Navigating in Deep Water: Greater Rewards Through Narrower Focus

Abstract

Management The deepwater oil sector is at a crossroads. Deepwater production (defined as oil produced in water depths of greater than 450 m) has had a spectacular run over the past decade as major oil companies broadened their portfolios worldwide. Global investment soared from USD 16 billion in 2003 to more than USD 70 billion in 2013, and production has more than doubled over the past 10 years to almost 6 million B/D, or 7% of the world’s total oil supply. The major oil companies have seen deep water as an attractive business that can deliver large volumes at high margins, more than offsetting its handicap of tying up immense amounts of capital and technical challenges. They have doubled down, betting on deep water across the globe: the average number of countries in which the supermajors participate, including investments made by BP, Chevron, ExxonMobil, Shell, Statoil, and Total, in deepwater projects has increased from three to seven over the past decade. In the past 12 months, however, deep water has come under new scrutiny. Even before the recent drop in oil prices, many big oil companies have been coming under pressure from investors to rein in their capital investment. Deepwater projects typically cost billions of dollars—the average cost of the 10 most recent deepwater projects in the US Gulf of Mexico (GOM) is USD 12 billion— and have been seeing sharp cost inflation in recent years, prompting companies to review them more critically, as onshore unconventional oil and other projects now appear to offer more capital efficiency. The heightened scrutiny is coming at a bad time for deepwater operations. Setting aside the inherent volatility of oil prices, a number of well-recognized trends are now in place that could seriously affect the value-creation potential of deep water over the next decade compared to its historical performance. First, costs have been increasing rapidly, and project delays are recurrent. Not only are shortages endemic for certain types of equipment, but also supply-chain constraints in certain basins are causing steep cost inflation. Second, deepwater players know from experience that pushing the frontiers of exploration into more challenging geological areas at evergreater depths farther from shore slows development and incurs higher costs: rigs need to be hired for more days to drill each well and require more support vessels. Third, oil companies also know that government requirements across the major basins are increasing and these requirements will be determining factors in the financial prospects of future projects. While the precise nature of the government requirements varies in different basins—whether it be degrees of operatorship control, local content requirements, new environmental regulations, or the share of revenue taken by governments—they all tend to reduce margins.