Is Big Oil Headed For Hypothermia?

Published in Investing on 26 April 2012

As it's forced to operate in more inhospitable venues, big oil continues to take gas.

A version of this article originally appeared on our US site,

It's not a particularly pleasant thought, but one can imagine how at least some of the members of big oil could become buffeted about by both the US and Russian governments.

You may have seen stories this week relating to the agreement between ExxonMobil (NYSE: XOM.US) and Russia's big state-run oil company Rosneft to jointly conduct operations in the Kara Sea of the Russian Arctic and the Black Sea. The ventures were agreed to last June and were further detailed last week. Also as part of the pact, Rosneft will begin participating in three areas of Exxon activity in the Gulf of Mexico, West Texas and Alberta, Canada.

Can you say colder than cold?

The deal demonstrates the extent to which the major oil companies are now willing to go for the possibility of finding meaningful new stashes of black gold. Should the companies chance onto a portion of the estimated 90 billion barrels of oil equivalent thought to exist in the Arctic and Black seas, they'll need to spend a king's ransom -- many billions of dollars -- on infrastructure that'll include airstrips, pipelines and production platforms that'll need to be impervious to marauding glaciers.

The Wall Street Journal quotes Igor Sechin, Russia's deputy prime minister and energy point man, as saying that the projects "could generate" investments in the $200 billion to $300 billion range during the next several decades. Somehow, it seems likely that Exxon, which will have a one-third interest in the projects, will be socked with a far higher percentage of their costs.

Sharp elbows and broken kneecaps

And then there are the uncertainties of dealing with the Russian government, which has repeatedly displayed sharp elbows in its relationships with the Western companies. Perhaps the most egregious example targeted Royal Dutch Shell (LSE: RDSB), which, after developing the Sakhalin-2 project on remote and challenging Sakhalin Island several years ago, was forced to sell its operating assets to Gazprom, the big Russian gas operator and supplier, at a bargain-basement price.

Even ExxonMobil CEO Rex Tillerson, who earlier had played a major role in his company's ultimate success in developing the Sakhalin-1 project, said several years ago that Exxon would need "more clarity about how the Russian government will treat foreign companies before it will undertake more projects there". But with the globe's obviously dwindling oil deposits left to be uncovered, you can see how long that contention held up.

And Exxon isn't the only Western major willing to swallow its pride and chance hypothermia and nasty political surprises for a chance at a big Russian find:

  • Chevron (NYSE: CVX.US), the second-largest of the US majors, agreed early last year to work with Rosneft in exploring the Black Sea's Shatsky Ridge. By mid-year, however, the California company had pulled out of the deal, ostensibly because of disagreements over geologic interpretation, but also likely because it was going to be hit with 100% of the exploration costs in exchange for a 33% stake in the operating company.
    Now, however, as my colleague Aimee Duffy told you not long ago, Vladimir Putin has indicated a willingness to at least consider permitting non-state-owned companies to gain controlling interests in Russian projects. So Chevron apparently is back talking to the powers-that-be in the country about Arctic projects. Since there haven't been instances of Chevron officials unknowingly negotiating with their Russian counterparts near live microphones, we'll have to wait and see how those talks eventuate.
  • BP (LSE: BP) also had announced an unusual share-swap agreement last year that would have had it working with Rosneft in the Russian Arctic. But the kibosh was put on that deal by BP's Russian oligarch partners in TNK-BP, its joint venture in that country. That, it should be noted, was far from the first instance of contretemps between BP and its Russian billionaire partners.

So the oil business has become far more challenging and, frankly, more miserable, than in days of yore. In 1901, for example, wildcatters could turn a bit to the right in relatively hospitable places like Beaumont, Texas, only to become showered by oil gushing from what came to be known as the Spindletop.

The Foolish bottom line

On that basis, and given the virtually insufferable conditions in which they now must operate, there's something at least naive about persistent shots at big oil from the Obama administration in the US. I'm referring to comments like the president's charge during his January State of the Union address (and repeated frequently thereafter) that: "It's time to end the taxpayer giveaways to an industry that rarely has been more profitable and double-down on clean energy."

Yes, the major oil companies produce large profits on an absolute basis. But if by "profitable" the president is referring to sizable profit margins, Apple (NASDAQ: AAPL.US), to name but one example, is three times as profitable as ExxonMobil. It therefore seems appropriate to suggest that Mr Obama recognise that, among all industrial endeavours, the search for oil and gas is least likely to be mistaken for a walk in the park.

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DirtyDollie 26 Apr 2012 , 9:20am

I agree - oil and gas companies make huge profits but it's because of sheer scale. The risks are very large, even for Big Oil.

People complain about the greed of oil companies but with so many producers they can't possibly manipulate prices because they'd be undercut by rivals. Oil price is market-driven, not dictated by companies.

In general, companies only exist to maximise profits. It's very rare indeed to find a company to act truly altruistically because then the board would come under pressure from shareholders.

ANuvver 26 Apr 2012 , 4:31pm

Russia. Makes Venezuela and Argentina look like Singapore...

Ne tantsuy s medvedem - Don't dance with a bear.

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