Big exploration challenges for Shell et al

Oil Exploration Challenges

Making money in the oil industry used to be pretty simple. If you found it, you drilled it and you made a whole lot of profit.

But if John D. Rokerfeller tried his hand in the oil market of today then Standard Oil probably would have been forced to diversify away from black gold. For example, nowadays if Rockerfeller struck oil in the desert he would have had to employ a whole army of scientists and engineers to construct a huge factory capable of transforming natural gas into liquid that can be used like oil.

He would have have been horrified by the price tag.

The capital cost of Royal Dutch Shell's Pearl gas-to-liquids plant in Qatar is a cool $18 billion or more - 10 percent of its market capitalization. Like Chevron's Gorgon liquefied-natural-gas project offshore Australia, it shows what big integrated oil companies are capable of spending.

But does it have to be like this for the world's oil giants? The Wall Street Journal asks the question: Have they neglected bread-and-butter exploration for lower-risk, lower-return engineering projects?

The figures regarding the percentage of energy-sector market capitalization made up by international oil companies (IOCs) have changed significantly over the last decade. At the start of the 2000s, it stood at 70 percent.

Exploration opportunities squeezed

Today the figures are 53 percent and 62 percent, according to Sanford C. Bernstein. Shell trades at a discount of 13 percent and 36 percent respectively to the 2010 forward price-to-earnings multiples at Petroleo Brasileiro and BG Group. But their estimated five-year average output growth is 5 percent and 9 percent compared with Shell's 3 percent, around the IOC average, writes WSJ's Matthew Curtin.

As geopolitics grow ever more tense and nations become increasingly over protective of their natural resources, governments face a tough choice between security and profit. This leads to exploration opportunities being squeezed.

What IOCs need nowadays is a blockbuster discovery that can shift the odds in their favor. You only have to compare companies such as Shell and BG to see this happening. When the smaller BG struck big off the coast of Brazil and West Africa, it spent 16 percent of net cash on exploration whereas Shell spent only 3 percent.

It is about finding the right balance between high-cost, widespread exploration and waiting for the one-off drilling blockbuster.

But sometimes you simply have to speculate to accumulate.

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