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The oil and gas business has undergone a fundamental shift in industry structure in recent years. Peter A. Davies, chief economist at BP, recently observed: "The most remarkable characteristic relating to the oil industry is probably the fact that its industrial structure remained largely intact for some 70 years or so, despite a wide range of global changes in markets, geopolitics, and technology. This period of constancy appears to have come to an abrupt end during 1998-99."
As the economic forces driving this change continue, the industry as we have known it will become less and less recognizable.
Four main factors account for the change:
* The increasing difficulty of finding new reserves to replace declining production from mature producing areas.
* The concentration of worldwide reserves in a handful of state-owned companies and their gradual emergence as viable competitors--both as newly privatized entities and as expanding government operations.
* The spread of technology to developing countries.
* Deregulation of energy markets, with the resulting competitive pressure on prices and the integration with other energy commodities, particularly electricity.
There are some predictable consequences as these changes continue and quicken. One is that large integrated oil companies (majors) that have for many years served as operators on large projects will much more frequently be nonoperators on large international projects.
In that circumstance, they should be keenly interested in seeing that the operator-oriented Joint Operating Agreement (JOA) so widely used in their domestic projects does not become the standard governance vehicle for their international projects.
At present, the Joint International Operating Agreement (JIOA) adopts man of the JOA's operator-favoring provisions. Looking forward, we believe even majors will be better served by a revised JIOA that is more balanced.
Economic forces at work today
Perhaps the most obvious change in the oil and gas industry in recent years has been the flurry of mergers among the industry's largest firms. The past 3 years have witnessed the marriages of Amoco Corp. and Atlantic Richfield (ARCO) to British Petroleum Co. PLC (BP); Mobil Corp. to Exxon Corp.; and Petrofina SA and Elf Aquitaine SA to Total SA. Smaller mergers occurred between regional subsidiaries of Shell Oil Co. and Texaco Inc. and between Ashland Oil Co. and Marathon Oil Co.
The primary rationales for these combinations have been the desire to reduce costs and increase capital.
For the most part, these firms represent the historically dominant integrated firms. Along with consolidations, many have shed activities such as chemicals, coal, and minerals mining, and even downstream activities such as refining and gasoline retailing.
Clearly, such firms see the future of oil and gas exploration and production as one that will require focus and low costs to assure competitive viability.
They are right to adopt that belief. Exploration for oil and gas reserves has in recent years turned to ever more remote and costly locales. After more than a century of worldwide exploration, most of the low-cost fields have been discovered, and many are largely depleted.
New, more-expensive production areas must replace mature fields, Today, wells are drilled in ever more difficult and inaccessible areas. Wells are deeper than a generation ago, and the cost of finding large, new reserves is rising accordingly. These trends can be seen in a gradual but long-term increase in US drilling depth and a sharper rise in US drilling costs over the last 6-7 decades (Fig. 1).
Technological advances, particularly 3D seismic imaging and horizontal drilling, have somewhat reduced cost and risk for any given well, but the overall trend is toward. larger, deeper, and more-expensive projects (Fig. 2). Moreover, for US-based companies, the shift to exploration and marketing overseas means increased political risk.
In today's energy world, E&P companies compete with a growing number of newly privatized entities and government-controlled enterprises. In addition, prices and margins will be set in an international market that quickly incorporates and reflects supply additions and demand shocks, not only for oil and gas but also for related energy products such as electricity.
In that environment, not only must overhead costs be held to a minimum, but the consequence of errors will be magnified. Companies with large, expensive projects that fail to achieve expected reserve or cost targets will be penalized.
Increases in depth and finding cost, political risks, and competitive pricing all serve to make joint operations among several firms on a single project more attractive. Such joint operations serve to spread those risks and thereby reduce the impact of errors on any individual participant.
Such risk-sharing can only be accomplished, however, if the terms under which joint operations are carried out reflect a mutual, predictable …