levels and not bet the farm on the next big price hike in oil or natural gas prices.
HIGH OUT OF CONTROL ENERGY PRICES has led many nations down to the brink of despair and thus made a way for their sovereignty to be diminished.
CASE IN POINT Chesapeake energy has been guilty of betting on the next price hike many times I know them well. The way they have run their business in the past is like a riverboat gambler runs his hands good or bad. The Old Mercury energy in FT Worth TX was the same and run by a bunch of hyped upped clowns who lied to all to get the bucks in ---- THEN SO WHAT.
The new mindset in Energy today that I have fault with are those that are in control of large reserves as in the former soviet union whose sole goal is to become a BIG SHOT and become a personal MULTI BILLIONAIRE.
And that kind of a goal for one a group or a cooperation to have that controls the earths wealth in our planets natural resources is a BAD THING FOR EVERY SOCIETY.
Thus as I have said before WE AMERICANS need to get all we can from our assets in oil and gas and then to make a way for a new wave of innovation to come along to make better the return on investments in our great amount of BLACK SHALE deposits.
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