The Fuse

Oil Majors Look to Smaller, Shorter-Cycle Shale Drilling

by Nick Cunningham | March 02, 2017

Just recently, ExxonMobil took about 3.3 billion barrels of oil reserves off of its books, an acknowledgement that producing Canada’s oil sands is not as viable as it used to be. With crude oil trading 50 percent lower than it was before the market downturn began in 2014, Exxon’s oil sands reserves are unprofitable.

Most oil majors are still giving the green light to a handful of complex and risky but potentially highly profitable projects offshore, while at the same time increasingly shifting more resources into safer, smaller-scale shale drilling.

 ExxonMobil is not the only big oil company rethinking its strategy. Persistently low oil prices are forcing all of them to pivot. High-cost, long-lived projects are no longer a top priority, even if those projects offer stable production and returns for years to come. Low and volatile oil prices have placed a premium on cash, with short-cycle drilling now much more attractive than the complex megaprojects of yesteryear.

The oil majors are deferring large projects and instead pouring money into shale drilling, hoping to catch up with some of their smaller peers. However, the largest oil companies still need to replace their reserves each year, which prevents them from abandoning large-scale projects entirely. As a result, most oil majors are still giving the green light to a handful of complex and risky but potentially highly profitable projects offshore, while at the same time increasingly shifting more resources into safer, smaller-scale shale drilling.

More shale spending

This week, ExxonMobil laid out its strategy to shift its sights to thousands of shale wells in Texas and North Dakota, hoping to capitalize on quick production that will recycle cash back to the company in short order. “More than one quarter of the planned spending this year will be made in high-value, short-cycle opportunities, including in the Permian and Bakken basins,” Exxon said in a press release. The oil major says it will increase capital spending by 16 percent in 2017 to $22 billion, with $5.5 billion to be spent on shale. “The company has an inventory of more than 5,500 wells in the Permian and the Bakken with a rate of return greater than 10 percent at $40 a barrel, with nearly one-third generating significantly higher returns,” Exxon’s statement read.

“The company has an inventory of more than 5,500 wells in the Permian and the Bakken with a rate of return greater than 10 percent at $40 a barrel, with nearly one-third generating significantly higher returns.”

The spending plan comes just a week after Exxon de-booked 3.3 billion barrels of Canadian oil sands reserves, wiping out 19 percent the company’s total. Moreover, in January Exxon announced its decision to spend $6.6 billion to double its acreage in the Permian basin. Taken together, the flurry of announcements in the past few weeks represents a notable shift: backing out of large-scale oil sands development while ratcheting up spending and drilling in U.S. shale.

Exxon believes the move will pay off, generating a sharp uptick in production. Exxon’s output in the Permian and the Bakken is expected to grow at a 20 percent compound annual growth rate over the next decade, with production reaching 750,000 barrels per day (b/d) by 2025, equivalent to about one-fifth of the company’s total output.

Exxon is not alone in its shift toward shale. ConocoPhillips, a company that also took more than 1 billion barrels of oil sands reserves off of its books in February, is aggressively pivoting to shale. In 2015, Conoco said that it would exit new deepwater exploration altogether, rerouting its resources to short-cycle shale drilling projects. In the fourth quarter of 2016, Conoco completed the sale of exploration blocks off the coast of Senegal, accelerating the company’s withdrawal from offshore development. The company reported better-than-expected results for the fourth quarter last year, and vowed to step up its rig count in across the Permian, Bakken, and Eagle Ford shale plays.

Chevron is also scaling up shale spending even as it cuts its total budget for 2017—a significant shift in focus toward shale. “I would expect an increase in unconventional spending,” Chairman and CEO John Watson told analysts in its January earnings call. “We’ve talked about our ramping up in the Permian— talking about $2 billion there but we easily could spend another $1 billion there. Just in the shale and tight areas you would see some increase but that’s short cycle.” Watson said that by the next decade Chevron could be allocating a quarter of its budget to unconventional shale plays.

Retrenchment for Shell

While a handful of oil majors are betting big on shale, a few of their competitors are taking different approaches. Royal Dutch Shell saw its total debt balloon to almost $80 billion last year, the second largest debt pile in the world, behind only Petrobras. Having completed the $50 billion takeover of BG Group, Shell is looking at taking a breather and slowly whittling away at its debt.

Shell also has radically transformed itself into a natural gas producer and exporter with its takeover of BG.

Shell also has radically transformed itself into a natural gas producer and exporter with its takeover of BG. Shell is now the largest LNG exporter in the world, with projects spanning the globe, exporting gas from Australia, Russia, Malaysia, Nigeria, and Qatar to name a few. Shell finds itself in a different situation from some of its peers. The Dutch major spent heavily in recent years and now is hoping to see some payback on those projects—it does not appear ready to dump more money into shale drilling. But, like other majors, it will have a much smaller appetite for megaprojects moving forward.

Large projects still key

But there are limits to this new strategy of a focus on short-cycle projects. Despite its plans for ramping up shale production, ExxonMobil, one of the largest companies in the world with a market capitalization of nearly $350 billion, won’t transform exclusively, or even predominantly, into a shale-focused oil company. In fact, Exxon made a “world-class” discovery off the coast of Guyana last year, which it believes holds more than 1 billion barrels. Exxon plans to rapidly develop the Guyana discovery, hoping to have it online by 2020. Other major projects that Exxon is pursuing include upstream investments in Far East Russia, Eastern Canada, the UAE, Qatar, and Angola. Exxon also recently closed on its acquisition of Interoil, a $2.5 billion bet on natural gas in Papua New Guinea where the major already has a large LNG export terminal.

Despite its plans for ramping up shale production, ExxonMobil, one of the largest companies in the world with a market capitalization of nearly $350 billion, won’t transform exclusively, or even predominantly, into a shale-focused oil company.

The moves highlight the urgent need for the largest oil companies in the world to replace the oil that they produce each year. Exxon replaced only 65 percent of the oil it produced in 2016, the second consecutive year of a reserve-replacement ratio less than 100 percent. “In our view, the company’s greatest business challenge is replacing its ongoing production,” credit ratings agency S&P Global said last year when it stripped ExxonMobil of its coveted AAA credit rating.

Similarly, BP gave the greenlight to several very large projects in late 2016, sanctioning the $9 billion Mad Dog Phase 2 in the Gulf of Mexico, while also spending $2.4 billion for a 10 percent stake in Abu Dhabi oil fields and a $1 billion for a stake in offshore drilling projects in West Africa. After years of shrinking as a result of the costs of the Deepwater Horizon disaster in 2010, the British oil giant is hoping to grow again—and it is doing so mostly through large-scale offshore projects rather than shale.

Majors appear poised to pursue a sort of two-track approach: moving forward on a handful of the most attractive billion-dollar offshore projects while also using a larger portion of their budgets on shale drilling.

As a result, even as shale is now a high priority for the oil majors looking for quick paybacks, tight oil drilling can’t entirely replace the reserves on their books. As a result, they appear poised to pursue a sort of two-track approach: moving forward on a handful of the most attractive billion-dollar offshore projects while also using a larger portion of their budgets on shale drilling.

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