The Fuse

Why Chevron’s Decision to Spend $37 Billion on the Tengiz Megaproject Makes Sense

by Nick Cunningham | July 07, 2016

On July 5, Chevron announced its decision, along with its partners, to proceed with a $36.8 billion expansion of the Tengiz Field in Kazakhstan, the world’s deepest super-giant oil field. When completed in 2022, the expansion will add 260,000 barrels per day, taking total output up to about 1 million barrels of oil equivalent per day. Chevron owns a 50 percent stake in the Tengizchevroil partnership, while Exxon (25 percent stake), KazMunayGas (20 percent), and LukArco (5 percent) control the remainder.

The approval of the $37 billion expansion is the largest final investment decision across the entire global oil industry this year, and ranks in the top three in recent years.

The approval of the $37 billion expansion is the largest final investment decision across the entire global oil industry this year, and ranks in the top three in recent years.

The Tengiz has been producing for more than two decades. Nevertheless, the expansion of Tengiz is a massive undertaking, a rare greenlight for a project of this size in today’s operating environment. With crude oil prices less than half of what they were two years ago, the era of the megaproject is fading. But as Chevron is out to prove there are still a few megaprojects left that offer large profits.

Megaprojects out of fashion

The Tengiz and Karachaganak oil fields make up half of Kazakhstan’s 1.7 million barrels per day of oil production. The discovery of these two oil fields date back to the 1970s, but it took years before the technology was developed to tap these deep, highly complex fields. High-pressure reservoirs and the presence of hydrogen sulfide require expensive and complicated production methods.

According to Rystad Energy, and reported on by Bloomberg, investment in oil fields that hold more than 1 billion barrels of reserves has been in decline since the financial crisis in 2008.

The megaprojects like those found in Kazakhstan have fallen out of favor with oil companies. That is not to say that the companies do not greenlight any megaprojects at all anymore, but only that they have become increasingly scarce, particularly since the collapse of oil prices. According to Rystad Energy, and reported on by Bloomberg, investment in oil fields that hold more than 1 billion barrels of reserves has been in decline since the financial crisis in 2008. Meanwhile, overall investment in oil fields of 300 million barrels of reserves or less has sharply increased over the same timeframe. Although large-scale investments like the Tengiz expansion make headlines, cumulative investment in small oil fields exceed that of large ones.

There are a few reasons for this. First, the megaprojects suffer from delays, cost inflation, and complexity. Chevron and Exxon do not need to look far to find an example of this problem. The Kashagan oil field, a massive offshore project nearby in the Caspian Sea (of which ExxonMobil is a stakeholder), is a monument to costly oil boondoggles. The more than $50 billion oil field is 15 years in the making and has yet to produce any meaningful volumes of oil—equipment failures, management problems, and poor execution continue to bedevil its operators. After briefly beginning operations in 2013, the Kashagan field located in the Caspian Sea was forced to quickly shut down because of corrosion to pipelines from hydrogen sulfide in the gas pipeline that connects the field to the shore. It is expected to start up later this year barring further delays.

Of course, another reason that megaprojects are becoming increasingly scarce is that there are alternatives. Short-cycle shale drilling may not offer oil companies the same volume of barrels for their books, but they allow companies to cycle cash quickly and bring production online in as little as a few weeks. Even the oil majors have refocused their operations, shifting their resources to places like Texas rather than the Caspian Sea.

Finally, the collapse of oil prices have made megaprojects too expensive to contemplate. The industry is downsizing, cutting capex and laying off personnel. Projects that cost tens of billions of dollars make little sense in this environment.

The rare megaproject that works with $50 oil

The upside to moving forward on such a massive project in a depressed market is that costs are much lower than they were in the past.

The upside to moving forward on such a massive project in a depressed market is that costs are much lower than they were in the past. Equipment suppliers and oilfield service companies have been cut down to size, and are offering discounts on goods and services. Starting today can help restrain the costs of the Tengiz expansion. “It’s a terrific time to be making this sort of investment,” said Todd Levy, Chevron’s president for exploration and production in Europe, Eurasia and the Middle East, according to The Wall Street Journal.

Moreover, it is not easy to for the oil majors to grow production. Tengiz is a rare breed these days—a super-giant oilfield not under the control of a national government, with accessible oil reserves that can deliver a profit. In addition, the expansion won’t be completed until the early part of the next decade, when in all likelihood oil prices will be higher than they are today. Chevron expects Tengiz to breakeven with oil prices at $50 per barrel, but the project’s lifetime will span decades, meaning the economics won’t be upended by short-term movements in oil prices.

Tengiz is a rare breed these days—a super-giant oilfield not under the control of a national government, with accessible oil reserves that can deliver a profit.

On top of that, Tengiz has already been hugely profitable for Chevron. Although Chevron spent a gargantuan sum to develop the field, and the expansion will cost another $37 billion, Tengiz has current production costs of just $6.50 per barrel, according to Jeffries senior oil analyst Jason Gammel. The WSJ estimates that Tengiz has delivered Chevron $70 billion in revenue, including $40 billion in profits since production began in 1993. Or, as the FT put it, Tengiz “last year accounted for 27 per cent of [Chevron’s] oil reserves, 8 per cent of its gas reserves and 13 per cent of its combined oil and gas production.” More impressively, Tengiz represented 42 percent of Chevron’s earnings in 2015.

With production costs at Tengiz one quarter of Chevron’s average cost of $16.60 per barrel across its entire portfolio, moving forward on the expansion makes sense. Chevron is currently wrapping up several other megaprojects, which gives it a bit of flexibility in regards to Tengiz. The $54 billion Gorgon LNG export project in Australia came online this year and the more than $33 billion Wheatstone LNG project will reach completion in 2017. Those projects will begin returning cash flow back to Chevron, which it will need to pay for the Tengiz expansion.

Few other megaprojects

The decision by Chevron and its partners to spend nearly $37 billion on Tengiz is not a signal that megaprojects are back in fashion. There are very few oil fields the size of Tengiz, located in countries with governments willing to work with international companies.

With the balance sheets of so many oil companies still damaged from the collapse in oil prices, investment dollars will continue to flow into smaller oil fields and shale plays. The Tengiz decision ranks as the largest investment by private oil companies this decade, and it will probably retain that ranking for quite some time.

ADD A COMMENT