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Deepwater – Bernstein Research’s view

Tuesday, June 15, 2010

Neil McMahon, senior analyst with Bernstein Research, presented an overview of where the oil and gas industry is with deepwater, at the May 26 Finding Petroleum forum in London

neilmcmahon.jpgRecent exploration success in the deepwater has been dominated by national oil companies (NOCs) and smaller exploration and production companies (E&Ps), not the oil majors (integrated oil companies / IOCs), said Neil McMahon, senior analyst with Bernstein Research, speaking at the May 26 Finding Petroleum London forum.

For example, in 2009, there were 42 deepwater exploration discoveries from IOCs, 111 from the NOCs and 211 from the E&Ps, he said.

However, “most IOCS have been talking about returning to exploration recently,” he said. ”The IOCS are picking up the pace of exploration or at least talking about this because they feel they are being left behind.”

“In late 80s and mid 90s - deepwater exploration was pretty much everything IOCs were doing. They took on the risk, they didn't mind doing things seen as quite technical,” he said.

“Today they're balancing the risk of doing a bit in the deepwater and doing lots and lots of easy unconventional stuff where the geological risk is zero.”

“I think they have lost their risk appetite,” he said. “But this could change in a few years as they are pushed into more and more exploration areas.”

“I think we could see the next renaissance of exploration activity over the next 5 years, where IOCs decide to take on risk again.”

Looking around the world, some of the oil majors are in Ghana, some are in Brazil, and most have gone into Indonesia. There is also new deepwater activity in the Gulf of Mexico and offshore Libya.

The country which has seen the most amount of deepwater discoveries over 2006 to 2009 surprisingly, is Australia.

There is still no clear consensus on what deepwater actually is, he said. Previously, anything over 200m was considered deepwater. But now most people class something over 1000m as deepwater. “Many people would say 1000m is far too shallow.”

Mr McMahon believes that the growth in deepwater exploration is driven more by the availability of opportunities, rather than a high oil price, as technology became available or license blocks were opened.

For example, there were many new discoveries in the period 1996 to 2003, despite a fairly low oil price at the time.

Looking for different geology

Until 2005-2006, people were only looking for a specific number of geology types in the deepwater, mainly submarine fans and clastic reservoirs.

But then “there was a big change,” he said.

“Wherever you take a step back - it’s the guys that have looked for something quite different which have met success in the past few years,” he said.

“You could argue the future is stratigraphic traps and presalt carbonate reservoirs. The next stage will get a lot more complex but it does open up a lot of new areas.”

History

The first wave of deepwater exploration was in the late 1980s, with Shell discoveries in the deepwater Gulf of Mexico, with submarine fans.

This was followed by a second wave in the late 1990s, with discoveries in the Gulf of Mexico, Angola and Nigeria.

There was actually a drop in the rate of new discoveries from 2002 to 2004, as the oil price was sharply climbing. “I think that's because Integrated Oil Companies stopped exploring,” he said.

“Beyond 2002 it’s difficult to name discoveries IOCs have actually made - you can do it pretty much on your hand.”

Then there has been a ‘third wave’ from 2004 to today, which has been driven by Brazil and the smaller E&P companies, he said, exploring in the Gulf of Mexico and new regions of West Africa.

There does also seem to be a trend for discoveries to get smaller and smaller, and deeper and deeper (see graph).

The flowrates from new discoveries are also decreasing.

“In fields from the late 1990s to early 2000s, the flowrates could be 55,000 bopd at Thunderhorse to 15,000 to 20,000 in places like Angola,” he said.

But for the Gulf of Mexico Lower Tertiary (where many of the newer wells are) “you’re lucky to get 10,000 bopd, or at best 15,000 bopd,” he said.

“I think this is going to be incredibly important going forward.”

The new wells outside Brazil tend to be drilled in “very technically challenged geology,” he said.

“In Brazil - the flow rates are well above what we expected 2 years ago and what oil companies had expected from carbonate reservoirs,” he said.

Satisfying Wall Street

Oil industry investors in Wall Street and the City are decreasingly rewarding oil majors for making safe investments, such as in Iraq, which is dangerous politically but geologically very safe.

“The market is not rewarding them for going for the non risky stuff,” he said. “A lot of investors are sitting there saying, what is your value added for developing this on behalf of someone else - it really isn't much.”

There are three simple things which investors are looking for now from oil companies, he said.

The first is big growth in production, which is profitable, and which does not include Iraq (which is considered to have low profitability, due to the technical service agreements);

The second is that they “need to be exploring and have potential for significant added value from exploration acreage for the company,”

And the third is that they need to be leveraged to high oil and gas prices – or in other words, their production costs should be high – so an increase in oil and gas prices should make a big increase in overall profit margin and investor returns.

“Most of the IOCs don't tick any of those 3 boxes,” he said.

West Africa

In West Africa, the growth in deepwater discoveries has shown “fantastic progression” until the past 5 years, he said.

Lately, “everything that's been discovered in Angola has been much smaller than what was discovered in mid 90s,” he said.

Deepwater Nigeria “has seen pretty much a stalling of any decent exploration activity,” he said. “Until we see a clear hydrocarbon law in Nigeria and people feel a bit more comfortable about the situation - the traditional exploration is pretty much dead.”

There are two very important wells in Sierre Leone and Liberia, being drilled by Anadarko and Tullow, he said.

“These follow from what Anadarko would say is a very important test of a hydrocarbon system in Sierra Leone.”

“In Ghana, Hess will be drilling just south of the Jubilee field in a 100 per cent owned block.”

“We will see if the deeper water offshore Ghana can prove up hydrocarbon plays.”

“So expect a lot more from this area in terms of industry news in next 12-18 months.”

Brazil

Brazil has recently “just taken off,” he said.

The industry is looking at a new type of deepwater carbonate reservoirs, where the sediment was originally deposited in shallow water.

“It’s more of an engineering challenge than geological challenge,” he said. “It’s not understanding where the reservoirs are, but understanding where the fractures are and how to drill and complete production wells.”

There haven’t been many new exploration rounds in the Santos and Campos basins recently, so there has been more appraisal drilling (trying to find out more about known reservoirs) rather than exploration drilling.

During the next 2 years, there will probably be a repricing of reserves in the Santos presalt, now more is known about how productive they are. The Brazilian government has asked independent valuers to work out how much the reserves are worth, and will sell them to Petrobras at that price. Bernstein anticipates that the price will be “at least $7 per barrel,” he said.

This means that companies which already have reserves in the Santos basin, including BG, Galp and Repsol, will be revalued.

“You're going to see a lot of drilling activity in the Campos basin as well,” he said.

French Guiana

“Probably the most interesting new area in South America from a deepwater exploration point of view is probably going to be French Guiana,” he said. “This is an area that hasn't seen much activity at all.”

“There's a Tullow/Shell/Total well going down in the 4th quarter of 2010.”

“It’s targeted historically structural traps - this time it will be probably more stratigraphic traps echoing what’s been going on in West Africa.”

South East Asia

“Indonesia is a place a lot of people have written off because it has come out of OPEC,” he said.

“Most people that aren’t involved in the industry think that pretty much Indonesia is completely done because it has been worked on for so long.”

“But there are 2 areas, Pasangkayu and Bone Bay around Sulawesi where exploration has never been done.”

“Marathon has got 2 wells going down here and plans to collect more data in Bone Bay, as well as in another exciting block  in West Papua.”

“Hess will be drilling in West Papua too.”

Moving further East, Exxon have had some success in the Philippines, and in the South Chinese sea there is a gas condensate trend. “CNOOC have a major position here along with Husky and Anadarko are involved yet again, and BG,” he said. “It will be drilled extensively in 2010 and 2011.”

Libya

In Libya, “there have been 2 dry holes drilled by ExxonMobil in the deep water,” he said. “The only real discovery we have information on is Hess' discovery starting to step out into deepwater.”

“However from a company point of view Libya is less relevant than other areas in the world given the fiscal regime that exists,” he said.

“We tend to discount it from a share price point movement of view because it can tend to add limited amount to valuation of a company because of the tax.”

Gulf of Mexico

The Gulf of Mexico went through “great wave” in the 1980s. “A lot of exploration kicked off then,” he said.

“There were great discoveries in late 90s - Thunderhorse being the best known.”

Then, “it started to drift a bit, he said.

“A lot of the Lower Tertiary discoveries were made in last few years then it started to take off again,” he said.

Oil spill

The Macondo oil spill is a “spill of such proportions that it has walked all over the safety record that was in place in the Gulf of Mexico,” he said.

There have been oil spills in the past, but the Macondo oil spill is much bigger.

“The total Gulf of Mexico oil spilled in 2005 was surpassed in 3 days by the spill from Macondo.”

The Gulf of Mexico has a far from perfect safety record. According to data from the US Minerals Management Service (MMS), there have been plenty of fires and explosions offshore since 1996, he said, (see graph).

“We haven't heard about them because in many cases the blow out preventors worked - we didn't have a situation like we have today,” he said.

“[The Macondo disaster] is regarded as a unique event which a lot of attention should be spent on,” he said.

“You could argue that a lot of attention should have been spent on this since 1996 - it’s not as though the industry has been squeaky clean.”

Reduced drilling?

As a result of the Macondo disaster, many people around the world are looking at deepwater drilling much more closely, which will have an impact on the amount of drilling that is allowed.

Already, the consultations which had been planned on oil drilling offshore Virginia for the weeks following the spill have been postponed. “So it looks like that's not going on,” he said.

“It looks very unlikely that East Gulf of Mexico lease sale is going ahead,” he said.

There are also areas Shell is trying to drill in the Arctic this year, where there are uncertainties, he said.  “We think this whole Arctic area isn't going to see any activity until 2012 and beyond.”

If all oil and gas deepwater production projects around the world which are planned, but have not yet been started were delayed by a year, there would be a shortage of oil of between half a million and a million barrels of oil per day, versus previous oil supply and demand forecastshe said.

“That gap could be closed by OPEC.”

But “any delays, any regulation, will just drive up the oil price.”

However, “a high oil price could then generate more exploration opportunities going forward,” he said.



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