Exploration's Role is to Create Value

Portfolios Need Prospects

For today's exploration industry, gain is the name of the game.

The buzzword is "value creation," which is the value of those discoveries versus the dollars spent to make them.

Strong oil and gas prices have focused industry attention once again on exploration opportunities. But exploration is no longer simply a matter of playing the odds by throwing money at prospects and ultimately finding substantial reserves.

Today's oil and gas firms must devise exploration plans tailored to their individual company philosophies and exercise strict discipline in implementing those plans.

That was the message that came through loud and clear recently at the AAPG Annual Meeting in Dallas — especially in a forum titled "Delivering On Our Promises: Managing E&P in the 21st Century."

For example, Andrew Latham, vice president of energy consulting with Wood Mackenzie, presented a paper titled "Value Creation Through Exploration," and discussed how the top 25 companies have fared in the last seven years in creating value through exploration.

His discussion highlighted what works — and what doesn't.

Here's some good news in his talk: The overall results of the 25 companies working in 80 different countries are positive, according to Latham. The firms spent $50 billion on exploration and created $23 billion in value (while discovering 45 billion barrels of oil equivalent of commercial reserves). That equaled an 11 percent return on their investment.

Performance was varied for the group of companies, however. Only 16 of the 25 created value, and nine companies failed to replace production through exploration, leaving 13 companies that both created value and replaced reserves.

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For today's exploration industry, gain is the name of the game.

The buzzword is "value creation," which is the value of those discoveries versus the dollars spent to make them.

Strong oil and gas prices have focused industry attention once again on exploration opportunities. But exploration is no longer simply a matter of playing the odds by throwing money at prospects and ultimately finding substantial reserves.

Today's oil and gas firms must devise exploration plans tailored to their individual company philosophies and exercise strict discipline in implementing those plans.

That was the message that came through loud and clear recently at the AAPG Annual Meeting in Dallas — especially in a forum titled "Delivering On Our Promises: Managing E&P in the 21st Century."

For example, Andrew Latham, vice president of energy consulting with Wood Mackenzie, presented a paper titled "Value Creation Through Exploration," and discussed how the top 25 companies have fared in the last seven years in creating value through exploration.

His discussion highlighted what works — and what doesn't.

Here's some good news in his talk: The overall results of the 25 companies working in 80 different countries are positive, according to Latham. The firms spent $50 billion on exploration and created $23 billion in value (while discovering 45 billion barrels of oil equivalent of commercial reserves). That equaled an 11 percent return on their investment.

Performance was varied for the group of companies, however. Only 16 of the 25 created value, and nine companies failed to replace production through exploration, leaving 13 companies that both created value and replaced reserves.

Some of the companies that have done a good job replacing reserves and creating value, according to Latham, are British Gas, Phillips Petroleum, Eni, Statoil, Petrobras, TotalFinaElf and BP.

Deepwater

Another interesting recent indicator is that major oil companies have continued to constrain exploration expenditures, closing the gap with mid-sized oil companies. Those mid-sized firms are investing in exploration at twice the relative rate of the majors, he said.

Exploration is not the only means for creating value, and Latham outlined how acquisitions by the 25 companies fared:

  • The firms spent $140 billion on nearly 170 international mergers and acquisitions from 1996 through 2002 and created $23 billion in value for a 12 percent return on their acquisition investment.
  • 16 companies created value.
  • 20 companies replaced production from acquisitions.
  • 12 companies created both value and replaced reserves.

While acquisitions certainly factor into every company's overall business plan, Latham's talk focused primarily on exploration. He noted that — not surprisingly — value creation by country also varied.

Some data:

  • The U.S. deepwater Gulf of Mexico ranks first with value creation of $11 billion from $11 billion spent on exploration.
  • Kazakhstan, by far, created the most value, almost $7.5 billion, on the least amount of exploration expenditures.
  • Angola was third in value creation at about $6 billion.
  • The United Kingdom performed the worst, with $11 billion in exploration investment, but value destruction of $2 billion.

Not surprisingly, these numbers indicate that deepwater regions and the Caspian Sea region were the premier exploration targets while exploration in onshore and shelf regions overall resulted in value destruction.

Global exploration success is now mostly from deepwater regions, he said. Deepwater accounted for 65 percent of all oil and gas discovered in 2002 and 2003, a huge jump from about 35 percent in 2001. Deepwater reserves discovered per well from 1996 through 2003 have averaged 50 million barrels of oil equivalent compared to just 15 million barrels of oil equivalent for non-deepwater exploration wells.

The good news, he added, is there appears to be plenty of life remaining in deepwater exploration regions.

According to Wood Mackenzie, six billion barrels of oil and two billion barrels of oil equivalent of gas have already been produced from deepwater plays, and 44 billion barrels of oil and 26 billion barrels of oil equivalent of gas remain to be produced. Those figures are dwarfed by the estimated 114 billion barrels of oil and 68 billion barrels of oil equivalent of gas yet to find in the deepwater plays around the world.

However, the value of deepwater reserves has declined since the mid-1990s due to several factors, including moves to higher tax regions, stranded gas, longer lead times and fewer giant oil fields.

As a result, the quality of new deepwater reserves will be a real challenge for companies.

Delivering

The outlook for exploration appears to be strong within oil companies.

A recent Wood Mackenzie survey indicated that about 60 percent of respondents said exploration can contribute to strong organic growth for the firm over the next five years, and over 60 percent said their exploration budget would be higher over the next five years.

About 55 percent of the respondents, however, said they have too few exploration opportunities in their existing portfolio.

Robert Ryan, general manager of global exploration for ChevronTexaco, used his paper ("Delivering on Our Promises: Improving the Value Proposition") to build on Latham's theme, saying that since the mid-1990s wildcat success has held steady at about 30 percent. Excluding a few giants, the average discovery size has been around 50 million barrels of oil equivalent.

The majors performed well in 1999 and 2000, but not as well as before and even less since 2000, he said. The bad news is that the average value of discoveries has fallen and overall oil discoveries from new fields have replaced only 40 percent of production.

According to Ryan, companies who seek to improve value creation:

  • Must be more efficient in execution, stewardship and technology.
  • Must have improvement in the consistency and accuracy of prospect selection.
  • Prediction is essential.
  • Exploration prospect generation must be consistent, technically driven, repeatable and measurable.

The approach to a basin, lease and then prospect must start with a technical assessment, Ryan continued, and then move through a series of steps, including:

  • Portfolio initial risk-reserves.
  • Validating risk and volumes.
  • Economic evaluation.
  • Peer review.
  • Decision review.
  • Plan endorsement.

During this workflow, Ryan said it is essential to focus on the basics.

"All of this is easier said than done," he said, "but in general we must take a global view of the opportunities. People and capital resources must be deployed in the right places on the right projects, the appropriate technology must be integrated into the exploration program, there must be a strong focus on the fundamentals and everyone from the technical teams to the executive suite must be part of the process."

This rigorous approach allows companies to align predicted and actual results, thus managing exploration appropriately, Ryan said. He noted, for example, that in 2002-03 ChevronTexaco was able to align its volumetric results, achieving 104 percent of expected gross resources and 93 percent of expected net resources.

In 2002 ChevronTexaco had a best-in-class exploration year, discovering over 800 million barrels of oil equivalent, he said.

Discipline

Of course, the approach to exploration varies dramatically from a major oil company to a mid-sized independent, as was noted in the paper presented by Henry Pettingill, director, exploration portfolio, with Noble Energy ("The View from the Middle: Risk Management of an Independent's Exploration Portfolio").

Pettingill said exploration risk analysis is critical for smaller companies because numerous studies have highlighted the challenges faced by the exploration and production industry in meeting expectations.

He pinpointed several keys to overcoming those challenges, which include:

  • Calibrate and compensate pre-drill and post drill expectations.
  • Select the best of the best. Companies have a large enough portfolio of prospects to be selective about what gets drilled.
  • Seek and capture project flexibility.
  • Fund project maturation. This allows the best targets to rise to the top.
  • Manage and communicate timeframes. A company must be willing to roll the dice repeatedly, he said.
  • Diversification with focus, not dilution. Generally a mid-sized company's portfolio needs to meet several different financial goals. For Noble, this is achieved by incorporating a mix of higher risk-higher reward projects, modest growth projects and short-term production replacement projects in its overall exploration portfolio, he said.
  • Good geology, geophysics and engineering.

Pettingill said a practitioner of risk analysis is like a reformed alcoholic: "You can conquer your weakness, but you are never cured and always one drink from relapse," he said.

"For an independent, discipline is required every day. We will not meet annual expectations with a come-and-go approach."