The Difference Between Shell and Barrick

Shell announced another big find in the Gulf of Mexico today.

The company's Vicksburg prospect tested 152 metres of net oil pay, at 8,000 metres deep. Vicksburg is believed to hold up to 100 million barrels. This is in addition to 500 million barrels already discovered at the next-door Appomattox target.

This is just another sign of the booming offshore oil and gas industry. In May, Petrobras set a fresh production record of 322,100 barrels per day from its offshore pre-salt play. Industry consultants Wood Mackenzie said last week they expect global deepwater oil and gas spending to nearly triple to $114 billion in 2022, from a current $43 billion.

It's interesting to compare the surging petroleum business with the sputtering mining sector. While petroleum players are rolling out billions, mining companies are slashing spending and cutting projects. Barrick said last week it will delay development of its Pascua Lama mine by at least 18 months, to mid-2016.

Why the different fortunes for these two businesses? It's not really prices. Despite having fallen recently, gold is still up about 300% from its 2001 low. Oil is about the same, currently going for 400% higher than its 2002 low of $20/barrel.

The culprit is costs. Newmont management said it best earlier this year. Noting that while gold prices have risen $1000/oz, the company's cost to produce an ounce have gone up $900. Not leaving much margin, higher prices or not.

The oil business is different. Drilling activity has been increasing steadily, with offshore rig contracting (the red line in the chart below) having risen steadily since 2011. And yet prices (the yellow line) have been more or less flat.

The difference is size.

The mining industry is a drop in the bucket compared to the oil patch. And yet excited investors have pumped billions into mining over the last decade. All that money started chasing too few mining service providers, equipment makers, and labourers.

You can see in the chart above that the oil sector can deal with investment. As rig contracting rose, so did the rig count (shown in blue). The well-developed oil services sector simply built more units. And prices were contained.

But the mining industry isn't large enough to handle mega-investment without bottlenecking. Paradoxically, what miners need now is for cash to flush out of the system. This will mean fewer projects get built. But the ones that do will be at costs where the operators can make the profit they need to stay healthy (or at least viable).

We're starting to see projects cancelled, which is the first step in the process. Keep an eye out for signs of costs coming down for the survivors.

Here's to getting things under control.

By. Dave Forest