Supermajordämmerung

The Economist has declared "The day of the huge integrated international oil company is drawing to a close" - Supermajordämmerung. Of course, they once declared that oil was heading for $5 per barrel, so I wouldn't necessarily happen on this betting any time soon. In the long run however, they are undoubtedly dead, as the product they are selling has a finite supply...

Poor choices and increased competition may explain deteriorations in the supermajors’ reserve replacement ratios (RRRs), a measure of the amount of oil discovered compared with production. In 2012 total hydrocarbon replacement (including gas) at Shell was a slender 44%. BP’s was 85% and Total’s 93%; that means reserves at all three are shrinking. Exxon’s RRR, which has not fallen under 100% for decades, was a more comforting 115%, and Chevron’s was 112%. But of Exxon’s 1.8 billion barrels, high-cost shale oil from the Woodford and Bakken fields in America accounted for almost 750m. Around 50% of Exxon’s reserves are now in heavy, unconventional or deep-water oil, compared with 17% in the early 2000s.

The supermajors are now spending $100 billion a year between them on exploration and production. But this level of effort has not impressed investors; their share prices (with the exception of Chevron’s) have been flat for years. Nor has it yielded net new oil; their output fell by 2% between 2006 and 2011. What it has delivered is greater gas production, a likely harbinger of things to come. The supermajors are finding themselves increasingly in the gas business. For most of them gas is currently more than 40% of their production—for Shell and Exxon it is more than 50%.

Oil and gas differ in several respects, none of them very good news for the supermajors. Because it requires the construction of expensive pipelines or liquefaction plants, gas is less profitable. It also needs to be marketed, with customers secured upfront to finance the vast cost of extraction at scale. And it could be susceptible to a steep worldwide drop in prices. The era in which most gas is sold at prices indexed to that of oil is coming to an end. Fields currently under development could provide a glut of gas in the second half of the decade which might put paid to indexation altogether.

What can the supermajors do about these threats? Spending heavily on replacing reserves to keep investors happy is not working. Selling off bits of the firms that no longer make sense, such as refineries, can help; ConocoPhillips hived off its upstream exploration and production from refining in 2011. But it hardly counts as a long-term growth strategy. Reviving unique in-house technology might help.

It will be an unhappy thought to many, but BP’s travails in the wake of the Gulf of Mexico disaster may be guide to the supermajors’ future. Forced to sell assets to raise cash to pay fines, it has found that those sales are often followed by a rise in the company’s share price. This suggests that investors like the idea of smaller, fitter oil firms. Rather than push towards ever more esoteric frontiers, the supermajors might do better to slim down and turn away from the oil that they prize so highly but that the world may no longer want ever more of—and that others can exploit equally well. They will find this hard, though. “Oil supermajor” has a much better ring to it than “fairly large gas producer”.