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The South Atlantic: Looking Ahead

A conference organised by the South Atlantic Council on 15 April 2011

The views expressed below were those of the speaker. None of the presentations are endorsed by the Council.
 

Exploring for Oil: Considerations and Challenges

Presentation by Roger Cartwright

Introduction

Is there commercial oil in the Falklands? If I knew the answer, I would not be here but rather in my villa in Cap Ferrat! So instead of trying to give a definitive answer to this, I am going to talk briefly about the following:

  • Putting Falklands oil into the international context for oil exploration and in particular how a major oil company approaches oil exploration.
  • Some thoughts about the current status of oil in the Falklands
  • The impact of a commercial oil find, development and production.

Although I will refer to oil throughout, much of what I going to say also applies to gas although there are some important differences.

Context

Oil is of course explored for, found and developed by a wide range of enterprises, from small companies borrowing to drill just one well onshore through active independents to mid-sized oil companies (very large companies compared with many other industries) to huge state owned enterprises.

Although we think of the likes of Shell and Exxon when we talk about 'big oil', national oil companies control over half of global production and around three-quarters of global reserves. In post-war Iraq, it is not US oil companies who have reaped the reward of the war anticipated by the conspiracy theorists, but Chinese state controlled oil companies who have taken up the largest share of oil developments. However, with the notable exceptions of Petrobras and Statoil, these companies lack deep water expertise.

At the same time, independent oil companies are becoming more prominent. In 2004 only 12% of new discoveries were made by 'independents' in 2009 the figure was 54%. In the case of the Falklands the currently active companies are at the smaller end of the scale.

Oil exploration is arguably the most expensive form of gambling in the world: offshore wells, which cost up to 5 times the cost of onshore wells, can cost up to $100mn. That said, the industry has got much better at de-risking such wells through the application of very advanced science and technology. But the only way to know if there is oil down there is to drill. The real trick is to drill more successful wells than unsuccessful wells but the company has to be able to learn from each well and then write off an unsuccessful 'dry' well without killing the company financially.

Most of the easy conventional oil in the world has been found onshore and in shallow water. But the industry has continued to develop in a number of directions which have the effect of increasing recoverable reserves of oil:

  • The percentage of oil recovered from oil fields has increased from around 40% to 60%
  • The risks of drilling dry holes have been reduced via the use of new technology including better seismic and its interpretation
  • Previously inaccessible oil is now reachable: both politically the (e.g. the former Soviet Union has opened up, as has Iraq), and geographically and technically (such as in deep water and in the Arctic)

Beyond this, there are huge heavy oil deposits of places like Canada and Venezuela and vast new resources are being discovered in terms of unconventional hydrocarbons including coal bed methane and shale developments. Technical and environmental issues need to be addressed but the prize is large enough to ensure that they will be. For major oil companies access to oil reserves is critical. The level of reserves 'booked' is seen by the markets a key measure of success essential because good reserve numbers offer the promise of good future financial performance.

Unsurprisingly, it is a good rule of thumb that rising crude oil prices will increase the amount of oil exploration being conducted around the world. But historically higher levels of exploration leads to higher exploration costs (as scarce resources e.g. drilling rigs are competed for), production rises, and increased supply causes prices to fall making some exploration uneconomic etc. That said, we now live in world of tighter oil supply and demand. Any development which has to the potential to reduce production causes a rapid rise in oil the oil price leading to greater price volatility.

Not all oil is the same: Libyan oil tends to be lighter (higher gasoline cut) and sweeter (lower sulphur) is cannot be replaced barrel for barrel by Saudi heavy.

Even the largest oil companies have to make choices: they cannot afford to explore and develop everywhere and indeed they probably cannot manage too many exploration programmes effectively. So, a good exploration strategy is essential.

The Challenges of Falklands Oil

By way of reminder, the Falkland Islands is a long way from anywhere:

Aberdeen 8,149
Rio de Janeiro 2,135
Montevideo 1,165
Cape Town 3,863
Houston 6,067
Seoul         11,424

Geographic remoteness per se is not a major problem, and it is usual for large pieces of equipment (like the topsides for oil production platforms) to be floated halfway around the world. However, as major developments get under way most equipment and supplies will have to come from a great distance and the net impact will be to increase development and operating costs. These higher costs mean that the size of the hydrocarbon resource found in this region will have to be commensurately larger rather than smaller.

Operating bases for the oil and gas industries can probably be established on the Falklands themselves if suitable ports facilities can found/developed. Things like drilling mud, pipe etc. would have to shipped-in in bulk and then held in these bases for supply to drilling rigs etc. But this has an impact: on land prices, jobs etc.

There are four basins around the islands:

  • North Falkland Basin, located to the north of the islands.
  • Falklands Plateau Basin, located to the east of the East Falkland.
  • South Falklands Basin, to the south-east of the islands
  • Malvinas Basin to the south-west, and part of this lies in Argentine waters

with the North and South Falkland basins considered to have the better prospects. Six wells that were drilled in the North Falklands basin in 1998 indicate that the necessary geological elements are in place. Five of these wells had oil and gas shows (including one which recovered live oil to surface 2 litres reportedly!). Only one well has been drilled in the South Falklands basin. The 1998 drilling campaign was a technical success - it proved the presence of the necessary ingredients for what we call an active petroleum system - but only limited amounts of hydrocarbons were discovered.

So why are oil companies investing in further exploration? A great deal was learnt about the geology of the Falklands petroleum system from the drilling in 1998. This can be used to target exploration and test potential reservoirs. And never forget, geologists are huge optimists and the rocks do not change, only the geologists

So what are the chances of success this time around? This will always vary from prospect to prospect and from basin to basin, but generally the chances of success range from about 10% to 20%. In other words, globally there is a hit rate of somewhere between 1 in 10 and 1 in 5.

And how big are the potential reserves? We simply do not know it is much too soon to say, despite reports of 60 billion barrels of reserves. So, so far only a limited number of wells have been drilled and such it is still early days in the development of this potential oil province.

Rockhopper Exploration Plc is the only explorer to have made a potentially commercial discovery in the Falkland Islands. Earlier this month they confirmed a new low case estimate of about 516 million barrels of oil in place at the field, of which 30 percent can be recovered has said. The key point here is the estimate of the amount of oil recoverable. Rockhopper has said it will drill at least three more appraisal wells.

The bottom line in all of this will be the scale of the resource. If one or more giant oil fields (fields with 500 million barrels or more of recoverable oil or gas equivalent) are found, the oil will almost certainly be developed. This is an industry that often has to deal with very large numbers: revenue illustration: $120/bbl times 100,000 b/d times 365 = $4,300,000,000 i.e. nearly $4.4 bn. p.a. Even 1,000 b/d generates $43,800,000

But costs, particularly offshore in a remote location lacking infrastructure will be commensurate. Even onshore, billions of dollars can be required (e.g. nearly $3bn. to develop the Cusiana/Cupiagua oilfields/pipeline in Colombia) and projects of this magnitude require top level project management skills to deliver production on time and in budget. Raising this kind of money can have its challenges, even for the biggest companies and lenders will look very carefully at things like political risk and environmental impact as well as the geology.

Politics

Oil is always a highly political subject, simply because of its importance to all economies, whether net consumers or producers. No governments want the lights to go out or petrol and diesel supplies to run out and income from domestic oil production will always be economically important.

Majors and minors:

  • Major oil companies have a global footprint and are thus likely to have potentially significant investments in countries which, at least publicly, might support the Argentine position re. the Falkland and any Falklands oil development
  • Smaller exploration companies do not necessarily face this kind of problem. Indeed some of them will have been established specifically to explore for oil in the Shetlands

Oil and gas development will seriously exacerbate the political problems, indeed it has already done so. Once a major oil/gas development is under way and revenues begin to flow, what has been for many people a simple matter of principle becomes a much dirtier argument over money.

In extremis, in the event of a united Latin American boycott of Falkland's oil, the impacts could include no technical/logistical support from those countries, possible retaliation against those companies involved, and closed markets to the oil. However, in my view, the likelihood of an effective and enduring boycott is likely to be limited. Words are cheap and any boycott is likely to vulnerable to erosion by economic self interest. So, action in this area might inhibit but probably not prevent an oil development.

An agreement with Argentina had set the terms for joint exploitation of offshore resources but in 2007 Argentina unilaterally withdrew from the agreement.

Would oil be good for the Falkland Islands?

This is subjective but in my view it is highly questionable whether commercial oil/gas development would be beneficial for the Falklands. This may appear surprising given that in many ways oil is money. However, many believe that Falkland islanders do not really need the money the economy of the island is not in bad shape with its fishing and tourism. And the scale of income and impact from a major oil find would be much bigger than anything than the islands have experienced to date.

A major oil development would bring negative impacts to the island: it would inevitably change the nature of its society profoundly; new employment options could damage existing economic activity; a major influx of oil men could bring things like increased drunkenness and prostitution; some land prices would rise and there is the risk of potential environmental impacts.

More broadly, experience elsewhere suggests that very large oil developments can distort an economy (sometimes called Resource Curse/Dutch disease), via factors including inflation and weakening links between governments and their people, when the majority of government income comes directly from oil revenues the broader tax base loses political importance/power and can encourage a more autocratic style government.

The oil genie is not quite out the bottle and we do not yet know if commercial oil will be found and developed but if it is may not necessarily be a good thing for the Falkland Islands.

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