Oil major model challenged by shift to gas

By Barbara Lewis and Alex Lawler – Analysis

LONDON (BestGrowthStock) – Oil majors have shifted toward natural gas as the world’s best oil territory is increasingly off limits, but the trend raises big questions about their future profitability and business model.

The profitability of gas has been undermined by huge reserves of shale gas and a supply glut after recession knocked a deep dent into industrial demand.

Many people have a stake in the future of the majors, which employ hundreds of thousands and pay out billions to shareholders.

BP Plc — whose U.S. Gulf oil spill has reopened the debate on deepwater oil access — accounts for about one pound in every five of UK dividends.

While paying lip service to renewables, majors have made little apology for their enduring commitment to hydrocarbons, but they have embraced natural gas, in line with expected demand growth, its status as the lowest carbon of the fossil fuels and its readily available reserves.

In tandem with their rising gas production, majors have pared back their exposure to the often unprofitable oil refining business. For factboxes showing the trend, please click on and

“While they don’t want to hear it, their business model as it currently exists is at risk,” said Ted Harper of U.S.-based Frost Investment Advisors, which manages $6.8 billion in assets mainly in the United States.

“They are constrained and essentially locked out of the high-impact basins of the world that remain. Their production profile is being forced to shift toward gas and away from liquids.”

While oil prices have rallied from a dip to just above $30 a barrel in December 2008 to around $70, less than half the 2008 record high of nearly $150, U.S. gas prices have stagnated around $4 per million British thermal units, less than a third of the highs above $13 hit in 2008.

“Margins in the gas business are much lower than in the oil business,” said Tony O’Reilly, chief executive of Irish explorer Providence Resources.

“And going forward, the real issue is whether shale gas productivity stays where it is now…the great unknown.”

THE QUEST FOR RESERVES

Since 2009, regulators have allowed the industry to include unconventional oil and gas as part of their proven reserves.

This has created an impression of reserves growth, but the majors face a huge challenge in gaining access to the remaining reserves of cheaply extracted conventional oil.

“Really as a group, the majors have not been able to replace reserves through the drill bit for the last decade and have relied on accessing discovered resources such as oil sands to replace reserves,” said Robert Plummer of Wood Mackenzie consultants.

The majors still have major advantages, namely technical expertise and piles of cash, which it is more logical to apply to high-risk oil and gas assets than lower risk renewables.

“Most parts of renewables are fairly simple. What advantage are you bringing?” he asked.

The remaining easy oil is in the Middle East, where it is controlled by the Organization of the Petroleum Exporting Countries and increasingly powerful national oil companies.

A potentially enormous exception to the access problem is Iraq, which last year held its first international bidding rounds since Saddam Hussein’s ouster in 2003.

But the desperation of foreign companies to get a foothold led them to agree to terms that leave scant profit margins.

SHRINK TO GROW?

Shares in integrated oil firms trade at relatively low multiples of their earnings as investors price in little growth.

A way forward could be to break the majors up, or “shrinking to grow,” along the lines of ConocoPhillips’ strategy of selling selected assets, Frost Investment’s Harper said.

“I think investors would be more willing to embrace these separate entities,” he said.

Some independent firms, who say their more agile business model is suited to the smaller scale projects readily available, have argued the majors are overvalued, but that is at odds with the analyst consensus.

On the contrary, many find BP — struggling with a multi-million dollar clean-up after its oil spill in the U.S. Gulf — has been punished too harshly. None of 37 analysts tracked by Reuters has so far rated BP anything lower than hold.

But the accident has revived controversy about deepwater drilling, which could further constrain the limited oil opportunities of the majors.

The access challenge has led some to take a second look at hydrocarbon territory in politically low-risk Europe, previously regarded as all-but exhausted.

They say technology makes older oilfields valid again and BP said it had bought stakes in Norway’s Valhall and Hod on the same day it announced a more than doubling of first-quarter net profits, driven by an oil price rise.

The seller was Total, which stands out among majors in its commitment to moving into nuclear power, as well as in joining them in increasing gas production and reducing refinery activity.

Petroleum geologist and peak oil exponent Colin Campbell, who worked on the Norwegian fields when he and they were in their youth, believes BP’s acquisition proves his theory conventional oil reserves have peaked.

“If they are reduced to trying to buy things like that, you can be sure they don’t have any other options,” he said.

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(Additional reporting by Daniel Fineren; Editing by William Hardy)

Oil major model challenged by shift to gas