The death of cheap oil
As the world struggles with the inflationary issues of oil heading towards US$130 a barrel, investors must focus on the opportunities this event throws our way.
There are supply issues supporting a long-term oil price above US$75 per barrel. Globally, maturing onshore oilfields can turn from low to high cost within just a few years.
When the giant fields in Saudi Arabia were young, they had individual wells with flow rates of between 40,000 and 80,000 barrels of fluid a day – virtually every drop was oil. Processing requirements were minimal. This level of production has not only fallen between 2,000 to 5,000 barrels of fluid a day, but the content has changed dramatically.
As an oil field matures, the reservoir pressure drops, allowing surrounding subterranean water to 'invade' the reservoir. This pressure drop may also prompt drillers to inject water, usually seawater, into the reservoir in order to maintain its pressure, thereby 'driving' the oil to the surface. To avoid contaminating the fragile water table, the injected water is normally desalinated, requiring costly desalination plants to be built.
The contamination of water creates a water and oil mix (water cut), which must be cleaned using a Gas and Oil Processing Plant (GOSP) at additional cost, before being sent through to a refinery. The older the well, the lower the reservoir pressure, the greater the water cut, the higher the cost.
This is one of the many factors that has pushed the cost of extraction in Saudi from $2 to $75 a barrel and this situation is echoed globally as many of the once giant, cheap producing oilfields have already peaked. With no major onshore oilfield discovery since 1975, there are few cheap drilling options replacing them.
In addition, companies are not producing enough of this 'expensive' oil. The industry uses a measure called the Reserve Replacement Ratio (RRR) - the number of proven reserves divided by the number of barrels being sold.
If the number is below 1, then they are not finding enough oil to replenish what they have sold. Industry RRRs have fallen from 1.3 in 1996-2000 to 0.9 organic RRR in 2007.
Offshore fields
The few onshore options available mean the industry must develop offshore fields. There are three ways in which the oil industry can address the issue:
*Companies can discover new resources by supporting providers of seismic equipment and 'exploration know-how'.
*The industry can improve extraction techniques. This favours sub-sea engineering companies, sub-sea equipment, manufacturers and companies that are involved in well maintenance and Enhanced Oil Recovery (EOR).
*The current 'economic conditions' have improved significantly, with the long-term oil price forecasts well above the investment 'hurdle rate' for many deep sea projects. This is extremely positive for oil service companies' order books and visibility of earnings.
As exploration moves into deeper and harsher environments, a new industry is being developed. This necessitates innovation in equipment design and expertise in extreme engineering – niches that the Norwegians are particularly adept in. These new designs and challenges are very evident.
Over-supply is not yet apparent. Visibility is high and deep sea rig supply looks tight until 2016, positively implicating demand for the entire oil services sector.
