Exxon, the Chase for Reserves, and the Oil Sands

Talking to corporate analysts over the several years that I've been back in the U.S. and covering oil, a recurring question I hear is how Exxon manages year after year without exception -- unlike its Big Oil rivals -- to replenish its cache of proven oil and natural gas reserves. That's what the company has reported in its news releases and annual reports for the last nine years -- an unbroken trajectory of replacing more than 100% of the oil and natural gas that it pumps out of the ground.

The answer is that it hasn't done so, not at least according to the rules of the Securities and Exchange Commission, which governs such matters. When you examine Exxon's annual filings for 1999-2008, the company has had a quite-normal -- for oil companies, that is -- four years of exceeding 100% replacement, and five years not. For instance, for 2008 the company issued a statement saying that it possessed 22.8 billion barrels of proven reserves; yet its 10-K filing with the SEC reported just 21.1 billion barrels in proven reserves (to get there, see page 7 of the 10-K, and tally up the developed and undeveloped reserves in the consolidated and equity categories).

So I gave Exxon a call. How do you get from 21.1 billion barrels to 22.8 billion barrels? I asked.

Add in the oil sands, was the reply.

That would be the approximately 1.8 billion barrels of oil equivalent that Exxon has booked so far in its Alberta, Canada, oil sand holdings (see pages 22 and 23 of the 10-K; add the Syncrude and Kearl reserves).

Strictly speaking, SEC rules don't permit comingling of oil that's pumped out of the ground, along with oil sands -- exceptionally tar-like material that in most cases isn't pumped, but instead is actually mined like a mineral, then mixed with chemicals in order to move it to a refinery for processing. But companies can comingle them in public announcements such as news releases and annual reports that are read by reporters, investors and Wall Street analysts, according to an SEC spokesman.

This isn't criticism of Exxon. Rather, it's simply evidence that Exxon, like all of Big Oil, is mortal. I wrote about this in a piece earlier this week for Business Week.

In fact, Exxon has been highly critical of how the SEC requires it to report reserves. It has said that it has its own, rigorous, internal methods of assessing its proven reserves, and that this process far more accurately reflects what it possesses.

Why does reserve replacement attract so much attention? Because investors and company analysts regard this metric as a primary measure of an oil company's health. If a company's reserve base is consistently stable or growing, then it's regarded as maintaining its assets as a base for growth. If the reserve base is consistently shrinking, a company can be thought to be cannibalizing itself.

For 2008, for instance, Shell says that it replaced just 95% of what it drilled. The year before, Chevron reported a replacement rate of just 10-15%. That attracted them much critical commentary.

And Exxon? It reported that it replaced 101% of its production in 2007, in addition to 103% in 2008. Yet its SEC report shows that its proven reserves actually dropped both years -- to 21.7 billion barrels from 22.1 billion barrels from 2006 to 2007; and, as mentioned above, on down to 21.1 billion barrels in 2008. The sands made the difference. Without the sands, Exxon's reserve replacement last year would have been about 27%.

The situation will change starting next year. The SEC is going to start allowing companies to combine the oil sands with other reserves. The decision came after oil companies argued strenuously that new technology makes unconventional oil equivalent to conventional reserves, so that now there is no reason not to permit companies to put them in the same basket.

Whatever the case, for the record below are the comparisons for the last nine years, including links for most of them to both the 10-Ks and the relevant news release or annual report.

Exxon's Reserve Replacement (in barrels of oil equivalent)

Oil sands

SEC-10K

In News Release

1999	577 mln		20.6 bln	21.3 b
2000	610 m		20.8 b	21.5 b
2001	821 m		20.79 b	21.5 b
2002	800 m		20.68 b	21.7 b
2003	781 m		21.1 b	22 b
2004	757 m		20.9 b	22 b
2005	738 m		21.6 b	22.4 b
2006	718 m		22.1 b	22.7 b
2007	694 m		21.7 b	22.7 b
2008	1.87 b		21.1 b	22.8 b

China Changes Calculus for Petro-Rulers

Much has been written on how low oil prices will help to reverse the fortunes of resource-strapped Big Oil – if not precisely jolly over their new penury, closed-armed petro-powers, it's said, will now allow western oil companies at least to make a case why they should be permitted to conduct exploration and production. Atop the list of this ostensible new state of affairs have been Venezuela, Libya, and Russia.

But so far, the opposite appears to be happening -- resource-rich countries are not opening up to new deals with western oil companies. One reason is that the analyses appear to have played down two factors – the depth of discomfort among the petro-powers with Big Oil; and the deep-pocketed willingness of China to step in.

The implications of China's entry as cash savior include not only trouble for non- state oil companies; it also could exaggerate an expected resumption of relatively high oil prices once the global economy recovers.

In the last week, we have seen China lending Russia's Transneft and Rosneft $25 billion in exchange for a guaranteed oil supply of 300,000 barrels a day for 20 years. The price of the oil wasn't disclosed. Look next for Gazprom to borrow from the Chinese to finance its ongoing operations.

Even more conspicuous was last Thursday's announcement that China is lending Brazil up to $10 billion to help develop its oil company Petrobras's deepwater oilfields. The deal is in exchange for up to 160,000 barrels a day of oil. Again, the price of the oil wasn’t disclosed.

The Brazilian case is perhaps more important because it appears on the cusp of the country becoming a huge petro-power on the backs of an estimated 12 billion barrels of offshore oil; Brazil itself says it may possess an additional 100 billion barrels of oil.

Because the oil has been found in extremely deep water, analysts have forecast that Petrobras will need Big Oil’s cash and capabilities in order to develop it. Indeed already Exxon Mobil, Amerada Hess and BG are among companies working offshore in Brazil. But if China remains open-walleted, there will probably be less need for more cooperation with multi-nationals.

Interestingly, both Russia and Brazil were willing to be on the hook to China for guaranteed reserves while at least for now remaining closed to new cooperation with Big Oil.

The ramifications for future oil prices stems from the nature of the deals. The price of oil is set to a large degree on the availability of supply during moments of man-made or natural crises, such as war or hurricanes. To the degree that the available supply is already tied up in long-term contracts, there’s less wiggle room during these crises, and thus more of a chance of a price spike.

Already, oil companies are significantly reducing new exploration projects, and shutting in uneconomic oilfields in the U.S. and elsewhere. This means that, once the economy and oil demand recover, there will be less supplies of oil and natural gas. China's new oil deals will exacerbate the supply tightness. And any geopolitical or weather-caused crisis will more likely drive oil and ultimately gasoline prices higher.

Is Exxon Right This Time?

I've written the cover story for BusinessWeek, which hit the stands today. The topic is Exxon. The premise of the story is to take a reading of Big Oil by examining the most successful by far of all the companies; if Exxon has got problems, the rest definitely do. The story points out that Exxon retains superlative cash flow, but has numerous weaknesses built in to its system.

Ultimately, Exxon has successfully navigated the real and supposed crises of the last several decades by sticking steadfastly -- some say rigidly -- to much the same highly cautionary formula devised in the 1870s by John D. Rockefeller, the founder of Exxon predecessor Standard Oil.

So where are we today? At the cusp of a fundamental shift in global energy, as many argue? Or, as Exxon asserts in continuing to adhere to its orthodoxy, are we in just another cycle?

Not Everyone is Losing Money

Pure traders are the only ones left standing in the crude oil speculation business now that oil prices have collapsed, sending hedge funds, college endowments and pension funds scampering. And these traders have found a new way to make solid double-digit profits. It's called betting on the contango.

What's contango? It's when the market as a whole bets that oil prices are going to steadily rise well into the future, and traders react by buying two contracts on the New York Mercantile Exchange -- say, one for the purchase of oil next month at $41.24 a barrel, and a second contract to sell it in February 2010 for the going rate of $60.22 a barrel. For those lacking a calculator, that's a cool 46% profit.

Here's the catch -- you've got to have some place to store the crude, and such places are so filled up that traders are now renting 2-million-barrel supertankers to store their contango bets.

I write about this as part of a story just posted on-line at Business Week.

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.

George Keller 1923-2008

George Keller, the former Chevron chairman, who died yesterday in Palo Alto, was an archetype of the intuitive, gambling, technologically driven men who formerly made up the spine of the oil industry. It's not sentimentality to say that one of Big Oil's biggest problems is that today there are none like him at the helm of the five or six top companies.

Keller is famous for the nervy play that created Chevron -- the 1984 purchase of legendary Gulf Oil, described vividly in Daniel Yergin's The Prize. But Keller's vision didn't end there. Just three years later, he made the decision that took Chevron into the Soviet Union, and later into Kazakhstan's Tengiz oilfield, the company's biggest single oil property on the planet.

In other words, when you look at Chevron, you are looking at the house that George Keller built.

Keller was essential to the early research that produced O and G. In the late 1990s, he sat down with me for several hours in his San Francisco office (at the time I was writing for The New York Times out of the former Soviet Union, and he delivered an age-old complaint of parents of grown children everywhere -- he didn't get to talk much to his son Bill, the Times editor, he said. A few years later -- while I was writing O & G at Stanford -- I ran into Bill in downtown Palo Alto; he was in town visiting his father).

Keller told me about the double-knee replacement he just underwent; he planned on being on the tennis courts in a few months. He talked about Chevron's pioneering of Saudi Arabian oil. And he told me about the day in 1987 when he got a call from his much-trusted investment banker, Nicholas Brady, about a fellow named Jim Giffen who had an interesting concept. Keller should give Giffen a hearing, Brady said.

A few days later, Giffen -- a little-known New York promoter of business in the Soviet Union -- arrived in Keller's office. He proceeded to describe to the Chevron boss and his lieutenants how they might acquire an oilfieild in the off-limits Soviet Union -- what Ronald Reagan at the time called the Evil Empire.

Few oilmen would have trusted a fellow like Giffen, who belonged to a class of businessmen -- middlemen -- who usually earned their money by getting between oilmen and the oilfield. But Keller did. He ordered his men to go with Giffen to Moscow. And so began Chevron's sojourn into the Soviet Union.

As in the Gulf deal, if Keller hadn't had the sure instincts of a winning gambler, Chevron would not be the company it is today. Indeed, it might very well have been swallowed up in the waves of mergers that have roiled the industry since.

Ripple From Russia: R.I.P. BP?

The stewards of Big Oil have to be watching the latest brawl in Russia with a sense of dread. For their brother, BP, is fighting not merely to save its assets in Russia; it's fighting for its life.

BP itself is rapidly becoming vulnerable as an acquisition target. And for the handful of companies of Big Oil, that's a picture of their own possible future.

For months now, we've been treated to a spectacle of three or four Russian oligarchs making BP miserable. These fellows -- the billionaire oligarchs and BP -- are 50-50 partners in a highly lucrative oil concern that they call TNK-BP. The company accounts for a full quarter of BP's entire global production, and a fifth of its reserves.

The oligarchs want something from the Brits, and the result has been the usual Russian treatment: visits from countless inspectors, summonses to the prosecutor's office, visa trouble.

Yet the TNK-BP dustup no longer has the ring of expropriation as usual.

In the latest development, the concern's BP-appointed CEO, Robert Dudley, fled Russia in secret and is now hiding out in some undisclosed place, prepared, according to BP, to continue running TNK-BP from a distance. I asked a BP adviser why Dudley is behaving so mysteriously. Couldn't he have set up shop like a normal CEO in London? Perhaps this is part of the antagonists' PR war? "I do not know anything about the location except that he is operating as CEO for both [the Russians and BP], and London might not be the most appropriate location," he emailed me in response.

After some three decades of petro-nationalism in the Middle East and elsewhere, Big Oil is accustomed to the puffed-out chest, the boot, and picking up the pieces. It has found a modus vivendi in most cases.

Recall previous bouts of trouble in Russia: In December 2006, Shell responded to a similar onslaught at Sakhalin II -- at the time the world's largest combined oil and natural gas project -- by going to the Kremlin and crying uncle. The response was some advice -- sell half your shares at below-market rates to Gazprom. The result is that Shell, now with 27% of Sakhalin II instead of 55%, is still in business in Russia. And just six months later, BP was forced to sell out entirely from Kovytka, a supergiant natural gas field. BP sold its expulsion publicly as a fair deal, considering that in exchange it was embarking on a worldwide partnership with Gazprom. This partnership was crucial, because BP and the rest of Big Oil is finding it almost impossible to acquire new reserves to replenish what they pump each year; combinations with national energy companies like Gazprom are one way of maintaining one's bulk.

But not so fast. That BP-Gazprom partnership has yet to materialize. Indeed, BP's hopes for this partnership seem not just wishful, but hubristic. Because part of its calculus appeared to be ceding control of TNK-BP to Gazprom, which ostensibly would buy out the oligarchs while leaving BP with a sizeable remaining chunk.

TNK-BP was never a stable grouping, and seems always to have been bound for divorce court. But BP's talks with Gazprom appear to have accelerated the estrangement. The oligarchs seem to have believed that BP planned to sell them out in exchange for a global lifeline from Gazprom.

And, as Yulia Latynina, the respected Russian commentator puts it, the oligarchs responded "in the most brutal manner. They effectively said ..., 'We're the big guys around here.' [What followed] was a shoot-out. The other side shot better."

Here is where the gunfight appears to diverge from Big Oil's prior confrontations in Russia. Previously, the Kremlin has halted the hostilities once a targeted Big Oil company surrenders. But not in this case: BP has made clear that it's prepared to surrender control to one of the state-owned Russian companies, yet that's not been enough.

One is led to the conclusion that control in fact isn't good enough. It looks like Russia may want all of TNK-BP. And it also may not mind Big Oil understanding that, even if the state stands aside in a turf battle, the BPs of the world aren't tough enough to hold their own in Russia's brutal business environment. It may be a warning to all foreigners doing business there.

Richard Gordon, an experienced observer of Russian oil, sees it slightly differently. He told me last week that the Russians want BP to reduce its share considerably -- to 25% or less. At that point, Gordon said, it's up to BP to decide whether it has faith that TNK-BP would be run well enough, and, "if they don't have faith in the company, why remain a partner?"

In The Guardian today, Oppenheimer's Fadel Gheit, one of Wall Street's most seasoned oil analysts, advised BP to get out. "It's a bit like Manchester United losing Ronaldo," Gheit said. "It would take time to recover -- a blow but not fatal."

What happens next? Wall Street would pummel BP's share price were it to lose or leave TNK-BP, which would make the company a highly attractive target for acquisition. In that case, Gheit thinks that ExxonMobil is the only Big Oil company with deep enough pockets to buy BP.

But both Gordon and Gheit think that BP might act first and seek out its own merger partner because, as Gordon put it, it's better to "do a deal than be done to." Gheit told The Guardian that a logical BP partner would be Shell, "with [BP CEO] Tony Hayward running both companies."

Yet why are the Big Oil companies the only perceived merger partners? As Big Oil seeks access to China and the Middle East, wouldn't their national companies and sovereign wealth funds seek equal treatment?

Harvard Business School will no doubt chronicle the brawl as a case for how the game of energy is changing. But Big Oil is observing more closely, because this is its own future.

Photo: lawkeven
Rights: Creative Commons

The End of Big Oil

For those interested in the history and future of Big Oil, I've got a piece in The New Republic this week on how one or two of the companies might survive despite their stubborn resistance to change. TNR is a pay site but if you take a free trial subscription you can read the whole piece, plus a few other items that look interesting this week. Here are the first few paragraphs.


When historians one day dissect the long arc of humankind’s use of fossil fuels, they may very well zero in on October 9, 2006, as a turning point for Big Oil. That’s when it became clear that the major oil companies—the giants that had survived numerous predicted extinctions and gone on to ever-greater profit and influence—were undergoing a tectonic shift and would either reinvent themselves or die. It’s the day Moscow dashed the hopes of five major oil companies from three countries and announced that Russia itself, and not they, would develop the biggest new natural gas field on the planet, an undersea Arctic reservoir called Shtokman.

Shtokman is the oilman’s Angelina Jolie: much-coveted but out of reach. Experts believe it contains the carbon fuel equivalent of 23 billion barrels of oil—that in an industry that considers a field of one billion barrels gigantic. Shtokman alone contains sufficient energy to power all of Europe for several years, and the world’s big oil companies had sought rights to it for years.

In another time, Russia’s declaration that its natural gas behemoth, Gazprom, would develop such a field would have set off peals of laughter among Western oilmen. Gazprom lacked the know-how to keep production at its current fields from declining; how would it manage a technological feat under the deep, icy waters of the Barents Sea? But there was nothing humorous about Russia’s plans. Gazprom knew it wasn’t capable of drilling the field; instead, it planned to hire Big Oil to do so. Big Oil would be its employee.

That notion flew in the face of oil-industry orthodoxy, which says that big potential profits accrue to those who assume big risks. If a company developed an oilfield, it was rewarded with the gold star used by Wall Street to measure oil company value—the rights to “booked reserves,” in industry parlance. Booked reserves consist of how much oil and natural gas a company controls, and thus can sell at some point at, say, $95 per barrel or $260 per 1,000 cubic meters. The Securities and Exchange Commission measures booked reserves, and investors regard them as the main determinant of a company’s fundamental worth. Yet now Gazprom was suggesting stripping the Western oil giants of that incentive—they would be unable to book Shtokman’s natural gas. The industry mood has become even more somber over the last half-year as two European companies—France’s Total and Norway’s StatoilHydro— actually agreed to Russia’s terms.

The truth is that any of the oil majors—with the possible exception of Exxon Mobil—eventually would have. Why? Because oilmen know that, despite recent unprecedented profits—Exxon alone reported a record $11.7 billion in net income for the fourth quarter of 2007—they are on the decline. The combined booked reserves of the world’s biggest five companies have shrunk by almost 20 percent on average since 1999, according to a paper by Rice University’s James A. Baker Institute for Public Policy. Shtokman is a blueprint for how the major oil companies are increasingly being treated around the world. Today, state oil companies and ministries from countries like Venezuela, Saudi Arabia, and Russia control somewhere between 80 percent and 90 percent of the world’s known oil and natural gas reserves. And, over the next two decades and beyond, those countries are going to ask foreign oil companies to serve as their contract employees in the same way that Gazprom brought on Total and Statoil.

Big Oil, then—the indomitable giant symbolized by the pitiless John D. Rockefeller—is dying. At the very least, it will soon have to fundamentally change the way it does business. But the shock of Shtokman is merely a tremor compared with the coming revolutionary transition to a non- carbon energy economy. Big Oil could transcend its current woes and weather that future revolution—perhaps even lead it—if it reinvented itself as Big Energy, striving to develop renewable power sources like wind and solar, or even to deliver the industry’s holy grail: a clean energy mechanism that renders fossil fuels obsolete. True, no one yet knows what the revolution
will look like; but the odd thing is that, for the most part, the oil companies don’t seem to care.

continued (free trial subscription required)

The Dislodging of Another Leg From Western Primacy

The news isn't grand for those accustomed to calling the shots for the last century and more. And it all gets back to oil.

As has been discussed on this blog and elsewhere, Big Oil is being eclipsed by national oil companies. Exxon, Chevron, BP, Shell -- the western companies that have swaggered their way through the halls of power since the beginning of the last century -- are losing out to Aramco, Gazprom, PetroChina, and so on.

Now another underpinning of Western primacy in the world -- global finance -- is going the same way. Take a look at this piece in the latest Business Week by Emily Thornton and Stanley Reed. It's on the so-called sovereign wealth funds, the diversified investment vehicles for the oil profits siphoned away by the six most important Gulf states: Saudi Arabia, Kuwait, Qatar, Abu Dhabi, Dubai and Oman.

Takeaways from this article: These states have amassed a stunning $1.7 trillion in their sovereign wealth funds, as much as all the hedge funds in the world combined. And their $180 billion in 2007 profit on these investments amounted to more than half their total $315 billion in profit from oil and gas. The money quote from Gregory A. White, managing director at Thomas H. Lee Partners: Soon "they will be the industry. We will be working for them."

When you add on the $156 billion held in Russia's Stabilization Fund and the $20 billion in Kazakhstan's National Oil Fund, these investment vehicles are buying up pieces of Western companies from Texas to Hong Kong and changing the finance world.

Merrill Lynch needs a $4 billion infusion to shore itself up after an expected $15 billion in mortgage writedowns, as The Wall Street Journal and The New York Times reported in the last couple of days? Don't be surprised if it's one of these funds coming to the rescue. Both Merrill and Citigroup have already received a combined total of some $13 billion in cash through stock sales to Abu Dhabi's sovereign wealth fund. The Journal reported yesterday that both are back in the Middle East to get more cash. Citigroup needs some $10 billion, according to the piece.

These are not silent investors, as were the Middle Eastern petro-states in the 1970s and 1980s. I watch Russia most closely in this regard, and Moscow has discovered that, in the 21st century, it's easier to march across Europe doing business than with an Army.

It's another dimension in the shift of the center of gravity of global influence.

UPDATE: The Wall Street Journal is reporting that the Chinese Development Bank and Saudi billionaire Alwaleed in Talal are part of a group coming to the rescue of Citigroup. Alwaleed already is Citigroup's second-largest individual shareholder.

Photo: IJsendoorn
Rights: Creative Commons

Finding An Honest Man in Big Oil

Those who follow oil seem forever doomed to be in a way like Diogenes, strolling with a lantern, looking for an honest man. There's always the nagging suspicion that one isn't getting the whole story about the state of global energy, and prices at the pump.

Christophe de Margerie, the walrus-mustached CEO of France's Total, champions himself as that singular candid man. A member of a select club that's traditionally delighted in its mysteriousness, De Margerie is the much-deplored, indiscreet fellow who spills the group's secret handshake to the world.

In this case, the whiskey-swilling Frenchman has been telling the world that the oil industry has or is about to reach a peak in the volume of oil it can produce. Furthermore, he's quoted in a piece posted today by the Economist, all his brother oil bosses “think the same. It's just a question of whether we say it.” The article is worth reading.

Where the fierce debate on peak oil gets mucked up is on the geology -- has the world used up half its available oil resources or not? De Margerie neatly ducks that labyrinth by saying it's irrelevant.

What matters isn't how much oil is there, but how much can be produced. He says there simply isn't sufficient skilled manpower, technical equipment and willingness in the petro-states to produce much more than current levels of about 85 million barrels per day.

De Margerie makes a lot of sense. If one extrapolates, there will be much more motivation for fuel economy technologies, the development of non-carbon fuels, and general demand reduction. That's because, even if the West's fuel appetite is more or less stagnant, the economies of India and China are becoming hungrier and hungrier for energy. So there's going to be more competition for that somewhat limited volume of oil.

Big Oil's Salvation in the Video Arcade?

The accounting firm Deloitte & Touche has devised a fascinating way to predict how events will transpire in the Alberta oil industry. It's a video game called Producers Dilemma. Gordon Jaremko, a reporter at CamWest News Service, wrote a piece about it last week.

The game, which seems so far to correctly anticipate moves both by the industry and the government, was built by a Deloitte team along with a Canadian game theory firm called Priiva Consulting. On its web site, Priiva says that it uses game theory "to help clients assess and solve their strategic business decisions."

The story piqued my interest a couple of ways. I've thought for some time that there will be a paradoxical resolution of global warming and plateauing oil supply. I've thought that Big Oil will play a big, early role in solving them because these lumbering giants have much to lose by there being a runaway train.

Big Oil has lost its global primacy to state-owned oil and natural gas companies in Russia, Venezuela, Saudi Arabia and elsewhere. Chuck Marvin at Thestreet.com wrote an excellent year-ender on this last week. So, unlike in previous decades, it's actually important to Big Oil's survival to develop alternatives to carbon-based fuels.

One has to think that these or other theorists have bigger challenges in mind. Have they already produced a video game that simulates Big Oil's current dilemma, and shows the way out? If they haven't started, here is an existing platform.

Photo: Duluoz Cats
Rights: Creative Commons

Book discussion note

I'm delighted that The Issue is featuring The Oil and the Glory this week in a discussion of the last hurrah of Big Oil, and what comes next in the industry. The blog has placed it beside one of my favorite current books, Zoom: The Global Race to Fuel the Car of the Future, by my colleagues at the Economist, Vijay Vaitheeswaran and Iain Carson. By agreement with Alex Welles over at The Issue, comments can be left at this blog. Just press the comments link below.

Big Oil's Last Heyday and What Comes Next

This blog tracks Big Oil’s last heyday – on the Caspian Sea – alongside its visible sunset as the major oil companies die off. As those who also follow these events know, the ‘Stans and Vladimir Putin already impact prices at the pump, and seem likely to have greater influence in the coming years. Meanwhile, what is coming a few decades ahead – the darkness and despair suggested by the self-proclaimed “doomers” of peak oil, or the relatively smooth transition to hydrogen cars and cellulosic fuel predicted by other futurists?

A couple of articles in today’s New York Times have interesting angles on the futurist questions. In one, Clifford Krauss describes how some of today’s big petro-exporters are themselves developing big carbon appetites, and will be competing with their customers for the world’s oil. In the second, Norman Mayersohn takes a spin in Honda’s FSX Clarity, the Japanese company's attempt to make a hydrogen car commercial. He likes it.

Both are worth Sunday reads.

Don Quixote and Exxon's Contrarian Gamble

Does Exxon Mobil know something that the rest of Big Oil doesn't? Or is Exxon on a noble but ultimately quaint and quixotic quest for the old days?

Around the world, Big Oil has been knocked back on its heels by the assertiveness of state-owned oil companies that are both developing their own fields, and competing vigorously in auctions for the rights to oil and gas reserves elsewhere. The upshot is that major oil companies look to be on the verge of a long, unpleasant (for them) decline, with the result that some of them -- such as Italy's Eni -- are scrambling to adapt by forming alliances with the state-owned companies.

Exxon is not only refusing to play along with this scenario, but is in battle around the world in a claim that the prior rules hold.

In Kazakhstan, it was announced this week that Exxon is the lone holdout on an agreement to resume work on supergiant Kashagan, the largest new oilfield on the planet; the rest of the field's big partners -- Europe's Total, Shell and Eni -- have agreed to shave off a bit of their collective shares in the field so that Kazakhstan can become a full partner.

In Russia, too, Exxon is at odds with Moscow's insistence that the company sell natural gas from its giant Sakhalin-I development within Russia instead of at a higher price to China. Meanwhile, the rest of Big Oil has thrown in the towel and done compromise deals with Moscow.

And, as my friend Paul Sampson at Energy Intelligence notes in a story this week, the company is in conflict with Venezuela after abandoning participation in the Orinoco heavy oil project when Hugo Chavez demanded a larger piece of the pie. Exxon and Venezuela are in arbitration over how the company will be compensated. Meanwhile, Total, Chevron, BP and Norway's Statoil went along with Chavez's terms.

In a speech last month in Rome, Exxon Chairman Rex Tillerson said, "Some exporting and importing countries are losing sight of their interdependence. They are responding to the energy challenge by pursuing policies of resource nationalism."

Tillerson is betting that the current phase is a blip. Oil prices ultimately will moderate, his thinking goes, and state-owned companies in Venezuela, Russia, China and elsewhere will be back on Big Oil's doorstep.

Meanwhile, Exxon's strategy is to morph into more of a natural gas company. My former colleague Russell Gold at The Wall Street Journal reported during the summer that more than a third of Exxon's total proven reserves are in the Middle East and Asia; five years ago, Gold said, Exxon reported just a sixth of its reserves from that region. Exxon's biggest play on the planet is Qatar, which accounts for much of its growth.

It seems un-Exxonish to bet one's future on a single country or region. But it's not contrary to company culture to resist change. This is a company that until recently was the biggest corporate funder of the narrow club of greenhouse gas "scientist" deniers. Exxon reduced that funding when it became too public and too embarrassing.

It would be foolish to pass judgment on Exxon's strategy. But it does seem to be betting the house against the tide.

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Kazakhstan Wants Equal Ownership Status at Kashagan

The news today in one of the world's great oil disputes is that Kazakhstan has made public a demand for an equal share in the supergiant Kashagan oilfield. Bloomberg reports that six of the field's seven partners have agreed.

Work at Kashagan, the world's largest oilfield discovery in the last few decades, has been suspended while Kazakhstan and an Italian-led foreign oil consortium settle their differences. Kazakhstan is upset that, in a period of $90-a-barrel-oil, the field will be at least five years late coming to market; in addition, costs are nearly double what was originally estimated, and Kazakhstan will have to wait several more more years for some profit until those costs are paid off.

It's been clear that the Kazakhs want more control over the field, plus more money, and earlier receipt of it. The announcement today, however, is the first concrete statement that the country expects a full share of the field. That would approximately double Kazakhstan's current 8.3% holding.

What wasn't said is the terms: Does Kazakhstan intend to pay for the share? If so, are they talking cash? And if they are, how will the price be decided? Or will the companies carry the Kazakh interest?

And who is the holdout on agreeing? Given its record, a solid guess would be Exxon Mobil, which previously said it would consent only if the country extends the contract beyond its current 40-year life.

Kazakhstan is unlikely to agree to that condition when the dispute revolves around fault on the part of the foreign companies.

Exxon, which like Total, Eni and Shell has 18.5% of Kashagan, still behaves as though it's in the driver's seat. But the final settlement -- according to Kazakhstan it will be tomorrow; the companies say it will be later this month -- is likely to reflect a much stronger position for Kazakhstan.

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Big Russian Deals; Motley Fool on Turkmenistan Gas

Cashing out in Russia? One sure signal of Vladimir Putin's actual political plans will be activity in big Russian dealmaking. One of the most active betting lines around the world is how Putin will manage to stay in the driver's seat after he's forced to step down as Russian president in March. If there's a rash of huge buyouts, mergers and share sales, it would be a sign of uncertainty of what comes after the presidential elections. It could mean that some of those who have gotten rich under Putin are cashing out. Dmitry Zhdannikov of Reuters has an interesting piece today suggesting that Gazprom may finally go after half of BP's venture with the Russian-held TNK, and that favored oligarch Oleg Deripaska may want to buy into Norilsk Nickel, the world's biggest producer of nickel and palladium.

Noticing Turkmenistan: I receive lots of emails and calls these days on whether the talk of deals and reform in Turkmenistan is realistic. David Lee Smith over at Motley Fool has a piece talking about the investment side. In a posting yesterday, Smith notes the international contest going on over the republic’s natural gas now that President Saparmurat Niyazov is dead. He’s only putting Turkmenistan on a watch list, which is about right. He does get it wrong when he says that Russia is the republic's only export route – Turkmenistan has a small natural gas pipeline into Iran. But essentially he's on the right track -- yesterday my friend Marat Gurt of Reuters reported a Russian announcement that it’s closer to sealing a pipeline construction deal that would virtually monopolize Turkmen gas. Look for another U.S. or European Union shuttle mission to Ashkabad.

For investment community readers of this blog, take a look at Smith’s prior posts on oil services companies (here and here). Given the coming demise of Big Oil, I’ve been suggesting that shareholders sell the majors and shift to the technology-laden companies that will be in huge demand by the new version of the Seven Sisters – state-owned oil companies in Venezuela, Russia, China, Saudi Arabia, Kazakhstan and so on.

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Twenty Dollars of Air

I've been exchanging comments the last couple of days with Geoff on the question of whether oil company shares have had their run, and are headed down. With the top-line question being: Is it time to sell one's shares in the oil majors?

Geoff kindly led me to an AP story that Forbes posted yesterday. The piece quotes Fadel Gheit, the sober-thinking Oppenheimer analyst.

First, Gheit thinks that traders have driven up prices to their current levels exceeding $90 a barrel. He notes that Wall Street's consensus 2008 forecast average is $75 a barrel.

Which means that, if the estimate is roughly correct, there's currently a bubble of around $20 barrel. Gheit asserts that commodities traders have exaggerated the global supply situation, which is right -- in fact there's plenty of oil sloshing around the world right now.

All bubbles eventually pop. Prices could go a bit over $100 a barrel, but eventually they'll fall as speculators find some other place to put their money.

Here's the key quote: "Declining oil prices dim the outlook for energy stocks, since their performance usually reflects the direction, not the level, of oil prices," Gheit says.

I don't intend to play stock analyst, but simply to note this logical extension of the conclusion that Big Oil is in trouble because its reserves of oil and natural gas are shrinking. The companies to profit from this shift away from Big Oil are national oil companies and oil service companies; they are the growth energy stocks of the next decade or two.

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Interesting Stories

When the U.S. economy begins its expected downturn late next year, oil prices will fall a bit with it. Until then, reports my former Wall Street Journal colleague Russell Gold in tomorrow's paper, we will remain in the neighborhood of current record-breaking prices. Gold wrote the story as oil closed over $98 a barrel for the first time, and analysts surveyed by the Journal saw nothing that will soon pop the bubble.

The Economist argues in its current edition that, if Vladimir Putin is seeking his country’s best interests, it’s not always clear what they are.

Blogger Jeff “Maximos” Martin has an interesting if ultimately flawed tirade against U.S. involvement in the Caspian Sea region.

Update on Demise of Big Oil: What Goldman Sachs Knows

Venerable Goldman Sachs, seemingly the only private institution to be actually earning money during the current international banking crisis, has issued a contrarian recommendation: Buy Eni, says the investment banker to the rich.

That's a good call. Why? Because, among all the Big Oil dinosaurs, Italy's Eni has figured out a modus vivendi with the new power on the block -- the world's national oil companies, specifically Russia's Gazprom.

Big Oil is on the way out -- its reserve base is cratering, and it's been supplanted as global oil king by state-owned companies in Venezuela, Russia, China, Saudi Arabia, Kazakhstan and so on.

But this is a fresh wrinkle: Who will survive in the decades ahead? One can quibble with Eni's methods and associations. But Goldman's call can be seen as a sign of confidence that this flexible company, with its carefully negotiated entanglements with Gazprom, is one model for a re-invented oil major.

I won't be surprised down the road to see an effective or actual merger of the two companies.

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The Truth About Big Oil

For the record, Big Oil ISN'T suffering because of $96-a-barrel oil. Its bottom-line ISN'T worse off than at $25-a-barrel oil. The companies are profiting, and doing so handsomely.

This is important because, if one listens these days to Big Oil, such as in a piece yesterday in The Wall Street Journal, one might be led to get out the Kleenex.

In it, my former WSJ colleague Guy Chazan quotes a BP man, Bob Dudley, who runs the company's TNK operations in Russia, saying the following: "In general, it is the governments who are the big winners when prices reach new heights."

That statement is wholly misleading. It's rooted in a couple of facts about oil contracts abroad: when oil prices are low, the host country suffers the most, because regardless of the price, the companies get to use the same portion to pay off the bills for developing the field.

But when oil prices are high, a sliding scale is triggered that allows the country to earn a higher percentage of the price. The companies earn much more, but not as high a percentage as they do at $25 oil.

Alice-in-Wonderland Big Oil is arguing that somehow its current profit slide is partly attributable to high prices -- that those dastardly contracts they signed earn them lower absolute profit per barrel at $90 a barrel than at $25.

I think we can say with some confidence that if any oil lawyer did negotiate such a contract, one giving the company fewer absolute dollars at $90 than $25, he or she would not only be fired on the spot, but would quite possibly be liable for violation of fiduciary duty to shareholders.

A subtext involves how Wall Street values the companies, and what happens at the actual oilfield under high oil prices. Under all these contracts, the companies commit a lot of the barrels produced at the field -- say 100,000 barrels a day -- just to pay off the bills first. They call that "booking" the barrels. And, Wall Street -- understanding that one day those bills will be paid and the barrels turn to profit -- runs up the companies' share price based on those "booked reserves."

Now, since the bills are being paid off at Ferrari speed, the companies are "unbooking" reserves. So with fewer reserves, say the companies, Wall Street is valuing them less.

Again, the argument is muddled -- Wall Street is not so stupid as to be blind to Big Oil's historically unprecedented profit.

Instead, what Wall Street may in fact be seeing is Big Oil's low horizon. As Chazan quotes Stephen Thornber, global equity fund manager at Threadneedle in London (who Chazan says is now buying the shares of state-owned oil companies and oil services companies, which in my view is a forward-looking strategy that understands the industry's dismal future): "The majors are like dinosaurs. Their production is flat or falling, and their returns are under pressure."

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Sell Your Oil Shares

I just got back from Houston on the book tour, and managed to get in some private conversations with oilmen I know from the Caspian. As we've been discussing over the last week or so, the private talk within the industry is that short of an evolutionary shift in business plan the oil majors as we know them are done for.

Oilmen know that, short of an innovation of the magnitude of the invention of the transistor, Big Oil has little growth ahead of it in the next five years, and no growth – and probably absolute shrinkage – over the next decade and beyond.

The reason is that the oil majors can't maintain the foundation of their value – how much oil and natural gas they possess in total, or their so-called booked reserves. State-owned oil companies in Russia, Iran, Saudi Arabia, Venezuela and elsewhere control between 80% and 90% of the world's oil reserves, leaving the oil majors the remainder, and that is a slender reed indeed. Some of the majors may actually replenish their reserves for the short term, or even in some individual years beyond that. But they can't do so over the long term.

So why are oil shares largely buoyant this year? Because Wall Street hasn't yet seemed to absorb the fact that the current explosion in oil company profits is smoke – a deception. It's not company growth, but the oil price bubble. But it will figure it out.

And that's why, for those who own shares of the big integrated oil companies, it seems best in my opinion to pocket one's profit from the price run-up. Oh, there's some time, some more profit to be eked out because of the price bubble, now heading to break the inflation-adjusted 1980 record of $101 or so, depending who is doing the calculations.

But look for the smart money to start migrating elsewhere. If one wished to stay in oil, for instance, one could go for where the real, long-term growth will come – in the service companies like FMC, Schlumberger or Halliburton, or pure drilling plays.

These companies are going to be used more and more as a replacement for Exxon, Chevron, BP, ConocoPhillips, Shell, Total -- the states will identify the fields to be developed, and simply hire the service companies as contractors to bring them to market. It is they who will pocket the big margins, and not Big Oil.

The oil companies are innovators, so there is always the chance that one or more of them will discover some new way of making cars move, cities light up and factories work. But short of that, they are dinosaurs.

Sign of the Times

Russia has provided evidence for the direction in which Big Oil is headed: smaller and humbler.

This indication comes with Russia's announcement that it's selling a 24% stake in one of its most strategic natural gasfields -- Shtokman -- to Norway's Statoil. Read AP report on WSJ.com

That deceptive news release by the Kremlin hides a bitter fact for the company -- the likelihood that Statoil will be a mere contractor; it will not occupy the accustomed role of developer.

The fine print is what the industry calls booked reserves. These are the standard underpinning of an oil company's worth -- how much oil and natural gas they themselves control, and thus can sell at some point at, say, $90 a barrel or $260 a thousand cubic meters.

In the Russian case, Moscow is denying the companies the right to book the reserves. Hence, there is no real reason to celebrate. That's the deal that France's Total got in July, when the Kremlin gave it a 25% stake in the operating company developing the field, and though no details were released on the Statoil deal, one would expect them to get the same terms.

Why do the companies go along? Because they are desperate for any entree into places like Russia, and hope (without basis) for better terms later.

This is a blueprint for how Big Oil is likely to be increasingly treated around the world. Somewhere between 80% and 90% of the world's oil and natural gas is controlled by countries like Venezuela, Saudi Arabia and Russia, not Exxon, Shell or BP. And, over the next two or so decades, those countries are going to turn the big oil companies into employees.

Is that bad or good for the buyers of the actual end product -- motorists and homeowners? It could very well mean even higher prices than Big Oil commands since the countries are not under the same competitive or cost pressures as the companies.

The Cheshire Grin in Kazakhstan

Talks under way between Kazakhstan and Big Oil are about much more than the nation's unhappiness with the work on the world's largest oilfield discovery of the last three decades.

It's about the future of oil. And what is it?

Despite their unprecedented profits, the Big Oil companies are on the decline, and in our lifetime -- except for those that manage to reinvent themselves -- will largely go the way of former industrial behemoths like United States Rubber, Goodyear and Bethlehem Steel.

Petro-states like Kazakhstan and Russia, meanwhile, are demanding and obtaining more control over their own fields, and increasingly marginalizing the once-omnipotent oil majors. In just two decades or a bit longer, they will be the world's big, self-contained providers of energy, and companies like BP, Shell and Exxon Mobil will either be transformed into something else, or be far smaller and mousier. They will be employees -- contractors -- for Kazakhstan, Azerbaijan, Russia, Nigeria and so on.

Already, the petro-states control between 80 percent and 90 percent of the world's oil reserves; the clock is ticking for the companies, based on reserves booked long ago, something that Wall Street will recognize at some point too.

The talks in Kazakhstan make it plain that at least Exxon -- long the most far-sighted of the companies -- understands this shift. The discussions are on the supergiant Kashagan oilfield, which is at least five years behind schedule for first oil and well over two-times over budget.

As partial compensation to irate Kazakhstan, the companies (Exxon, Shell, France's Total, Italy's ENI, ConocoPhillips and others) yesterday agreed to grant the state a larger share of the field. It's clear that Kazakhstan wants an equal share with the bigger companies, and since no dollar figures were mentioned there is still the question of whether it's willing to pay market price -- or anything at all -- for that increased stake.

In this gentlemanly form of back-alley extortion, Exxon had the gumption to insist of the man wielding the knife the equivalent of train fare home so as to live another day. Kazakhstan could have this increase, Exxon said -- but only if the contract were extended beyond its current expiry in 2041.

Kazakhstan so far has refused (it's not clear, for instance, if Exxon -- as brazen as any petro-state -- offered any money extension), but the demand is brilliant.

If such an extension is granted for, say, a decade or longer, Exxon and its partners would be on the road to extending their lives just that little bit.

There has seemed to be a Cheshire grin on some of the Kazakh and Russian oil officials in recent months.

Where's My Cut?

What does $86 oil mean in the former Soviet Union? More muscular attitude from Russia's already swollen President Putin, and greater petro-assertiveness from Kazakhstan.

Putin is on his way to Tehran, where there will be much in the way of chest-beating from him and the leaders of the other Caspian Sea states with whom he is meeting tomorrow.

But Kazakhstan in particular will be in a fighting mood over the now 41% surge in crude oil prices this year (read New York Times account). Why, when it is earning more money than it ever expected from contracts negotiated years ago on the basis of $17-$20 a barrel oil?

Because it would be receiving much more money had its foreign partners -- Big Oil -- fulfilled their word and begun producing oil by now at the supergiant Kashagan oil field. The Italian-led consortium -- which includes most of the big names in Big Oil -- was supposed to produce the first barrel in 2005, but now says that won't happen before 2010.

Some people interpreted a recent public remark by Kazakhstan President Nazarbayev as proof of a calming ocean on the topic of Kashagan. If it was, the storm is back.

Over the weekend, Prime Minister Karim Massimov made that plain with a renewed demand for a higher state stake in Kashagan, according to a report in The Independent of London. If he was having sleepness nights over such assertiveness, it did not show, as he said there was "big line of potential investors" should anyone be excessively discomfitted.

Chevron is in the same stew. The California company cannot seem to close a deal with Russia over doubling the size of the dedicated export pipeline from Kashagan's sister oilfield, Kazakhstan's supergiant Tengiz, of which it has a 50% share. That is sure to slow down and complicate Chevron's plans to vastly increase Tengiz production next year, and to vex Kazakhstan over the relative stagnation of its bottom line.

Kazakhstan has already made it plain to Chevron that, as with the Kashagan partners, it means business. It recently levied a $609 million environmental fine for sulfur deposits from Tengiz, demonstrating that the country expects the companies to think of Kazakhstan, too, when they are counting their windfall profits.