Tuesday, September 14, 2004

Total Speaks Out
The Financial Times reports that Total's CEO, Thierry Desmarest, has publicly called for OPEC countries to open up access to their oil reserves for international development, in order for oil production to keep pace with global demand. Regular readers of my blog will recognize an issue I've been harping on for a while, but M. Desmarest goes beyond this to highlight a critical crossroads for the industry. I hope that the head of every oil company reads his comments, particularly those running the national oil companies in OPEC countries.

When considered carefully, his remarks point out the disconnect between the current business model of the international oil and gas industry and what is required for future oil production to keep up with growing demand, ignoring concerns about geological limits to oil production. He is saying that the international oil majors can be quite successful and profitable operating as they are, relying largely on developing their own exploration discoveries and bringing them to market, but that this will not close the gap that is now apparent between future production capacity and potential future demand.

Several key facts support his argument. First, as we've known for years, OPEC has a disproportionate share of the world's oil reserves, and these tend to be more easily produced than non-OPEC's. In addition, the price collapse accompanying the Asian Financial Crisis of the late 1990s taught oil companies that it is much riskier to overestimate future demand than to underestimate it. The latter also turns out to be enormously more profitable, as we are seeing now. M. Desmarest has omitted a third contributing factor, industry consolidation.

Part of the process of delivering merger synergies entails high-grading the exploration and production portfolios of the merging firms. That means that some upstream projects are cancelled, postponed, or sold off to companies with fewer resources. The result of the seven recent top-tier mergers that come quickly to mind must be lower aggregate oil production in the future than would have been the case without the mergers, unless you believe the survivors are going to be that much more efficient at executing the remaining projects, or at finding new ones.

So the crossroads looks like this: one branch takes the oil majors down a road of strong financial performance on a base of stable (+/-) production volumes, but risks sustained oil prices that justify lots of alternatives, while the other branch involves a number of initially less profitable ventures with OPEC countries, but keeps the industry healthy and capable of supplying all the transportation fuel the world wants for many years to come. It's a fascinating choice, especially when you start probing the criteria for making such a choice.

I think M. Desmarest is also sending a subtle message to Russia. Because their oil tends to be cost more to extract than OPEC's, they face a window of opportunity that may close when and if OPEC realizes it could produce a lot more oil, a lot faster, with outside help. Does Mr. Putin hear this clock ticking?

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