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Can producers adapt and collaborate in order to grow?

Stakeholders are calling for a radical change of behaviour in order to achieve an outcome that's beneficial for all

In some ways, the upstream oil and gas industry is its own worst enemy, from the perspective of achieving its full commercial potential. Producers of hydrocarbon resources bring them to market at a higher cost than theoretically achievable – only to find that other people have got there first with their lower-carbon alternatives, such as nuclear power and renewables.

True, there are plenty of companies who are merging or forming strategic alliances that will help them accomplish the same objectives more cheaply than otherwise, or bring within financial and technical reach those projects that are beyond the capability of a single entity.

And from the other side, there are many places where no amount of cooperation will help because the situation on or under the ground, owing to anything from civil war to bad geology, is simply too risky, even with the benefit of partners sharing the risk.

But one enduring factor is the majors’ hard-wired pursuit of competition, which means not only doing a job better or more smartly than anyone else through proprietary technology or innovative trading, but even stopping a rival from doing it at all. This killer instinct is fine up to a point. But taken too far, it is a self-defeating exercise as it limits the amount of resource for sale, with the attendant impact on the all-important matter of the price.

As one executive remarked at the Offshore Europe 2015 conference, companies do not promote individuals for being nice to their counterparties, but for putting one over a rival. In the North Sea and elsewhere, this rivalry has had outcomes that do not suit today’s regulators.

The old, state-owned British Gas field-specific contracting model is a case in point. In the days when it was a monopsony it would nominate maximum delivery rates from fields operated by third parties that it had good reason to suspect were on unscheduled maintenance. That allowed it to collect heavily on the penalty payments. This was standard operating practice and an accepted part of the give-and-take offshore. Doubtless its sellers similarly used contracts to extract more value than the mere price per therm.

But more recently, disputes in the UK over third party access rights and infrastructure tariffs have been protracted for long enough to lead newcomers to quit. No gas flow, no cash flow. And also in the UK, contracts that were drawn up to suit buyers and sellers in one set of circumstances in the last century now can thwart another outcome that would benefit more stakeholders overall in this one.

Contracts of course are contracts and a lot more money will have to change hands before the problem can be sorted out, but until these dilemmas are resolved there will be less oil and gas in the market than otherwise. That in turn could in extreme circumstances lead to higher wholesale prices, making the fuel less competitive; and harm the treasury. That is not so funny when national security of supply is thrown into the mix and there is a regulator able to impose fines.

And taking that argument further, gas – in particular, but oil too – is facing competition from other fuels that are now – thanks to great leaps forward in technology – affordable even without heavy subsidies. The lessons of the European power sector are instructive. Cheap and plentiful US shale gas began to displace coal from the power sector so US coal exports joined the ranks of other exporting nations – while industrial demand for power in Europe slumped after the 2008 recession.

And since that year too the policy goals of the European Union led to a surge in constructing plant to generate subsidised renewable energy, while pressure from coal-reliant nations made it impossible for the carbon price to rise to the point at which it could drive another dash for gas.

These two factors – cheap coal and subsidised renewables – squeezed gas out of the fuel mix to a greater extent than anyone had foreseen, given its green credentials. But in the meantime technology has brought down the cost of renewables to the point where they need less or even no subsidy.

Their generating capacity has grown a lot faster than even the International Energy Agency (IEA) forecast, according to Energywatch Group (EWG), a Berlin-based think-tank, in a report published in September. It says the IEA has been grossly understating the position of renewables. Actual wind capacity in 2010 exceeded by 260% and 104% the IEA’s World Energy Outlook 2002 and 2004 projections respectively for 2010. And WEO projections for wind energy from 2002 for 2030 were reality 20 years earlier, in 2010.

EWG believes that projections by independent analysts have been nearer the mark regarding the successful expansion of renewable energy. If the EWG is right, development has been proceeding faster than some experts thought possible, and this could explain the surprise that demand for fossil fuels is as low as it is. Once panels and the windfarms are up, that is gas demand gone.

Finding areas for collaboration is as easy as agreeing the terms of the partnership is hard: Gazprom and Qatar thought it would be straightforward to form an alliance in LNG shipping, for example, with the shipping side of the contract divorced from the supply side. LNG from Sakhalin could supply Qatar’s customers in Asia, freeing up more tankers for customers in Europe.

The value is in the gas itself and that is reduced if the LNG is stuck on the contractual seller’s vessel, shrinking in volume each day while it makes a journey that is longer than necessary.

But nothing ever came of those talks between the two producing nations. And there are also issues of competition law, as Shell is finding out as it buys BG. Some buyers may find too much selling power is concentrated in one new entity.

But powerful stakeholders are calling for a radical change of behaviour at a time when customers have never had such a good choice of alternative fuels for their needs. From that perspective the industry’s ability to adapt to the new circumstances will be critical. 

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