Redrawing frontiers: Natural resources firms

BG's hostile bid for Origin is just one more example of how far natural resources firms can, and will, go to secure supplies now that oil and gas prices are at record highs. By Danny Fortson
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The Independent Online

Such are the heights that the oil price has reached that just about every politician, be they in the UK or China or America, has made it their business to figure out ways to force the cost of the black stuff back to a more reasonable level, or at least to talk about the need to do so.

Nowhere have the cries been as consistent, and as desperate, as in America, the world's single biggest consumer of the fuel. President George Bush recently called for the opening of southern coastal waters, long deemed off limits, to help alleviate the country's vulnerability to the rocketing price. The idea of a windfall tax on giants such as ExxonMobil, which last year managed to make $1,300 (£660) per second, persists. Oil has become the quintessential political football.

There is, however, a flip side to this boom. In March, the US government pocketed a record $3.7bn from the auction of new offshore exploration permits in the Gulf of Mexico – a sum far beyond any amount it had previously fetched for these "blocks", many of which are located in extremely deep water that had previously been passed over as too expensive or too speculative to be worth taking a punt.

Just a month earlier, Royal Dutch Shell paid $2.1bn in a separate auction for blocks in the Chukchi Sea off the coast of Alaska. The price for the 277 blocks was the most it has ever paid for offshore exploration rights. When the company begins drilling wells there by the end of the decade, it will officially bring to an end a 25-year absence of oil and gas groups in the ecologically sensitive area. Six other companies, including ConocoPhillips, also bought blocks in the contentious area. The total take for the US government: $2.6bn.

Even for the cash-rich petroleum industry, these are large sums for unproven patches of land thousands of feet under water. Yet in this new age of expensive oil, it is a trend that is manifesting itself, in different ways, across the globe. Oil companies are plunging into new technological areas or locations that not long ago had been deemed as too expensive, too dangerous or just too difficult to be worth the billions of investment required to produce usable fuel. A lot of things change, however, when the product you are selling more than doubles in value over the space of a year, and more than quadruples over the past five years.

So it is that as oil hovers above $136 per barrel – up from the $65 it at which it traded a year ago – once marginal resources such as Canada's tar sands or coal seam gas (CSG) in China are now in vogue. In war-torn Iraq, oil majors are making their first tentative steps toward re-entering the country after more than three decades despite ongoing violence there. The gold-rush mentality is easy enough to understand. When one considers that the average price of oil extraction for Shell, for example, is between $7 and $8 per barrel across its portfolio, it becomes clear why the company and its rivals are so much more willing to sink billions into risky deepwater platforms or costly tar sands.

"The key driver is price," said Rhodri Thomas, an analyst at Wood Mackenzie. "It has freed oil companies to look at other areas to replace production, both through newer types of more unconventional resources as well as locationally."

Consider BG Group's latest gambit in Australia. A month after Origin Energy rejected a £6.6bn takeover offer from the UK gas group, BG relaunched its offer yesterday, on the same terms, convinced that this time it can take it direct to Origin shareholders and convince them that the $15.50 per share bid it has tabled is fair. It is a bold strategy for BG, which is desperate to get its hands on Origin's coal seam gas assets.

BG's plan, should it win Origin, is to build a facility that would convert its coal seam gas into liquefied natural gas (LNG).

Extracting coal seam gas is costly, and until the recent spike in gas prices, which are linked to oil, was something mainly done in America, where gas has traditionally fetched much higher prices than other parts of the world. Converting CSG to super-chilled LNG will be not only be costly; it is something that has never been done, anywhere in the world, on an industrial scale.

The £6.6bn price tag might thus seem a hefty bet on an entirely new process. Yet BG isn't the only one enticed by the possibilities. Shell paid £395m for a stake last month in Origin rival Arrow's CSG-to-LNG project, while Malaysia's Petronas paid $2.5bn for a stake in the Australian group Santos's project.

Part of the sudden attraction of Australia is its proximity to key Asia's customers, who have shown themselves willing to pay well above the odds for LNG shipments. Yet perhaps more important is the comfort that companies feel investing in the country. "Questions of political and tax risk are very important," said a Shell spokesman. One needs only to look at the recent escalation of attacks on installations in Nigeria, or the bullying of BP by its Russian partners in its TNK-BP business to see the risks of pumping oil in less-than-friendly countries. Taxes, meanwhile are rising. Companies exporting oil from Russia now pay more than 70 per cent in tax to the government on each barrel.

In other words, doors that had long been open to international oil companies are slamming shut at an alarming rate, leading them to turn up investment in novel or less-attractive geographies and technologies, like squeezing the black stuff from grains of sand or sucking gas out of dirty old coal. "Their real problem is that they can't have access to the big, easy reserves. They might have to pay significant amounts upfront, but their reserves would be secure well into the future," said Leo Drollas, the chief economist at the Centre for Global Energy Studies.

Demand, meanwhile, continues to grow. The stumbling economies of the US and Europe have already led to sharp drops in petrol usage. China, India and the Middle East have more than taken up the slack. The oil price will almost surely relax to some extent, but most now accept the view that a new, much higher floor has been set. And that means the oil industry will continue to push itself further afield and the to edge of technology to get its product out of the ground.

In a conference room on the 34th floor of One Shell Centre in downtown New Orleans, one gets a glimpse of the forces at work. On the wall, a giant map of the Gulf of Mexico is divided up into a grid of squares representing blocks of seafloor of three square miles. Huge swaths of the Gulf are shaded in, the coloured squares representing the identity of the company that has bought the rights to each parcel. More than half of the Gulf, however, is still up for grabs.

Tar sands

Not too long ago, Alberta's tar sands were still being dismissed as a marginal resource. Sure, some estimates put Alberta's reserves at roughly equal to those of Saudi Arabia, owner of the world' s largest oil fields, but it was just too expensive to do on any grand scale. The "easiest" oil, like that in Saudi Arabia and Iraq, costs a few bucks per barrel to extract. Tar sands – essentially gooey dirt – on the other hand, can cost between $20 and $40 to make into a usable fuel. With oil showing no signs of relaxing, a big fight is in the offing. Oil companies want to ramp up production, green campaigners say the environmental impact is too great.

Alaska

Oil companies are set for a monumental clash with environmental campaigners and several Congress members over the hotly contested Chukchi Sea off the Alaskan coast. The US Minerals Management Service raised an unprecedented $2.6bn in February from seven oil companies which bought the rights to exploration blocks in waters trawled by bowhead whales and polar bears. Three months after the government agreed to take the petrodollars, it officially placed the polar bear on the endangered species list. A row is brewing. In the meantime, Shell, the biggest winner in the Chukchi auction, agreed to delay drilling in the nearby Beaufort Sea.

Deep water

The going rate for drilling a single deepwater exploration well comes in at between $100m and $200m. If the well hits paydirt, it can cost between another $3bn and $6bn to build the high-tech platforms that in the outer depths are not planted to the sea floor but held afloat and nearly stationary thanks to some incredibly complex engineering. All of that before they extract a single drop from the wells, which can be as far as 8,000ft under water plus an additional 20,000ft into the earth's crust. Understandably, five years ago when oil was around $30 per barrel, companies were much less keen on such projects. At $136 per barrel, they make sense.

Hotzones

Royal Dutch Shell and BP are among five major oil companies near to completing talks with Iraq's oil ministry that would see oil majors re-enter the country for the first time in more than three decades, it emerged last week. Along with rivals ExxonMobil, Chevron and Total, the companies are close to agreeing on "technical service contracts" under which the companies would send in professionals to help boost production of the country's operating fields. These deals are seen as a prelude to full licensing deals for new drilling and production. Getting back into Iran is also high on many companies' list, though that is highly unlikely any time soon.

Coal seam gas

The hype around coal seam gas really centres on making it into liquefied natural gas, or LNG. Neither process is easy, or cheap. Coal seam gas is extracted by drilling a hole into a coal seam and capturing the gas as it escapes. Sometimes this requires extracting water from the seam to free the gas. It has been widely used in America. Eastern Australia is the other hotbed, though countries like India, China and Indonesia are also looking closely at developing it on a large scale. LNG shipments have been fetching record prices in recent months from fuel-hungry Asian nations. Converting coal seam gas to LNG, something that has not been done before, is the key.

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