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Big Energy Got It Wrong

Commodities / Energy Resources Oct 03, 2012 - 01:03 AM GMT

By: Andrew_McKillop


Best Financial Markets Analysis ArticleENERGY FUTURE? NO FUTURE
Exxon Mobil CEO Rex Tillerson claims he always applies the Boy Scout dictum "Be Prepared" and many critics of Tillerson like to poke fun at his Boy Scout background and way of soing things, which served him well until recently. Upper levels of Exxon management started taking notice of him during the little-known southern-48 oil boom of the early 1990s. As head of Exxon's highly lucrative exploration and production — E&P upstream — operations in the Texas-Oklahoma Belt he never put a foot wrong, nor when he moved for a short while to head E&P at Exxon Neftegas in Russia.

After the formal Exxon and Mobil merger of 1999, the finance-oriented and mercurial Lee Raymond was CEO but almost at once Raymond began to groom Tillerson as his heir. Tillerson became president of ExxonMobil in 2004 and was elevated to chairman and CEO in January 2006. Even as recently as early 2012, Exxon but not its gas subsidiary XTO Energy was still hailed by analysts as a probable outperformer of DJIA companies. Things still look relatively good for Exxon stock, for some analysts, but current earnings and the outlook are not incandescent: in particular the earnings numbers which closely resemble BP for the most recent Quarter; 7.1% down for Exxon and 7.9% down for BP.

For British Petroleum, of course, things are more openly changing, but just as fast changing as for Exxon and the other "historic oil majors". 

The recent CEO and longtime E&P boss of BP, Tony Hayward had this to say at the 2009 edition of the 'Oil and Money Conference':  “I do think the market is driven by the fundamentals of supply and demand...Between 2004 and 2008, the growth in (oil) demand meant almost all of the world’s spare capacity had been consumed. As we came into 2008, spare capacity was probably somewhere just a bit above a million barrels a day...Declining production from existing fields, coupled with new demand, mean we’ll have to find ways of bringing on-stream nearly 50 million barrels a day of new capacity between now and 2030...". He then added exactly what Rex Tillerson or any "historic oil major" CEO will say, at least until very recently, at the same cue: "The problem in meeting that goal isn’t geological. It’s political. We have the natural, human and financial resources...We need secure and reliable access to those resources. If the conditions are right, industry will invest.”

Adding to these fake problems, the new and real problem is economic, particularly how much it costs to maintain output through covering depletion losses, and raising output to meet expected or hoped-for growth of global oil demand. Both Tillerson and Hayward (who has far from quit the oil business) are exposed to a real mega problem: using IEA data, world total energy consumption in 2011 grew by an almost infinitely small 0.15 percent. 2012 may be even worse, for big energy.

The IEA's politically correct line is that "Without a bold change of policy direction, the world will lock itself into an insecure, inefficient and high-carbon energy system....but the window of opportunity is closing", but the IEA has to give real world details on the real trends in energy. IEA data on 2011 and 2010 for the OECD group of countries shows their total energy demand decreased by 1.9%, including a fall of OECD electricity demand by 0.9%, a 9.2% decrease in nuclear energy supply in the OECD countries, and the fifth yearly fall of OECD oil demand in 6 years, at an 0.7% fall in 2011.

Big Energy corporations, especially in oil and gas, but also in coal, power generation and the renewables were unprepared for the mega changes coming in world energy since the 1990s, accelerating all the time. These trends are no longer "short run reversals". Taking oil demand, the EU27 countries in 2012 "celebrate" their sixth consecutive year of oil demand decline: many countries (not only the PIIGS) are in double-digit percentage falls in national oil consumption since 2006. For the USA, the decline trend is also becoming hard to brush aside as "only due to recession": the all-time high of US oil demand was in 2007, five years ago.

The favoured claim from Hayward and other CEOs, especially in the oil patch was that OPEC states, and increasingly Russia - as BP knows to its cost - are for political-only reasons "denying access" to their energy resources to "western" energy companies, who have the technology and know-how to develop these resources for the always-growing oil and energy demand of the global market. This of course regrettably, makes it necessary to constantly raise oil prices for the public.

Supposedly, the "historic majors" are forced to look elsewhere for finding and developing new oil and gas resources - E&P - where the task is harder and more expensive. In fact, the historic majors like the NOCs of the OPEC group, and NOCs and state-linked energy entities in other major producer and consumer countries, including Gazprom in Russia or Sinopec in China and ONGC in India, have actively collaborated in E&P both inside their own territories and worldwide, for more than 20 years. The so-called "sovereign rent and resource question" in world oil is not the problem.

The Hayward-type rhetoric implies the world outside the OPEC states and a few larger NOPEC states is "drilled out" and ever-growing oil demand will soon hit a supply ceiling, with an inevitable price explosion, but this is totally contradicted by the facts. World natural gas discoveries, since 2005 and especially since 2009, have never been so massive. Oil discoveries have also been impressive. But the decline of energy demand - which has a lot more powerful meaning than "declining growth of demand" - is at least as important, as a game changer. 

Before 2005, we can concede, it was possible to see longterm "overdemand" or global energy demand always hitting supply ceilings, themselved dragged down by oil depletion, costs of E&P, political denial of access to "highly endowed" regions, technology problems, environmental problems and the rest. Since then, this theme or meme is energy history and empty rhetoric. One immediate and early response by big energy corporations, and a costly mistake for them, was to crowd into renewable and alternate energy business. In some cases, as for BP, its flirt with renewable energy quickly morphed into a cash burn which BP was forced to terminate for biofuels in July 2009, and for solar energy in December 2011. Losses are variously estimated at a minimum of $250 million, probably double that figure. Exxon's increasingly dubious flirt with algae-based biofuels development, already needing more than $600 million of spending by Exxon is a likely coming disaster for the corporation.

Other "historic majors" like France's Total have been persuaded or forced by government stakeholders to move into renewable energy, in a symbolic way, but in solar energy Total is already losing money with a clutch of uncompetitive subsidiaries operating overpriced technology and production strategies. Italy's ENI has also followed the same "government friendly" path, notably in windpower development in Italy, but has backtracked to focusing on technology R&D in the renewable energy field. The basic rationale, here, was that due to declining resources of oil and gas, higher prices for coal due to its environmental costs raised by carbon taxes and permit costs, and ever rising global energy demand driven by "Asian locomotive" demand, renewable energy was needed as a high cost "vanity tech" energy stopgap.

All components of this homely energy-corporate fairy tale were wrong, even if it was great stuff for those corporate after dinner speeches with government-friendly media on hand. The costs of getting things wrong are high, as energy corporations are finding out today.

Being prepared is simpler when you know the game: when the game changes the problem is harder. E&P was always the key to future earnings - but at least since 2000 the costs of E&P have only gone one way: up. Even worse, when oil prices fall and in the US case gas prices crash to the floor, E&P stays expensive, or even gets more expensive. The financial risk of E&P, like other high cost activities in major oil coporations, such as oil transport and refining, has soared since the turn of the century - which was OK as long as energy demand went on growing, and oil prices stayed high or went on growing. When these parameters change, the game changes.

Governments have plenty of responsibility for the lost focus in global energy, pursuing a widening range of contradictory and dysfunctional energy, economic and environmental policies, none more out of synch with reality than the climate-energy policies foisted on, and accepted by EU27 governments since 2008, but also applied in the majority of OECD and Emerging countries. All of these policies have the two basic drivers which have wrongfooted the "historic majors": global energy demand can only grow, probably fast; fossil fuels are declining and depleting, and always cost more.

One simple example is now in the Romney-Obama duel and debate: the US has had an exceptionally hot summer and drought is likely to further drive up food prices. Global warming is back on the agenda, at least in the US, so the drive to "decarbonize energy" is back on the agenda, enabling Romney to say he can do it better than Obama, who with typical arrogance says he already did it. Both also claim that growing shale gas production is a chance for America. Although outclassed and outperformed on building costs, security issues and operating costs by every alternative from shale gas and coal to the renewables - and wrongfooted by declining needs for more power capacity - nuclear power is back on the US political agenda: because it is "low carbon". Nuclear power therefore has to be supported, otherwise the US will be held hostage by foreign energy exporters, but obviously not the exporters of the 80% plus of the uranium fuel imported by the US for its current reactor fleet.

Similar elite shcizophrenia themes and memes, in energy, are available in other countries but the bottom line for major energy corporations is a red line for earnings - even for corporate survival. For as long as the economy holds up, and tax-and-borrowing support from governments to vanity tech energy can continue, the party can continue. In the short-term future however, this fool's game with its bent rules is likely to fall apart with heavy collateral damage across the energy sector

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2012 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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