Big spenders the outlook for the oil and gas industry in 2012

In a 2011 report by the Economist Intelligence Unit, commissioned by GL Noble Denton, 76% of our survey respondents said they were either highly or somewhat confident about the business

© The Economist Intelligence Unit Limited 2012

The outlook for the oil and gas

About this report

Big Spenders: the outlook for the oil and gas industry

analyses the oil and gas industry outlook from the point

of view of top-level operators, including CEOs and other

board-level executives and policymakers The report has

been commissioned by GL Noble Denton

The Economist Intelligence Unit bears sole responsibility

for the content of this report Our editorial team

executed the survey, conducted the interviews and wrote

the report The findings and views expressed do not

necessarily reflect the views of GL Noble Denton

Our research drew on two main initiatives:

A global survey of senior executives was conducted in

October and November 2011 In total, 185 executives took

part, representing a cross-section of firms in the oil and

gas industry These executives were very senior: one in

three respondents were CEOs or managing directors They

represented firms ranging in size from less than US$500m

in revenue (76 executives) to more than US$500m (109)

A series of interviews was carried out with leading

industry figures between October and December 2011

Interviewees and other contributors are listed here

We would like to thank all those who participated

in the research

Interviewees and other contributors:

Thomas Ahlbrandt*, former vice president of exploration, Falcon Oil & Gas

Marc Albers*, senior vice president, ExxonMobil

Thomas P Barney, chief economist, Marathon Petroleum Corp

Steve Chazen*, chief executive, Occidental Petroleum

Jean-François Cirelli*, vice chairman and president, GDF Suez

Fereidun Fesharaki*, chief executive, FG Energy

Hamid Gayibov, managing director, Xenon Capital

Andrew Gould*, chairman, Schlumberger

Simon Henry, chief financial officer, Shell

Jaap Huijskes, executive board member responsible for exploration and production (E&P), OMV

Bill Day, corporate communications manager, Valero

Bill Klesse, CEO, Valero

David Knox, chief executive officer, Santos

Helge Lund, chief executive, Statoil

John Richels*, chief executive officer, Devon Energy

Christof Ruehl, chief economist, BP

Carl Sheldon, chief executive officer, Abu Dhabi National Energy Corp

Jon Tait, head of global attraction, BP

Donald C Templin, senior vice president and chief financial officer, Marathon Petroleum Corp

Mehdi Varzi, president, Varzi Energy

Gonzalo Velasco, communications manager, Repsol

*Comments from these executives were obtained from conferences and company conference calls.

Key findings from the Economist Intelligence Unit’s survey of oil and gas industry professionals

A look at the industry’s investment plans for the year ahead

After a tumultuous couple of years for the sector, how are attitudes to risk evolving?

Implications from a year of turmoil in the Arab world

Oil and gas industry confidence is rising In a 2011 report by the Economist Intelligence Unit, commissioned by GL Noble Denton, 76% of our survey respondents said they were either highly or somewhat confident about the business outlook for their company over the next 12 months This time around, that figure has grown to 82% Backing this up, we find a large rise in the share of respondents who describe themselves as highly confident about the next 12 months Only 8% of respondents describe themselves as pessimistic about the outlook for 2012

This optimism does not mean that executives are sanguine about the industry’s prospects, however Rising costs and increasing regulation are both big concerns Moreover, the outlook for the global economy remains deeply uncertain and, if economic conditions deteriorate, oil and gas companies will have to scale back their spending commitments accordingly.

Executive summary

© The Economist Intelligence Unit Limited 2012

Increased optimism will feed through into capital

spending increases According to our survey, nearly

two-thirds (63%) of respondents are planning to

invest either somewhat or substantially more over the

next 12 months, whereas in last year’s survey that

figure was just 49% There has also been a shift in

where companies see the greatest opportunities for

revenue growth Last year South-east Asia came top of

the pile, with North America second, the Middle East

and North Africa third and the Far East fourth This

year the rankings have changed, with North America

top, the Far East second, South-east Asia third and

Latin America fourth

Rising operating costs emerge as the main barrier

to growth When questioned in detail about costs,

more than 50% of respondents say that they expect

an increase in wages over the next 12 months

The second-biggest concern is the rising cost of

contractors, with 54% expecting costs to increase,

compared with only 11% anticipating a decline

The upstream remains the core focus for spending

A majority of respondents identify the upstream as the

key area for business growth in 2012, meaning that

exploration will be a major beneficiary of increased

investment Our survey shows that 41% of industry

professionals expect to see increased investment

in exploration activities over the year, with only 4%

anticipating a decline

Risk remains a key challenge. A combined 55% of

respondents confirm that in the aftermath of the 2010

oil spill in the Gulf of Mexico, drilling permits have

become harder to obtain Even more decisively, an overwhelming majority of respondents (82%) agree that in the post-Macondo period regulatory issues have become more important The survey shows that increasing regulation is regarded by more than 30% of respondents as the main challenge for their company over the next 12 months, exceeded only by the impact

of rising operating costs and the shortage of skilled professionals

Unconventionals have revolutionised North America’s gas sector, but progress has been much slower elsewhere The advent of projects such as

the Marcellus, Barnett, Haynesville and Fayetteville shales has created a supply glut that has affected global prices Development has been slower elsewhere because the “perfect storm” that made shale gas a scalable reality in the US is not as powerful in other geographies

There is some scope for optimism for refiners After a

dismal few years the downstream sector is showing some signs of life, at least in the US Refining profitability has improved in the US, where robust margins have resulted from a revival of consumption of refined products But Asia and Europe remain in the doldrums

Skills shortages are becoming more acute According

to our survey, this will be one of the major barriers to growth over the next 12 months Last year skills issues came fifth on our list of barriers and were only identified

as a top-three issue by 25% of respondents This year the issue has risen to second on the list and has been identified as a key barrier by 34% of respondents

Key findings

The oil and gas industry barometer

Findings from the Economist Intelligence Unit’s survey

of oil and gas industry professionals

• Optimism is high across the industry

• The biggest challenges are rising costs for both labour and contractors.

• Skills shortages are a growing concern and regulation has remained a key issue.

• The Far East (including China, Japan and Korea) has emerged as the key area for revenue growth, leapfrogging three places from last year’s survey.

• In the aftermath of the 2010 Gulf of Mexico oil spill, executives are pessimistic about the regulatory impact.

Key points

1

How confident are you about the

business outlook for your company

in the next 12 months?

Highly pessimistic

Figures for 2011 were collected at the end of 2010.

Figures for 2012 were collected at the end of 2011.

industry confidence is rising In last year’s survey 76% of respondents said they were either highly or somewhat confident about the business outlook for their company over the next 12 months; in this year’s survey, that figure has grown to 82%

As figure 1 shows, most of the increase is attributable to a large rise in the share of respondents who describe themselves as highly confident about the next 12 months Only 8% of respondents say they are pessimistic about the outlook for the coming year

Optimism is high across the industry, but confidence levels vary significantly between regions In North America 90% of respondents describe themselves

as highly or somewhat confident, in Asia-Pacific the figure falls to 81%, and in Europe it drops to 70% (see figure 2)

Increased optimism looks set to feed an expansion in capital expenditure during 2012 According to our survey, nearly two-thirds (63%) of respondents are planning to invest either somewhat or substantially more over the next 12 months, whereas in last year’s survey that figure was just 49% (see figure 3)

Our poll also shows that there has been a shift in where companies see the greatest opportunities for revenue growth Last year South-east Asia (including India) came top of the pile, with North America second, the Middle East and North Africa third and the Far East (including China, Japan and Korea) fourth This year the rankings have changed, with North America top, the Far East second, South-east Asia third and Latin America fourth

(see figure 4 for the full rankings)

There has also been some rebalancing in expectations about which part of

© The Economist Intelligence Unit Limited 2012

the industry is likely to be the strongest source of business

growth over the next 12 months Upstream activities were

the most popular choice for this question last year, and they

have become even more heavily favoured this year, with

the share of people selecting this option rising from 42%

to 56% Downstream activities are also expected to provide

a stronger source of growth than last year, rising from 10%

to 14% Meanwhile, marketing has declined significantly,

falling from 22% to 8%

Continued challenges

Of course, growing optimism about the future does not

mean that companies are sanguine about the challenges

they are likely to confront For the second year running,

rising operating costs come out as the top barrier to growth

in the industry (see figure 6) When questioned in detail

about costs, more than 50% of respondents said that they

expect an increase in wages over the next 12 months The

next-biggest concern is the rising cost of contractors, with

54% expecting costs to increase, compared with only 11%

anticipating a decline

One of the issues businesses seem to be getting more

concerned about is a shortage of skills Last year, skills

issues came fifth on the list of barriers, and it was only

identified as a top-three issue by 25% of respondents This

year 34% of respondents think skills shortages are going to

be a big problem, placing the issue second in importance,

behind rising operating costs Similarly, access to finance

appears to be a growing concern for the industry, rising from 7th to 4th in the list of top 10 issues

Regulation remains a key concern, coming third on this year’s list of barriers to growth When asked about regulation directly, more than 82% of respondents agreed that regulatory issues have become more important since the Deepwater Horizon disaster in the Gulf of Mexico in

2010, and 55% of them think that obtaining drilling permits has become more difficult in the aftermath of Macondo

Does your company plan to make more or less capital investment in dollar terms over the next 12 months? Select one

(% respondents)

North America

How confident are

you about the

business outlook

for your company

in the next 12 months?

(% respondents)

Source: Economist Intelligence Unit

Figure 3

Invest substantially more (At least 25%

annual increase)

Invest substantially less (At least 25% annual decrease)

Invest somewhat more

Invest somewhat less

Keep investment the same as before

Which sgment of the industry do you expect to see the strongest business growth in the next 12 months?

Select one. (% respondents)

Which of the following regions do you think will offer the greatest opportunities for your business in terms of revenue growth over the next 12 months?

South-east Asia (including India) 32 % North America 36%

North America 30 % Far East (including China) 31%

Middle East and North Africa 29 % South-east Asia (including India) 29%

Far East (including China) 26 % Latin America 26%

Latin America 23 % Middle East and North Africa 23%

Australasia 10 % Western Europe (including Scandinavia) 12%

Source: Economist Intelligence Unit.

Figure 4

Rising operating costs, including insurance

Rising operating costs, including insurance

Increasing regulation 30 % Shortage of skilled professionals 34%

Limited new areas for exploration 25 % Limited access to capital/finance 23%

Shortage of skilled labour 25 % Limited new areas for exploration 20%

Increasingly limited areas of “easy” production 20 % Competitors 20%

Limited access to capital/finance 16 % Public backlash/litigation over environmental

© The Economist Intelligence Unit Limited 2012

If your company is involved in exploration, does it plan

to increase or decrease the frequency or intensity of its exploration activities over the next 12 months? Select one

(% respondents)

• Investment intentions have risen significantly.

•Exploration is looming as a key spending growth area for a number of oil companies.

• While most companies expect a supportive price climate, smaller firms may be more exposed to weaker prices.

• National oil companies appear particularly bullish about raising capital expenditure in 2012.

• There is no evidence yet that the euro zone crisis will have a major impact on investment.

Despite the difficult economic climate and fears of recession

in the euro zone, the oil and gas industry is showing a growing

sense of confidence about the future investment outlook

More than four-fifths of respondents (82%) say they are either

highly or somewhat confident about the business outlook for

their company over the next 12 months Translating this into

corporate action, a significantly larger share of companies than

last year (63% this year compared with 49% last year) say their

firm plans to increase investment over the next 12 months

Upstream activities are seen by the majority of respondents

as the key area for business growth over the next year, so it

should come as little surprise that exploration will be a major

beneficiary of this increased investment Our survey shows

that 41% of industry professionals expect to see increased

investment in exploration activities over the course of 2012, with

only 4% anticipating a decline (see figure 7)

Reflecting differences in demand and infrastructure

requirements, however, expectations about capital spending

vary across regions In the Asia-Pacific area 72% of survey

respondents predict an increase in capital spending, compared

with only 55% in North America and 57% in Europe

The desire to invest also varies between companies Majors like

Shell are in active spending mode The company has taken 16

new final investment decisions since the start of 2010 for more

than 400,000 barrels of oil equivalent per day of new production

As spending ramps up on these and other projects, it expects

that overall capital spending levels will increase as well The

major growth themes for Shell include deep water in the Gulf

of Mexico, liquefied natural gas (LNG) in Australia, tight gas

in North America, traditional plays in the North Sea, and its worldwide exploration programme

In general, the Anglo-Dutch supermajor sees a robust demand outlook for oil and gas, and host governments and regulators are supportive of Shell’s plans to invest for new energy supplies “The thinking tends to be long-term – many years or even decades in our industry, rather than driven by short-term factors,” says Shell’s chief financial officer, Simon Henry

0

Big spenders The outlook for the oil and gas industry in 202.

Upstream activities are seen by the majority

of respondents as the key area for business growth over the next year, so it should come as little surprise that exploration will be a major beneficiary of this increased investment Our survey shows that % of industry professionals expect to see increased investment in exploration activities over the course of 202, with only %

anticipating a decline (see figure 7)

Reflecting differences in demand and infrastructure requirements, however, expectations about capital spending vary across regions In the Asia-Pacific area 72% of survey respondents predict

an increase in capital spending, compared with only 55% in North America and 57% in Europe

The desire to invest also varies between companies Majors like Shell are in active spending

l Investment intentions have risen significantly.

l Exploration is looming as a key spending growth area for a number of oil companies.

l While most companies expect a supportive price climate, smaller firms may be more exposed to weaker prices.

l National oil companies appear particularly bullish about raising capital expenditure in 202.

l There is no evidence yet that the euro zone crisis will have a major impact on investment.

Key points

Somewhat decrease

Significantly decrease

If your company is involved in exploration, does it plan to increase

or decrease the frequency or intensity

of its exploration activities over the next 12 months? Select one.

Significantly increase

Stay the same

Bullish in the US

The oil majors are generally more confident about the investment

outlook than their smaller rivals Over the next two years the

US firm ConocoPhillips plans to execute a US$28bn capital

programme, almost 90% of which has been allocated to

exploration and production (E&P) supporting the company’s

100%-plus reserve replacement target

In geographical terms, the US is absorbing the largest amounts

of capital in the current market According to Barclays Capital, it

pulled in 21% of US$529bn in global E&P spend in 2011, with the

capital commitment of US$110.7bn representing an 18% increase

over 2010 spending levels

Companies with large international portfolios are in the midst of

ambitious capital expenditure (capex) programmes Occidental

Petroleum, the fourth-largest US oil and gas company, revealed

a 56% increase in 2011 capital spending to US$6.1bn, which

will increase further as the company proceeds with its extremely

capital-intensive Shah sour gas development in the UAE offshore

with Abu Dhabi National Oil Co (Adnoc)

Big spending from NOCs

Meanwhile, many national oil companies (NOCs) also look likely

to go on spending in 2012 In Europe, Norway’s giant Statoil will

continue to invest at a high level, “to mature our attractive portfolio

and realise our strategy for growth towards 2020”, according to

the company’s CEO, Helge Lund And in Russia, Rosneft has said

that it will boost its investment programme for the year by 35% to

approximately US$15bn as part of its push to upgrade refineries

In South America, Brazil’s market-leading giant Petrobras is planning a 24% increase in spending, much of it focused on its deepwater reserves in the Atlantic, and Mexico’s state-owned oil company Pemex is also lavishing large sums on an expanded offshore drilling programme

There is, however, evidence of a more cautious approach in the Middle East For example, Carl Sheldon, the CEO of Abu Dhabi National Energy Company (TAQA), sees the company spending US$2bn in 2012, a small increase on the previous year:

“Essentially we have a capital spending programme that started

in 2010 and goes up to 2013 For each of those years we’ll spend roughly US$2bn each year in five major programmes – drilling in Western Canada, drilling in the North Sea, the Bergermeer gas storage project in the Netherlands and two power projects in Morocco and Ghana.”

Like other companies, TAQA is prepared to cut spending should the price climate become less inviting “If prices went south

in a big way it is pretty easy for us to toggle our Canadian expenditure down, because we drill a lot of wells in the onshore

We drill 70-100 wells a season in Canada, whereas in the North Sea we might drill just 8-12,” says Mr Sheldon

The threat of another major downturn in the global economy could see this happening, warns Hamid Gayibov, the managing director of Xenon Capital Partners, which advises

on Russian energy merger and acquisition (M&A) deals “I do see there being some increase in capex, and the momentum

is there However, there is big uncertainty regarding the global oil market, and if there is a major dislocation in the global economy, we could see the oil price collapsing and fundamentals continuing to weaken In that event there will be little incentive for Russian oil companies to increase investment.”

This sense of caution contrasts with the generally positive view

of industry fundamentals outlined by the international majors

Statoil’s Mr Lund, for example, argues that the industry remains fundamentally attractive, with energy demand growing

The overall message is that for those plays where the economics are supportive, oil companies will continue to spend big in

2012 There remains a big caveat, however: if global economic conditions were to foment, oil and gas companies, whether big

or small, would have to scale back their spending commitments

in those areas where they can do so without creating damage to their wider portfolio

Does your company plan to make more or less capital

investment in dollar terms over the next 12 months?

(% respondents)

Source: Economist Intelligence Unit

Invest substantially/ somewhat more

© The Economist Intelligence Unit Limited 2012

Risk is integral to the investment process in the oil and gas

industry As the supply-demand gap drives oil companies

towards resources that are more difficult to develop and

increasingly located in politically challenging terrain, the risk

challenge is gaining in intensity

Our survey bears out the sense of heightened risk and

regulation A combined 55% of respondents confirmed that

in the aftermath of the 2010 oil spill in the Gulf of Mexico,

drilling permits have become harder to obtain Even more

decisively, an overwhelming majority of respondents (82%)

agree that the in the post-Macondo period, regulatory issues

have become more important

From the secular trends shaping the industry – the steady

move into deep water, the tapping of tight hydrocarbon

formations – to the “black swan” events like the Deepwater

Horizon disaster of April 2010, oil companies must confront

an environment where risk is far more prominent

“The outlook for upstream is shifting as the reserve

base addition is becoming increasingly complex and

unconventional Complex hydrocarbons make up

approximately 85% of the world’s total yet-to-find resources,

and conventional resources are increasingly hard to access

for international companies,” says Mr Lund

More than 18 months after the Macondo oil spill, the disaster

still casts a shadow over the industry through raised risk

aversion, heavier financial commitments and a stronger

regulatory footprint in the Gulf of Mexico and beyond

Despite the lifting of the moratorium on drilling in the Gulf, activity had not returned to pre-Macondo levels by end-2011 Ironically, given the location of the Macondo disaster, the countries named by the largest number of respondents as having the most favourable regulatory climate in which to operate in 2012 are the US and Canada, at a combined 23% However, North America also comes top of the list of regions expected to see an increase in regulation over the next 12 months, with 69% of respondents forecasting an increase in

Africa is another region where regulation is increasing In South Africa, for example, the government has imposed a moratorium on exploration in the semi-desert Karoo region amid strong opposition to the use of hydraulic fracturing in drilling activities there In Nigeria, the Petroleum Industry Bill threatens to impose a range of increases in taxes and royalties, as part of a wider overhaul that includes reform of the state oil company

Above-ground risks increase

Many of the regulatory bugbears are familiar The oil industry has been heavily regulated for years, more than the natural

• Across the board, oil companies confront a wider array of risks

• The post-Macondo environment has seen operators seeking to offload risks onto contractors.

• In the context of troubled finances, governments are seeking to tax the industry more heavily.

Key points

Risky business

How are oil companies’ attitudes to risk evolving?

3

gas sector “Oil prices are higher for ‘above-ground’ reasons,”

says Christof Ruehl, chief economist at BP “It is because of

politics, and the cartels.” Reflecting this, our survey shows

that increasing regulation is regarded by more than 30% of

respondents as the main challenge for their company over

the next 12 months, exceeded only by the impact of rising

operating costs and the shortage of skilled professionals

New sources of risk

Issues like Macondo will also exert a lasting impact because

of the ways in which governments and oil companies must

now formulate new responses to mitigate or disperse the

heightened risk profile

Companies acknowledge the necessity of instituting greater

remedial measures to prevent the recurrence of such events

For example, large oil companies, including BP, ExxonMobil,

Shell, Chevron and ConocoPhillips, joined forces in 2011 to

spend US$1bn to establish the Marine Well Containment

Company, a new entity that will respond to blowouts and spills

in the Gulf of Mexico

For Andrew Gould, the chairman of the oilfield services group

Schlumberger, the post-Macondo industry shakedown has

created new sources of risk: “Post-Macondo there are many

oil company lawyers who consider it their duty to pass the

catastrophic risk horizon arising from an incident like Macondo

off onto the contractors In the past, there has always been

a tacit bargain that catastrophic risk, except in cases of gross

negligence, was a risk that belonged to the operator – because

the operator held the resources and therefore had the upside

if things went right But a lot of lawyers are now trying to break

that model.”

Tax and spend

Tax is another pressing issue, identified as the main challenge

by 17% of respondents The growing tax burden is one

by-product of the global economic crisis For example, the UK

government, strapped for cash, has identified the country’s

maturing offshore oil and gas sector as a revenue source that

should be squeezed

It announced in March 2011 that the supplementary charge

on corporation tax would be increased from 20% to 32%,

resulting in a tax rate on UK oil and gas production of between

62% and 81% The lobby group Oil & Gas UK estimates that

the unexpected tax change has rendered marginal 30% of investment in projects previously considered likely to proceed

in the next decade

Despite this, the UK government announced 46 new licenses for North Sea exploration in early January 2012, including awards for the French major Total, suggesting that the impact

of the tax change might not be as significant as some had feared

Nevertheless, industry insiders remain hostile “In an era when the government has to adopt far-reaching austerity measures, this was a quick way of hitting a constituency that doesn’t have any votes,” says Mr Sheldon of TAQA, which has a number of production assets in the Brent system of the North Sea

“However, in the long run it was not a very well through thing to do Hopefully they will take a more pragmatic approach going forward and will try hard to incentivise further investment in the basin - and understand that is not going to come from the supermajors.”

thought-The political risk premium

Inconsistent regulatory approaches remain a cause of consternation across the industry, with broad agreement among industry leaders on this point Jean-François Cirelli, the vice chairman and president of GDF Suez, told the European Autumn Gas conference in Paris in mid-November 2011 that EU regulations were creating an unstable investment climate that was discouraging essential energy investments

“Governments do not hesitate to take decisions that are not totally based on economic rationale,” he said “European political risk has become a major concern to energy companies and investors and will clearly impede our ability to invest in Europe.”

This concern about the damaging effects of government action

is widely shared The largest US refiner, Valero, is keeping

a close eye on is the implementation of California’s carbon dioxide cap-and-trade regime, known as AB 32 Rules have been approved and will start taking effect in 2013 “We believe this will be very costly to Californian consumers and the state’s economy, and will have no impact whatsoever on overall carbon levels or climate change,” says Valero’s corporate communications manager, Bill Day

© The Economist Intelligence Unit Limited 2012

Few oil company executives could have anticipated the

collective shock to the system that would unfold in the Middle

East and North Africa (MENA) region in 2012

The Arab Spring, still a work in progress in early 2012, will leave

a substantially altered political and economic landscape

According to our survey, however, there is unlikely to be a

significant near-term impact on MENA host government polices

towards international oil companies (IOCs) Approximately

one-quarter of our survey respondents (25.9%) believe that

government and/or NOC policies towards IOCs will become more

restrictive, whereas about one-fifth (20.5%) think they will

become more favourable, and nearly four out of ten (37.3%)

think approaches will be broadly unchanged

In an attempt to thwart the spread of the uprisings into the

Arabian peninsula, major MENA oil producers such as Saudi

Arabia have massively ramped up social spending, and with

it the oil price they need to balance the state budget The kingdom, which at the end of 2011 was pumping nearly 10m barrels/day (b/d), has seen its target budget figure rise

to above US$90/b, as it seeks to increase revenue to fund additional US$130bn in spending programmes aimed at raising living standards for ordinary Saudi citizens

Arab Spring’s mixed results

Yet the direct impact of the uprisings on the oil and gas sector

is mixed There has been some collateral damage: the sporadic sabotage on the main Egypt-Israel gas export pipeline is a by-product of the security vacuum that affected Egypt in the wake

of the Arab Spring; Yemeni gas exports have been disrupted; and the Syrian regime’s robust response to its domestic protests has triggered a ban on Syrian oil exports from the EU

Despite the disruptions, the short-term effect on oil and gas markets was smaller than initially feared Global markets were broadly able to cope with the Libyan oil and gas outages, with sufficient spare capacity to prevent sharp price increases – helped along by dampened demand in Europe and a surfeit of global LNG

Increased security in key oil- and gas-producing areas is one obvious consequence for oil companies “As of now we have 540 security consultants working for Schlumberger, 440 of these in Iraq And I suspect we will have 100 in Libya by year-end,” says the chairman of Schlumberger, Mr Gould

• Ongoing political unrest in the Middle East and North Africa (MENA) will have long-term, rather than short-term, impacts on the oil and gas sector.

• Governments affected by the Arab Spring are under pressure to increase spending and drop subsidy reforms.

• Security will remain a key concern for IOCs active in MENA.

• Pressure on Iran could have a starker impact on oil and gas markets in 2012 than the Arab uprisings.

Key points

A new energy politics

Implications from a year of turmoil in the Arab world 4

The Arab Spring will take time to settle,

but it will bring with it a lot of opportunities

because one reason it happened is that

many of these countries have young,

growing populations with rising expectations

You cannot contain those expectations –

they have to be met

Carl Sheldon,

chief executive officer, Abu Dhabi National Energy Corp

And now, the upside…

But some senior oil executives disagree with the notion that

the Arab Spring is necessarily bad for business Those in strong

regional positions believe the Arab Spring will ultimately offer

growth opportunities TAQA is active across the region, with a mix

of properties in oil, gas and power and water sectors

“The Arab Spring will take time to settle, but it will bring with it a

lot of opportunities because one reason it happened is that many

of these countries have young, growing populations with rising

expectations You cannot contain those expectations – they have

to be met And within that bunch of expectations is economic advancement – better living standards, access to clean water, power, better economics,” says Mr Sheldon

The Arab Spring is far from over, and 2012 will see continued political risk impinging on oil company strategies in the Middle East-North Africa region In the long term, industry fundamentals will reassert themselves more strongly Says Mr Sheldon: “The upheaval and lack of certainty make it harder to put a lot of money at risk quickly, but over time, as things stabilise, the basic dynamics will be the same, whoever leads.”

© The Economist Intelligence Unit Limited 2012

The shale revolution has transformed the US natural gas

market over the past five years in a way few could have

imagined, dramatically altering the supply landscape and

depressing gas prices The rapid development of projects like

the Marcellus, Barnett, Haynesville and Fayetteville shales has

created a ripple effect that has spread across the global energy

industry In Europe, Poland and Ukraine have emerged as a

focus for shale gas exploration Even oil and gas companies

with no exposure to unconventional energy sources have been

affected by its speedy rise

The scale of the ramp-up bears examination A decade ago,

gas from shale accounted for barely 2% of US natural gas

production Today it is approaching 30% and rising The price

impact has a significant bearing on the industry The surge in

production has forced domestic natural gas prices to plummet

below US$4/m Btu (British thermal units), considered too

low to justify many large investment projects The advent of

substantial domestic gas supply has rendered a number of

North American LNG projects uneconomic, with majors like

ExxonMobil spending billions building LNG receiving terminals

that may never reach their intended capacity

Despite these signs, our latest survey shows that 53% of

respondents worldwide think that gas prices are set to rise

over the next 12 months

Talking ‘bout a revolution

The foundations of this unconventional “revolution” were laid

in the US, where advances in technology such as horizontal drilling and hydraulic fracturing have dramatically increased production Unconventional US output soared to 10bn cu ft/day in 2010, around one-quarter of the country’s total By

2035 this proportion could rise to one-half, according to the

US Energy Information Administration

Oil companies active in this terrain acknowledge the transformative impact of unconventionals on the industry, particularly natural gas “We are in the midst of a structural revolution There are now three times the number of gas wells being drilled compared to oil wells The debate is no longer,

‘are we running out of gas?’ The debate is, ‘do we now have 100

or 200 years of gas supply in the US?’,” says Thomas Ahlbrandt, the former vice president of exploration at Falcon Oil & Gas.North America’s unconventional revolution rests on a confluence of favourable factors — a “perfect storm” in the words of one executive Most important is the strong geological resource base, estimated by the US Energy Information Administration (EIA) at 862,000bn cu ft Also important are the US’s provision breaks, a stable regulatory regime, private ownership of mineral rights and the existence

of a strong service industry

• Unconventional gas is now approaching 30% of total US natural gas output, transforming the global supply situation.

• Production of 10bn cu ft/day of unconventional US gas will continue to depress gas prices.

• Shale plays are economically competitive to develop, though not unanimously so.

• European oil companies are cautious about prospects for developing unconventional resources in Europe.

• Unconventional projects will absorb a larger proportion of corporate capex in 2012.

Shale plays are proving a magnet for oil companies In

the Eagle Ford play, 1,010 permit applications were filed

to drill into the Texas play in 2010, a ten-fold rise on the

previous year In 2011 it attracted more than 2,000 permit

applications

“North America has seen the bulk of the activity so far, since

that region has a well-developed oil services industry – rigs

and crews – and an extensive pipeline network to move the

products to market,” says Shell’s Mr Henry

“At Shell, we are looking into the opportunity worldwide,

including interests in China, eastern Europe, South Africa

These plays need to be drilled to delineate the potential, and

the industry at large will need to build up the services and

pipeline infrastructure in these new regions,” he adds

However, some senior executives caution that shale plays

may not be as economically competitive as advocates make

out – highlighting the point that unconventionals is one area

where oil industry consensus is distinctly lacking “Over time,

if you look at the marginal cost of producing shale in volume,

only the very best properties in the big shales in Haynesville,

Barnett and Horn River can be produced for US$4 Everything

else is in the range of US$5.5 to US$6,” says Mr Sheldon

America alone?

There is widespread doubt as to whether the unconventionals revolution can be exported outside North America The perfect storm that made these developments scalable realities in the US is not evident in other geographies

Furthermore, the technologies that made the rapid US advance possible – horizontal drilling and fracking — have drawn increasing criticism Governments, such as that of France, are seeking drilling moratoriums Meanwhile, there is concern that the depletion rates of unconventional fields are far faster than those of their conventional counterparts

Whereas US-focused players are notably bullish about unconventional plays, European industry executives are notably more cautious “Unconventional gas, and especially shale gas, was a game changer in the US gas industry

Operations in Europe are far less mature, and Europe has seen only a couple of exploration wells targeting shale gas,”

says Jaap Huijskes, executive board member responsible for E&P at OMV

Slow progress

Europe’s unconventional developments will advance at a slower pace than those in North America “No significant production contribution is expected within this decade, as

Figure 9

How do you expect natural gas prices (as per Henry Hub or European benchmarks) to change over the next 12 months?

(% respondents)

9

© The Economist Intelligence Unit Limited 202

times the number of gas wells being drilled compared to oil wells The debate is no longer,

‘are we running out of gas?’ The debate is, ‘do we now have 00 or 200 years of gas supply in the US?’,” says Thomas Ahlbrandt, the former vice president of exploration at Falcon Oil & Gas.

North America’s unconventional revolution rests on a confluence of favourable factors — a

“perfect storm” in the words of one executive

Most important is the strong geological resource base, estimated by the US Energy Information Administration (EIA) at 862,000bn cu ft Also important are the US’s provision breaks, a stable regulatory regime, private ownership of mineral rights and the existence of a strong service industry.

Shale plays are proving a magnet for oil companies In the Eagle Ford play, ,00 permit applications were filed to drill into the Texas play in 200, a ten-fold rise on the previous year In 20 it attracted more than 2,000 permit applications

“North America has seen the bulk of the activity

so far, since that region has a well-developed oil services industry – rigs and crews – and

an extensive pipeline network to move the products to market,” says Shell’s Mr Henry.

“At Shell, we are looking into the opportunity worldwide, including interests in China, eastern Europe, South Africa These plays need to be drilled to delineate the potential, and

© The Economist Intelligence Unit Limited 202

times the number of gas wells being drilled compared to oil wells The debate is no longer,

‘are we running out of gas?’ The debate is, ‘do we now have 00 or 200 years of gas supply in the US?’,” says Thomas Ahlbrandt, the former vice president of exploration at Falcon Oil & Gas.

North America’s unconventional revolution rests on a confluence of favourable factors — a

“perfect storm” in the words of one executive

Most important is the strong geological resource base, estimated by the US Energy Information Administration (EIA) at 862,000bn cu ft Also important are the US’s provision breaks, a stable regulatory regime, private ownership of mineral rights and the existence of a strong service industry.

Shale plays are proving a magnet for oil companies In the Eagle Ford play, ,00 permit applications were filed to drill into the Texas play in 200, a ten-fold rise on the previous year In 20 it attracted more than 2,000 permit applications

“North America has seen the bulk of the activity

so far, since that region has a well-developed oil services industry – rigs and crews – and

an extensive pipeline network to move the products to market,” says Shell’s Mr Henry.

“At Shell, we are looking into the opportunity worldwide, including interests in China, eastern Europe, South Africa These plays need to be drilled to delineate the potential, and

© The Economist Intelligence Unit Limited 202

times the number of gas wells being drilled

compared to oil wells The debate is no longer,

‘are we running out of gas?’ The debate is, ‘do we

now have 00 or 200 years of gas supply in the

US?’,” says Thomas Ahlbrandt, the former vice

president of exploration at Falcon Oil & Gas.

North America’s unconventional revolution

rests on a confluence of favourable factors — a

“perfect storm” in the words of one executive

Most important is the strong geological resource

base, estimated by the US Energy Information

Administration (EIA) at 862,000bn cu ft Also

important are the US’s provision breaks, a stable

regulatory regime, private ownership of mineral

rights and the existence of a strong service

industry.

Shale plays are proving a magnet for oil companies In the Eagle Ford play, ,00 permit applications were filed to drill into the Texas play in 200, a ten-fold rise on the previous year In 20 it attracted more than 2,000 permit applications

“North America has seen the bulk of the activity

so far, since that region has a well-developed oil services industry – rigs and crews – and

an extensive pipeline network to move the products to market,” says Shell’s Mr Henry.

“At Shell, we are looking into the opportunity worldwide, including interests in China, eastern Europe, South Africa These plays need to be drilled to delineate the potential, and

© The Economist Intelligence Unit Limited 202

times the number of gas wells being drilled compared to oil wells The debate is no longer,

‘are we running out of gas?’ The debate is, ‘do we now have 00 or 200 years of gas supply in the US?’,” says Thomas Ahlbrandt, the former vice president of exploration at Falcon Oil & Gas.

North America’s unconventional revolution rests on a confluence of favourable factors — a

“perfect storm” in the words of one executive

Most important is the strong geological resource base, estimated by the US Energy Information Administration (EIA) at 862,000bn cu ft Also important are the US’s provision breaks, a stable regulatory regime, private ownership of mineral rights and the existence of a strong service industry.

Shale plays are proving a magnet for oil companies In the Eagle Ford play, ,00 permit applications were filed to drill into the Texas play in 200, a ten-fold rise on the previous year In 20 it attracted more than 2,000 permit applications

“North America has seen the bulk of the activity

so far, since that region has a well-developed oil services industry – rigs and crews – and

an extensive pipeline network to move the products to market,” says Shell’s Mr Henry.

“At Shell, we are looking into the opportunity worldwide, including interests in China, eastern Europe, South Africa These plays need to be drilled to delineate the potential, and

© The Economist Intelligence Unit Limited 2012

activities are at best at the technical pilot stage,” says

Mr Huijskes, whose company has access to interesting

unconventional acreage in Central Europe, Tunisia

and Pakistan

“E&P is, however, by its very nature, a long-term,

capital-intensive and risky business It is definitely too early to

say if commercial production of unconventional gas/shale

gas in Europe is possible,” says Mr Huijskes

Look East

China has been talked up as a major future source of

unconventional developments with estimated reserves

at 1,275trn cu ft – greater even than North America’s

combined 1,250trn cu ft Beijing held its first shale gas

licensing round in June 2011, with several exploration

blocks awarded to domestic companies

“China will develop shale gas, but it will take time,”

says David Knox, the CEO of Santos, which is developing

unconventional gas projects in Australia to serve the

Asian market

In Australia, the speedy development of coal-bed

methane to LNG export projects promises to make the

country the world’s biggest exporter of unconventional

gas However, broader issues of licence to operate

are a consideration for the companies tapping its

unconventional gas base

“What is challenging in Australia is the enormous

ramp-up [in gas production],” says Mr Knox, whose company,

Santos, is the sponsor of the large-scale Gladstone LNG

project, processing coal seam gas (CSG) into LNG “The

larger onshore footprint of gas production does raise

challenges for our industry One of the concerns we

must address and manage is overland access and water

production At Santos we are committed to developing

CSG to co-exist with local communities and with

agriculture The environmental regulations are also very

onerous – but that is valuable to us as well, as we can show

to communities that we are heavily regulated.“

Unconventional capex

Inflation is having an impact, particularly in the new unconventional plays that are revolutionising the industry In the US, E&P companies have responded to inflation in the oilfield services sector with steadily rising capex spend on liquids-rich plays such as the Permian and Eagle Ford basins in Texas, and the Bakken in North Dakota

The migration to liquids-rich projects has served to heighten competition for staff and equipment on these fields The result is that companies are factoring in much larger capex spend in 2012 The chief executive of Apache, Steven Farris, says his company saw cost inflation on the scale of 10% to 15% in the oil-rich Permian Basin in West Texas and New Mexico during the first quarter of 2012 For the industry as a whole this could lead to 10-12% growth

in spending in the next 12 months in the region and high single-digit increases annually through to 2015

Strong project economics has incentivised greater spend

on shale plays compared with conventional natural gas projects, which are still compromised by the generally weak price environment for gas

Hess, a significant US integrated company active in the Bakken shale, is meanwhile spending nearly half of its US$7.2bn capital budget on unconventional development,

up from 16% two years ago With Bakken production alone expected to more than triple to 120,000 b/d by

2015, Hess sees unconventionals contributing 40-50% of its production and reserve growth over the next five to seven years

Despite the rapid advance of unconventional energies in North America, its capacity to transform the long-term global natural gas supply picture is still unproven The horizontal drilling and fracking technologies that have brought these volumes of unconventional gas on stream remain highly controversial And the conditions that have made these projects viable in the US are not easily replicated in other geographies Time will tell as

to whether the reality of unconventional gas will ever live up to the hype