The End of Big Oil

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When historians one day dissect the long arc of humankind's use of fossil fuels, they may very well zero in on October 9, 2006, as a turning point for Big Oil. That's when it became clear that the major oil companies--the giants that had survived numerous predicted extinctions and gone on to ever-greater profit and influence--were undergoing a tectonic shift and would either reinvent themselves or die. It's the day Moscow dashed the hopes of five major oil companies from three countries and announced that Russia itself, and not they, would develop the biggest new natural gas field on the planet, an undersea Arctic reservoir called Shtokman.

Shtokman is the oilman's Angelina Jolie: much-coveted but out of reach. Experts believe it contains the carbon fuel equivalent of 23 billion barrels of oil--that in an industry that considers a field of one billion barrels gigantic. Shtokman alone contains sufficient energy to power all of Europe for several years, and the world's big oil companies had sought rights to it for years.

In another time, Russia's declaration that its natural gas behemoth, Gazprom, would develop such a field would have set off peals of laughter among Western oilmen. Gazprom lacked the know-how to keep production at its current fields from declining; how would it manage a technological feat under the deep, icy waters of the Barents Sea? But there was nothing humorous about Russia's plans. Gazprom knew it wasn't capable of drilling the field; instead, it planned to hire Big Oil to do so. Big Oil would be its employee.

That notion flew in the face of oil-industry orthodoxy, which says that big potential profits accrue to those who assume big risks. If a company developed an oilfield, it was rewarded with the gold star used by Wall Street to measure oil company value--the rights to "booked reserves," in industry parlance. Booked reserves consist of how much oil and natural gas a company controls, and thus can sell at some point at, say, $95 per barrel or $260 per 1,000 cubic meters. The Securities and Exchange Commission measures booked reserves, and investors regard them as the main determinant of a company's fundamental worth. Yet now Gazprom was suggesting stripping the Western oil giants of that incentive--they would be unable to book Shtokman's natural gas. The industry's mood has become even more somber over the last half-year as two European companies--France's Total and Norway's StatoilHydro--actually agreed to Russia's terms.

The truth is that any of the oil majors--with the possible exception of Exxon Mobil--eventually would have. Why? Because oilmen know that, despite recent unprecedented profits-- Exxon alone reported a record $11.7 billion in net income for the fourth quarter of 2007--they are on the decline. The combined booked reserves of the world's biggest five companies have shrunk by almost 20 percent per year on average since 1999, according to a paper by Rice University's James A. Baker Institute for Public Policy. Shtokman is a blueprint for how the major oil companies are increasingly being treated around the world. Today, state oil companies and ministries from countries like Venezuela, Saudi Arabia, and Russia control somewhere between 80 percent and 90 percent of the world's known oil and natural gas reserves. And, over the next two decades and beyond, those countries are going to ask foreign oil companies to serve as their contract employees in the same way that Gazprom brought on Total and Statoil.

Big Oil, then--the indomitable giant symbolized by the pitiless John D. Rockefeller--is dying. At the very least, it will soon have to fundamentally change the way it does business. But the shock of Shtokman is merely a tremor compared with the coming transition to a non-carbon energy economy. Big Oil could transcend its current woes and weather that revolution-- perhaps even lead it--if it reinvented itself as Big Energy, striving to develop renewable power sources like wind and solar, or even to deliver the industry's holy grail: a clean energy mechanism that renders fossil fuels obsolete. True, no one yet knows what the revolution will look like; but the odd thing is that, for the most part, the oil companies don't seem to care.

The irony of the events at Shtokman, and the lesson to be learned from them, is that the former Soviet Union represents Big Oil's last hurrah. It's there that the major oil companies have rushed over the last two decades and been permitted access to several of the world's biggest oil and natural gas fields. When the companies arrived in the late '80s, it was amid their last industry-threatening crisis.

Back then, a Houston man named Tom Hamilton was BP's new chief for international exploration. Hamilton is a paunchy, slow-talking, professorial Ohio native with a PhD in geology. When he inspected the company's books, he saw that it was in deep trouble. Its bank of oil reserves had fallen from 70 billion barrels to 4 billion barrels, partly as a result of a wave of nationalization that had swept away some or all of BP's oil supply from six different countries, including Libya, Iraq, and Kuwait. Hamilton foresaw a similar future in the British company's actual sales--the prospect that current production of 1.5 million barrels per day would decline below 900,000 barrels a day within just a few years, a 60 percent drop in its key marketable commodity. In Hamilton's view, that wasn't just the fault of OPEC politics. BP itself had become complacent in the fat years, the 1960s and '70s, and excessively fearful of drilling a dry hole, he thought.

Worse, at the same time that the company recognized its supply problem, it also realized that it lacked the in-house skill to rectify it. Over the years, BP had retired too many of its expert oil trackers, the seasoned hands who seemed able to divine where to drill on little more than intuition. Now the company mostly had younger geologists, who relied too heavily on often-imperfect technology.

The problem plagued BP's rivals as well. The era's petronationalism confused the industry, and, to stabilize profits, many companies tried to diversify and expand the kinds of business they did. In those years, BP went into animal feeding and breeding; Mobil bought the Container Corporation of America and the Montgomery Ward department store chain; Exxon made office machines; and, though it eventually dropped the idea, Gulf Oil actually agreed to buy the Ringling Brothers/ Barnum & Bailey Circus. A raft of mergers broke out, as well: Chevron paid a then-record $13.2 billion in cash for Gulf, and Texaco acquired Getty Oil for $10.2 billion. Then, in 1985 and 1986, oil prices plummeted from more than $31.50 a barrel to less than $10, and the mass firings began.

At BP, Hamilton was appointed to head a study of the most important oil-field discoveries in the industry's entire 140-year history, the aim being to track how the company had reached its current crisis. With a team of some 30 men, Hamilton inspected a Los Angeles field struck in 1887; Texas's famous Spindletop, which hit in 1901; Venezuela's Maracaibo Basin, which delivered a giant in 1914; the massively prolific Arabian Basin, which yielded its first reservoir in 1932; and West Siberia, which produced a gusher in 1961. In all, they examined more than 1,000 fields. The result was a report titled, "The Way Ahead," whose chief finding was that BP, like its rivals, had a habit of spending large sums for ever-smaller pieces of proven oil regions. Such methods were safe--there was little danger of drilling a dry hole--but they would never produce sufficient volumes to turn around the company. The group stressed an odd fact regarding discovered oil basins: Many held far less than one billion barrels, and some possessed far more than three billion barrels, but few were in between. In other words, oil fields were either monstrously large or relatively small. Hamilton's group proposed that BP aim only for super-giant fields in previously unexplored parts of the world.

BP's competitors reached similar conclusions. The firm now called Amoco resolved to penetrate what it labeled "breakthrough countries." A company report from that time discussed the virtue of trying to secure deals in oil-rich countries by overcoming existing political, economic, or legal obstacles. Chevron, concluding its own "Global Basin Study," watched to see if any such territory opened up. Under the microscope were Latin American countries, Arab nations that had previously nationalized Western holdings, and so-called "rogue states," such as Libya and Iran, which were off-limits to American companies because of U.S. law.

But the Soviet Union, with enormous known reserves trapped behind the Iron Curtain, led everyone's list. So, when Soviet leader Mikhail Gorbachev invited the Western oil companies to take a look around in the hopes of reviving the country's economy, the companies poured in. In 1990, Hamilton flew into Kazakhstan to inspect its super-giant Tengiz oilfield, which could build up BP's reserves by some 9 billion barrels of oil. After a sumptuous 2 a.m. meal of jellied camel tendons and fermented camel's milk, he and his colleagues got a few hours' rest before being invited to gather in front of a snooker table. As the BP men watched, their hosts unfurled enormous rolls of paper containing the geological outlines of the northeast Caspian Sea. Scrutinizing the data, Hamilton suddenly saw the lines of a huge, previously undiscovered offshore reservoir. He and his companions thanked the Kazakhs and suggested they take a break. "Holy shit," Hamilton blurted out when they were alone. "These were Ray Charles kind of structures--a blind man could see what they were."

Hamilton didn't end up securing rights to those fields for BP; instead, he moved on to Azerbaijan, on the west side of the Caspian. There, BP eventually booked a 34 percent share of a 5.6-billion-barrel oil region offshore from the capital of Baku.

Hamilton, who left BP and is currently a private wildcatter, sees parallels between then and now. But he doesn't expect the industry to explore its way out of its current crisis. Big Oil has been so talented and lucky, he says, that it's already found almost all the world's easy crude. What's left is a slew of much smaller fields--those reservoirs of fewer than 1 billion barrels of oil--and therefore far more expense and difficulty in amassing the volume of energy needed to supply the world economy. At the same time, he thinks it will take two or three decades before any alternative fuel can substitute for oil. So the question for Big Oil, he says, is, "How do you build a bridge to something else? How do you transition? What might that bridge look like?"

There are several ways in which Big Oil could reinvent itself-- or at least pretend to reinvent itself. One of the most probable is, in essence, a ruse: To hide the fact that they are shrinking, the major companies could attempt to persuade Wall Street to stop evaluating them by barrels of oil and cubic meters of natural gas and instead look at the pure profit they can muster by managing and financing projects. Big Oil could argue that its ability to take on the most difficult jobs, such as drilling in deep, offshore fields, is worth the same multiple on earnings that Wall Street is currently paying. But there is little appetite on Wall Street for such brazenly self-interested changes. And, indeed, one might ask whether one can plausibly argue that "Exxon, project-completion company" is worth the same as "Exxon, company with 23 billion barrels of oil and natural gas." It's hard to imagine the stock market according the companies the same value, since it's hard to imagine profits being the same.

That is why it seems more likely that Big Oil will pursue a different tack: merging with national oil companies--such as Brazil's Petrobras, Russia's Gazprom, or Qatar Petroleum--and thereby sliding right back into the slipstream of high profit. At least one member of Big Oil has already explored this idea. In 2003, Chevron and Russia's Yukos completed an agreement that would have resulted in Chevron being heavily influenced by two Russian oligarchs: Mikhail Khodorkovsky and Roman Abramovich. According to a senior Russian official, the plan was for the two Russian energy giants they controlled, Yukos and Sibneft, to first merge. Then that company would have joined with Chevron. The resulting behemoth would have been American, but the two oligarchs would have owned 20 percent of Chevron's shares. (Chevron declined to comment.)

The courtship between Chevron and Yukos has been public knowledge for some time, but not how transformational the plan was, nor that it was basically a done deal, one actually approved by Russian President Vladimir Putin. In the end, it collapsed when Putin and Khodorkovsky fell out and the former threw the latter in prison. The Yukos-Sibneft agreement, too, unwound, and, in an ugly aftermath, the companies were largely subsumed by Gazprom and Rosneft, another state-owned Russian oil firm.

Nevertheless, in some ways the deal could serve as a model for future mergers: Yukos and Sibneft were interested in Chevron because of its cash, its established reputation, and its far-flung refinery-and-retail network. But Big Oil will need to accept that it is in a real bind--reserves and stock prices may need to crater--before it cedes substantial control to a national oil company.

Ultimately, the only Big Oil company left standing in 20 years may be the one that wholly reinvents itself. The future of energy, after all, lies not in hydrocarbons like oil and gas, but in cleaner fuels that emit fewer greenhouse gases or in some other transformational technology. Unfortunately, that is about all we know about the future of energy right now. Hydrogen fuel cells and cellulosic ethanol could someday replace oil, but neither has proved workable yet. Indeed, there is a considerable chance that we will be surprised by both the timing and the substance of the post-carbon revolution.

One would expect that Big Oil would be trying to unmask the nature of that revolution so that it could be the one driving and, more importantly, profiting from it. But neither the oil companies nor the world's energy experts seem to think this leap forward is on the horizon. Recently, Fatih Birol, the much-respected chief economist at the Paris-based International Energy Agency, suggested that it "may be too optimistic" to expect a discovery any time soon of a clean-energy mechanism that replaces fossil fuels. In a November appearance at the Council on Foreign Relations in New York, Birol said he expects improvements in energy efficiency "but no major surprises in the next twenty years."

That's a remarkable statement, given the technological breakthroughs of the last two decades--and given the hundreds of billions of dollars that would accrue to the inventor of an energy breakthrough. Silicon Valley certainly doesn't agree with Birol: Venture capitalists are pouring money into the competition to invent a technology that would be as significant as the transistor. It would be insane to presume to predict a winner. But the revolution is likely to come from one of the high-tech corridors in India, China, Europe, or the United States; the research arms of associated industries, like auto manufacturing; or the laboratories of Big Oil.

I myself have put much store in the latter-- because the oil companies have the most to lose. In particular, I've focused on Exxon, with its disciplined and ostensibly forward-thinking 25-year plan. Within the bowels of the world's largest publicly traded company, I've imagined, a group of energy nerds surely sits, cooking up some new, new thing. But, if it is, Exxon Chairman Rex Tillerson is doing a mighty head fake. In speeches and remarks to shareholders in recent months, the Exxon chief has aggressively argued that the carbon world is not changing--that oil will rule the planet until at least 2030. And it's true that the world is so dependent on oil that, even if a technological breakthrough happened today, we would require decades to adapt to its use. Until then, oil would remain king.

Where Tillerson's confidence begins to assume the worrying character of ancient Rome is on Exxon's role in that future. While some of the oil majors may die in the new world of national oil companies, he argues, Exxon won't be among the victims. Why? Because it's more financially disciplined and technologically equipped than anyone else. "If everyone were equal, if all of us had the same technology capabilities and the same know-how, then it would just be a straight up bidding war. You know, I'll give you ten, and the next chap says, 'I'll give you eleven,'" Tillerson told the Financial Times last summer on Exxon and its rivals' efforts to book new oil reserves against competition from majority state-owned companies. "But we're not all equal, and most of the host governments recognize that we're not all equal."

This argument misses the point. The national oil companies know that the West has technology they need. But, in most cases, they can bring in oil service companies like FMC, Schlumberger, and Parker Drilling to develop their fields for them. And, in the minority of cases where they need to bring in the majors and confer reserves upon them, they will grant Big Oil a miniscule position, not the large share to which it is accustomed. There simply will not be sufficient reserves for Big Oil--including Exxon--to maintain its size.

Exxon's final line of defense is its toughness--it simply won't be pushed around. Russia is an example: In addition to the European concession at Shtokman, Big Oil rivals Shell, BP, and Total have been forced over the last year to surrender their majority positions in other key oil and natural fields to Russian companies. Yet, so far, an Exxon project called Sakhalin-I has been exempt from contract revisions. Tillerson maintains that Sakhalin-I's contract will continue to be honored because Exxon won't contribute its technological know-how unless it is. But, eventually, Russia will treat Exxon as it has everyone else and demand revisions, and, eventually, Exxon is likely to accept those demands--as it recently did in Kazakhstan, where it agreed to make the state an equal partner in the super-giant offshore Kashagan oilfield.

Will Exxon be a major player in the energy world beyond 2030? On the record, at least, Exxon isn't hedging its bets. Its publicly released research focuses on carbon fuels. Last February, at the industry's leading annual event, the Cambridge Energy Research Associates conference, Tillerson maintained the standard line: Two trillion barrels of conventional oil sources are left on the planet, and Exxon will find and produce those, not make "moonshine," as he calls biofuels. Nor is he interested in developing a successful formulation of cellulosic ethanol: "There is really nothing I see Exxon can bring to this."

What about the other members of the Big Oil fraternity? On paper, Shell is aggressively pursuing company reinvention. It is taking dual stabs at cellulosic ethanol and hydrogen fuel cells--and speaks enthusiastically about both becoming commercial in the next couple of decades. Still, Shell maintains that fossil fuels will be the world's main fuel source 50 years from now. By then, Shell as we know it today will not exist. BP and Chevron are behaving little differently.

From an outsider's perspective, it is difficult to fathom such obstinacy. A whole raft of factors--including the natural instinct to self-preservation and the possibility of enormous profit--is pushing Big Oil to become something else. But the culture of the industry--a macho tradition that is resistant to change--seems to refuse to countenance evolution, even when the alternative is extinction. Such an attitude may seem absurd, but, of course, this phenomenon has a long history in American capitalism: A friend reminds me that U.S. steel and automobile companies also had much advance notice of impending doom but opted to ignore the barbarians just over the hill. In that case, perhaps Houston will soon look like Detroit.

Steve LeVine is the author of The Oil and the Glory: The Pursuit of Empire and Fortune on the Caspian Sea. He blogs at www.oilandglory.com. This article originally ran in the February 27, 2008, issue of the magazine.

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