Many of the successful companies of the 21st century had two things in common. Firstly, they were visionary. They accurately understood, early on, what the future of their industry would look like, what big business opportunities for success were hidden in that future, and what kind of company they would need to become to capture those opportunities ahead of the competition.
Secondly, they were driven. They relentlessly pursued becoming the “company of the future” in their industry, innovating in areas such as technology, management practices and corporate culture.
This description will lead most people to think of tech-companies like Apple, Google and Facebook. However, the supermajors of the oil industry deserve to be included in the list.
During the 1990s the supermajors realized that a growing global demand for crude oil would eventually lead to the world running out of “easy-to-find-and-develop” crude oil. And thus, that the future of their industry would be about “tough oil”, crude oil in remote locations, difficult to access and hard to develop, such as the (ultra)deep-water regions of the Gulf of Mexico and West Africa, and the Canadian tar sands.
Consequently, they worked hard to develop the scale and capabilities necessary for meeting the unique engineering, project management and financing challenges such development projects would require. They merged or bought up smaller competitors. And they became hierarchical, process and procedure oriented, focused on detailed planning and disciplined execution, in order to excel at the management of complex, multi-billion dollar and multi-year projects in the harshest of terrains.
For oil investors the question is whether this operating model will remain the recipe for success. This will depend on a number of factors.
Crude oil demand growth
According to the IEA, at present, crude oil demand is around 95 million barrels per day. By 2040 demand is forecasted to grow to 104 million barrels per day, an increase of 9 million barrels per day. The amount of new oil that will need to be found and developed between now and 2040 is much greater than this, however, as production from existing fields declines over time.
Again according to the IEA, the longer term average for the natural decline rate is 6.2 percent per annum, or some 6 million barrels per day. Continued investment in enhanced oil recovery techniques can reduce the decline to 3 to 4 million barrels per day, but this still means the oil industry will need to find at least 4 million barrels per day of new production per day, every year, until 2040.
Sources of supply growth
The IEA believes crude oil production from conventional fields peaked (sometime around 2006). Consequently, future new production will need to come from unconventional sources. This no longer implies just (ultra)deepwater and tar sands, however. Innovations in (horizontal) drilling and hydraulic fracturing have made development of tight oil reservoirs an option as well.
According to WoodMackenzie, amongst the different unconventional options, tight oil reservoirs can be the most cost-effective. As tight oil is also the area where most innovation to reduce operating costs is taking place (production has already been reduced dramatically over the past year), it is well under way to becoming the preferable unconventional resource globally.
For this reason investment in deepwater development has been cut hardest in response to the fall of the oil price, and the supermajors ConocoPhillips and Chevron announced that they now prefer opportunities in tight oil over (ultra)deepwater.
Tight oil potential
Today, tight oil production is a little over 4 million barrels per day, essentially all of it in the U.S. Because of the abundance of tight oil reservoirs globally, production has the potential to increase to 20 million barrels per day by 2035.
Tight oil production techniques have also been proven effective as quaternary recovery technique for conventional fields. One estimate holds that if adopted globally these techniques could reduce the natural decline in conventional oil production by a further 20 million barrels per day by 2035.
The winning operating model in the future
All this means that the ability to apply tight oil production techniques effectively and efficiently around the globe will become critical for success in the crude oil industry. This has important implications for the ideal operating model.
While the supermajor operating model has proven successful in the area of development, it has put them at a disadvantage when it comes to other areas such as exploration. Tight oil development and production is another area where the supermajor operating model is sub-optimal, as indicated by ExxonMobil’s surprise decision to not incorporate the shale producer XTO into its hierarchy, policies and procedures when it acquired the company in 2009, but rather allow it to operate essentially on a standalone basis. (Which is the complete opposite of what happened when Exxon acquired Mobil back in 1999…).
Essentially, ExxonMobil realized that its operating model cannot compete in the world of tight oil. The operating model of the successful tight oil producers in the U.S. is about being nimble, agile and quick to respond. Their operations are based around teams, where the different players take on different roles on an as-needed basis, instead of a hierarchy with clearly defined roles and responsibilities. And the objective of these teams is not to diligently execute a detailed plan according to policies and procedures, but to deliver the required results however they may deem fit, leaving substantial room for continuous, controlled experimentation.
That said, it is unlikely that all the future growth in crude oil demand will be met by tight oil opportunities. Undoubtedly, new sweet spots will continue to be found in other areas of the “tough oil world” as well.
Consequently, the future winners in the oil industry will most likely be the companies that have the ability to excel in both kinds of operations, i.e. the tight oil operations where success is dependent on fast improvisation and innovation, as well as the “tough oil” operations where success depends on detailed planning and discipline.
By Andreas de Vries and Aarn Wennekers for Oilprice.com
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