The oilmans dilemma

Written by Vikram S Mehta | Updated: May 7 2008, 02:53am hrs
It is the best of times; it is the worst of times. Thus might one summarise the predicament of international private petroleum companies. There is hardly a drawing room conversation at which I am present where the comment is not made, So youre raking it in, or the question asked Where is the price of oil headedThis reflects reality.With crude oil prices touching $120 per barrel, up from around $85 in February, oil companies are indeed in a clover.Exxon has announced first-quarter earnings of$10.8 billion, Shell $9 billion and BP $7.6 billion. These are record results and well beyond the expectations of managements and market analysts.The questions, however, suggest ignorance. Ignorance of the complexities of the international petroleum market; ignorance of the unpredicability of geopolitics; ignorance of the fallibility of the oil company executive.Who knows the direction of pricesCertainly not those in the business. Their projections to date have been strikingly inaccurate.This does not mean that they cannot offer cogent explanations for the recent price surge.But then, hindsight is always 20:20.

Yes, if current profits are the benchmark for judging the times, then oil companies are indeed in good shape.If, however, future growth and sustainable earnings are the touchstones, then the picture has a cloudy edge.The worst of times may perhaps over-dramatise it, but it does serve to forewarn observers against the blithe assumption that oil companies have little to worry about.

Success in the exploration and production of oil & gas requires a company to overcome three interlocking sets of probabilities.The probability that a given geologic structure contains hydrocarbons; the probability that hydrocarbons will be located, and the probability that once located, the find can be commercially exploited.No one gains if hydrocarbons are found but cannot be produced.And that can happen because of logistics, economics and/or markets.The Tripura gas field, for instance, was discovered decades ago, but remains under the surface because of the absence of a proximate market. Today, the probability of locating hydrocarbons and then producing them on a commercial basis are more challenging than perhaps ever before. Why

First, it is because private companies do not have access to easy oil.Most if not all such designated oil is under the control of state-owned companies that are understandably disinclined to share their resources with the private sector.To sustain growth, therefore, private companies have had to extend their exploration activity into geologically complex, environmentally harsh and logistically labyrinthine acreages like the Arctic and deep waters.They have, thankfully, measured up to the task. They have developed technological processes to map the subsurface of such areas and also to build the complex structures required to bring new discoveries to the market.But they have also had to accept the reduced probability of finding new reserves and the consequential hike in overall discovery and development costs. Besides, commercialisation of a discovery is no longer a slam dunk.

The cost increase is not simplybecause of geography and terrain.It is also because of general inflation in the costs ofmaterials, equipment and technical personnel.For instance, Cambridge Energy Research Institute (Ceri) has estimated that such costs have ratcheted by over 60% over the period 2001-2006.And even then, some items are not readily available.

Regardless of record profits, oil company executives are confronted with difficult questions. Where to investHow can a private oil company expand in the face of increasing resource nationalism, complex geology, harsh geography, rising costs and cut-hroat competition And most worryingly, perhaps, how can the company meet the expectations of its shareholders while also meeting the energy needs of society on a sustainable basis

The debate on climate change is substantively over.People may query the details, but few today oppose the assertion that fossil fuels are a significant contributor to global warming and that the world must shift towards a cleaner and more energy-efficient economy.Equally, though, there is no escaping the reality that the world cannot do without fossil fuels for the foreseeable future.Certainly, the reign of the petrol combustion engine does not look like coming to an early end.Yes, there are glimpses of alternativescellulosic biofuels converted from straw and other vegetable wastes, and electric vehicles powered either by batteries or hydrogen fuel cellsbut a lot more development and technological breakthroughs are still required for them to become competitive and reliable substitutes.

The deepening furrows on the brows of oil company executives reflect these conundrums.Fossil fuels must be found and produced, but this is no longer so straightforward.There is money, but where to invest itDemand is growing, but the environment compels restraint.

Drawing room discussions about the oil industrys alleged bounty call for deeper understanding.A balanced view would be: oil companies are caught at the crossroads of the best of times and the most challenging of times.

The author is chairman of the Shell Group of companies in India. These are his personal views