Asset sweating, paltry returns and new business models

Back from the Society of Exploration Geophysicists convention, Oil IT Journal editor Neil McNaughton reviews some of the keynote talks, along with a new study from Cambridge Energy Research Associates. Despite calls for new business models and better ROIs, competition is keeping everyone on their toes—and ensuring relatively low returns for the service sector and many independents.

Seems like we have been reporting a lot recently on the state of the industry. Of returns on investment and new business models. If you had too much of this stuff, my apologies in advance and a promise—that I have a more technical subject in the pipeline for next month’s editorial. But to get on with this month’s pontifications, I bring you first some snippets from the Society of Exploration Geophysicists convention held last month in Dallas.


Our latest crop of industry analyses, predictions and opinions was captured during The Leading Edge Forum—on the ‘Future of Petroleum’ no less. Our award for the ‘most heartfelt and least likely to have any effect’ talk goes to Peter Gaffney for his entreaty to ‘explore more—there are lots of under-explored basins still out there’. True perhaps—but too 1980’s to be taken seriously by today’s analysts, still fixated on the specter of $10 oil.


Peter Rose of Rose Associates accuses the industry of ‘habitual under-delivery’. In a study of 160 of BP’s evaluations, the company only realized around 45% of the originally estimated reserves. This translates into financial underperformance. In the period from 1989 to 1999 the industry returned a paltry 9% on capital as compared to 16% for the S&P 500*. Elsewhere a Wood Mackenzie study determined that the industry ‘only’ offers an 11% ROI. To do better, companies have to be more critical of there investments—which unfortunately for the geophysical industry is likely to be interpreted as an entreaty to ‘explore less’.


Apache president and CEO Steve Farris described how independents can ‘sweat’ assets better than majors. Examples of Apache’s acquisitions from Shell Oil in Australia, the US and Canada showed how the smaller company’s attention to detail has paid off. In one example, Apache has already made a return on investment over acquisition cost of 105% (since 1999) and there remain 70% of the reserves as estimated at the time of acquisition. Farris puts this down (charitably) to better seismics. But his real message is that these properties don’t really interest the majors—and that the independents are the ones who know how to ‘sweat’ an asset and to add value to old fields.

Wanna sweat?

The notion that smaller assets are better managed by smaller companies is fairly entrenched by now. Notwithstanding Apache’s success, the concept is seemingly at odds with the business world at large. To truly ‘sweat’ an asset, whether it is an auto plant or a supermarket, nothing beats being really big. It’s the GMs and Wal*Marts that are best placed to drive costs out of the system. Although whether they produce a humongous ROI depends on the state of the economy. Smaller companies operating in auto or retail usually tend to offer more than just sweat—something extra in the form of quality, perceived or otherwise, justifying a higher mark-up.


A new study** authored by David Hobbs of Cambridge Energy Research Associates (CERA) sheds more light on the economics of changing ownership. Hobbs asks what new operators in the North Sea do that their predecessors didn’t—and whether the independents demand lower returns than the Majors. In other words, is a new, sustainable exploration and production paradigm developing on the UKCS? In a webcast introducing the new report, Hobbs described the subtly different approach adopted by the newcomers who tend to adopt a conservative approach to spending. There is more focus on building reserves and prolonging infrastructure life. Independents drill smaller offset step-outs which would have been below the ‘materiality threshold’ of previous owners. The end result is that independents deliver lower returns than majors. Hobbs asks if the new paradigm is sustainable or whether the economic potential be of the North Sea will be ‘competed’ out of the system. Another fly in the ointment of the asset transfer model—and a possible motivation for prolonging asset life—is the cost of the abandonment of offshore structures—particularly in the face of ever more stringent environmental constraints.


Similar soul-searching was evidenced in discussions following the TLE Forum. One questioner asked why new companies still venture into ‘this money losing business’? Dalton Boutte (Western Geco) proffered that the entry barriers are quite low (unfortunately!), and that newcomers to the seismic business can use balance sheet ‘elasticity’ to turn over-capacity into spec data! Farris noted the ‘huge transfer of wealth’ from service companies to oils as being ‘unsustainable’ and advocates a new business model. Indeed, from our interview with Input Output president Bob Peebler on page 3 of this issue, it appears that Farris is doing more than just pontificating about new ways of conducting geophysical business.

More next decade

But the real strategies for the 2000’s are likely being thrashed out in corporate boardrooms unbeknownst to us lesser mortals. Only when they prove their worth will they become stories for the analysts. We will be hearing all about them in the year 2010 no doubt. Strategies are only good with hindsight anyhow—and the best laid plans of all are subject to the vagaries of the oil price. And, at least for non US companies, the increasingly wayward behavior of the dollar.

* One could suggest a more favorable period than the 1990’s for such a comparison.

** UK Offshore—A Whole New Ball Game, CERA 2003— .

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