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The National Post: Shell story reflects a scary trend


Claudia Cattaneo

Financial Post

April 26, 2004


Energy prospectors are increasingly coming up dry


The sensational cover-up conducted by Royal Dutch/Shell Group executives to manage aggressive bookings of reserves points to a wider, even more alarming problem: The rate of oil and gas discoveries around the world has plummeted in recent years.


Many oil and gas producers are struggling to replace their production, or are even in a state of "irreversible decline," as energy investment bankers Simmons & Co. International put it.


In fact, if the low discovery trend continues, cover-ups of dwindling reserves may be the least of our problems, given a 1.5% annual increase in global energy demand over the medium term projected by the International Energy Agency.


The biggest fear -- one that markets and policy makers should really be worried about -- is that we could be facing oil shortages after 2007, as predicted by the Energy Institute in London, based on a study of all major oil projects now in the development stage.


Some food for thought: Wood Mackenzie, the British-based energy research firm that monitors global oil and gas fields, has found that the world's ten largest Western oil companies -- including Exxon Mobil Corp., BP PLC and Royal Dutch/Shell Group -- are actually finding fewer new reserves than they booked.


In fact, many are relying on reserves already found, like stranded gas and oilsands deposits in Canada and Venezuela, to boost their numbers, which "will flatter the explorers and disguise the real picture."


According to the firm, the combined commercial discoveries of the top ten, which account for a large proportion of the world's oil and gas output, rose from 1997 to 2000, peaking that year at about 13 billion barrels. Discoveries then fell sharply to about 4 billion barrels in 2001 and 3.3 billion barrels in 2002.


According to Chris Skrebowski, author of a report on the state of global reserves for the The Energy Institute: "There are not enough large-scale projects in the development pipeline right now to offset declining production in mature areas and meet global demand growth beyond 2007."


Mr. Skrebowski's study of 54 oil megaprojects, each with estimated reserves of more than 500 million barrels and the potential to produce 100,000 barrels a day, most of projects under development are scheduled for startup in the next three years, ensuring plenty of supply over that period. But only three are expected to come on stream in 2007 and another three in 2008, with no new projects scheduled after that.


Mr. Skrebowski said new discoveries have become so scarce the days of large companies having substantial reserve banks are largely over.


"Companies are putting on stream everything they got," he said in an interview. "The moment you find anything half decent, you tell the stock market, you cheer up your share price, and you rush out and start developing."


So, why is this happening? Robert Plummer, a senior analyst at Wood Mackenzie, said a major reason appears to be the 30% decline in exploration spending in the aftermath of the big consolidation wave that ended two years ago. The cut, he said, reduced companies' odds of making big finds.


"One of the fundamental basis of the big mergers was cost cutting, and the easiest way to cost cut is not to drill dry exploration wells," he said in an interview.


Another reason is that industry, thanks to technological advances, got so good at finding oil and gas all the big deposits may have been found.


"Life is now getting harder for the explorer ... there is no escaping the fact that the oil and gas are finite resources: the more that have been found the less that remain to be found," Wood Mackenzie said in a report.


Industry may also be suffering the consequences of finding huge fields in the 1990s, aided by new technologies as well as changing geopolitics that opened new exploration acreage. Having found the big prospects early on, now it's the smaller ones that remain.


Financial market pressures, too, is playing a role because of investors' dim view of exploration risk. It takes on average six years to bring a major oil discovery to production, while investors are looking for results quarter to quarter, Mr. Skrebowski notes.


To compound the problem, many new prospects are far away from major markets, making them more costly to drill and to produce. They are also located in less politically stable regions that make them less accessible. Most of the finds that could be developed in the future are in the Middle East and Russia.


Canada is both a winner and a loser from this trend. On the one hand, the Athabasca oilsands are benefiting, becoming big investment gainers, because they have no exploration risk.


But the natural gas side of the business is similarly struggling to replace production, despite spending more than it's ever had to find new fields.


Skeptics may argue that it's in oil producers' self interest to claim oil and gas resources are increasingly scarce. After all, the tight demand/supply balance is a key reason energy prices have been so robust, generating unprecedented profits for the business.


Yet companies and their managements, whose compensation is often tied to reserve additions, have an even biggest interest in boosting the size of their reserves, their main asset and the basis of stock market valuation, as shown by the schemes Royal Dutch/Shell Group executives were willing to engage in.


National Post 2004

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