Concentrate on capital costs
Oct 11, 2016
Speech given by Maarten Wetselaar, Integrated Gas & New Energies Director at Shell, at a panel session on commodity prices at the World Energy Congress in Turkey on October 11, 2016.
There is no certainty on what future oil and gas prices will look like, says Maarten Wetselaar. However, capital costs is one important factor over which companies have some control. In this speech, Maarten argues that it comes down to the whole supply chain working together to create radically cheaper solutions.
Ladies and Gentlemen, good afternoon. It’s a pleasure to be on this panel.
Time is tight, so I’ll jump straight in.
As you know, oil and gas prices are ultimately determined by supply and demand, as well as geopolitics.
This means the impact of the global economy in driving future demand for oil and gas is critical when looking at prices. History tells us that weak economic growth tends to equal weak demand and tumbling prices.
Growth in supply, especially US light tight oil, also requires careful scrutiny. Ever since the oil price started to fall in June 2014, there’s been scepticism on whether US producers will survive. We’re now more than two years on, and they’ve proved resilient time and again.
Another important factor is OPEC’s focus on defending market share to maximise export revenues. On this point, I’ll leave it to His Excellency Mohammad Barkindo to elaborate.
And then there’s non-OPEC oil and gas supply. The discovery of new resources and more attractive tax regimes are among the trends which will boost the competitiveness of future supply from outside OPEC.
In the short-term, many companies are prepared to keep producing with an expectation that prices will recover. But in the long-term, prices inevitably need to cover marginal cost of production. If that doesn’t happen, supply will inevitably shrink and prices will be driven back up.
Everyone on this panel employs big brains to analyse these points. And for good reason. But the truth, painful though it is to admit, is that there’s no certainty on what future prices look like. If there were, our jobs would be a lot easier.
Look at Iran’s oil production. It’s grown quicker than many analysts expected. And what about oil supply disruptions a few months ago from Canada, Nigeria, Iraq, and Libya? Not all of these were anticipated.
In short, we can’t hope to predict all moving parts.
There is, however, one important factor relating to oil and gas prices over which companies have some control. And that’s capital costs.
The oil and gas industry has been profitable before when prices were similar to what we’re seeing today. In fact, if you go back 15 years, prices were even lower. But companies pulled through. This proves that the industry can adapt. We need to do so again now.
We need to see this time as an opportunity. And we’ve got to focus attention on ensuring our industry is competitive throughout the price cycle.
So what needs to be done? It comes down to the whole supply chain working together to create radically cheaper solutions. That means drilling contractors. It means equipment suppliers. And yes, it means companies like Shell.
Take Shell’s Stones Deepwater project in the Gulf of Mexico, for example. We fundamentally redesigned our wells by working closely with drilling contractors and oilfield services groups. And we started using lower cost practices developed by our onshore shale oil and gas team.
This collaborative effort paid off, as we reduced the planned capital cost of the wells by more than 50%. This was done chiefly by using less materials in a slimmed down well design and further reducing installation costs.
Many more efforts like this are needed.
It’s not the case that if one company wins another loses. It’s a mutually beneficial partnership throughout the supply chain.
Back to Stones. We asked our equipment supplier what clauses in our contracts were causing them headaches. They pointed out that our requirement to have backup service equipment ready to go in case of transport damage could be cut without compromising safety.
We looked at this with the supplier and figured out a way to reduce the number of service tools needed to support our projects by over a third. This, in turn, led to significant cost savings for both us and them.
Of course, if all companies in the room take such steps, some still may not be profitable if they’re not at the low part of the cost curve. So as usual it’s all about developing an edge and achieving relative cost competitiveness against you peers. I believe that’s what the acquisition of BG Group did for Shell.
The commodity price storm may well continue. But companies have always been able to respond to lower oil and gas prices in the past.
They must be able to do so again now. I’m convinced they will. It’s down to every one of us to make sure it happens.