Special Report: American Independents Operating Abroad

American independents continue to pursue international activity based on the Independent Petroleum Association of America’s (IPAA) latest producer survey that was conducted in 2007-2008. Despite the growing popularity of North American natural gas shale plays over the past few years, it remains the case that the global exploration and production (E&P) arena should still be considered for a company seeking a diverse portfolio in an increasingly volatile marketplace. A few key trends bear further delineation as the recession continues to pressure the upstream component of the industry. The data from the survey illustrates that going international can help in strengthening portfolio diversification and access to the resource base.

Applying yesterday’s themes to today’s marketplace

Since IPAA was created in 1929 by producers who feared that imports were displacing U.S. production, independents have primarily focused on domestic E&P activities. Over time, the marketplace has become more global and our conventional resource base has matured considerably. While the majority of independents prefer opportunities in the U.S. and North America based on a comfort level with the geography, geology, politics or economics, a sub-section has continued to pursue reserves further afield or overseas. The IPAA International Activity Survey released in February 2008 listed the following conclusions regarding independents’ level of interest in international operations:

First, the international arena is a niche area where U.S. independents can risk a relatively small per centage of their exploration budgets for large potential reserve payoffs.

Second, geographic proximity and political risk are key factors in decision-making, especially given the rise of trends such as ‘resource nationalism’ and increased international competition by the national oil companies (NOCs).
Third, international interest has roughly correlated with commodity price trends based on IPAA survey research over the past decade.
From the survey, it appears that growth in existing markets is preferred and oil is the primary focus.

The rest of the world has become more competitive in this search for energy as their economies develop and industrialize. Over the past year, the economy has buckled but pundits are already talking about tomorrow’s demand. At their 2008 Statistical Review of World Energy, in Washington, D.C. in early June, BP representatives noted that last year was the first year in which developing country demand was greater than developed country demand. This structural change and the growth of volatility were sure to be themes in near-to-medium term markets where fossil fuels would continue to play a very large role.

Portfolio diversification and international markets see upside for petroleum

Since the days of Spindletop in January 1901, wildcatting for oil remains a timeworn hallmark of independent producers. Many forget that oil and natural gas discoveries are often made by the smaller company who took inordinate amounts of risk to find oil or natural gas in an area that had no history of production. This is also true overseas, especially as many of the larger conventional reservoirs at home become depleted after over a century of production. As written in the IPAA Primer on International Petroleum Taxation, “By world standards most of the US is super-mature and field-size distribution overseas are orders-of-magnitude greater than much of what is available domestically. For example, average discovery size worldwide the past 10 years or so has been around 100 Mmboe. Test rates per well in the various international discoveries worldwide average around 4,000 to 5,000 Bopd for oil discoveries and 20-30 Mmcfd for gas discoveries.”

The IPAA International Activity Survey noted that 65 per cent of respondents were searching overseas for oil plays compared to 48 per cent for natural gas. However, access to the resource base overseas has its particular challenges as countries have nationalized their reserves or as companies have become more competitive in foreign investment. International oil companies now have full equity access to less than 16 per cent of global oil reserves compared to 85 per cent in the 1960s. There is more access to international natural gas but much less infrastructure is in place.

Oil is getting harder to find and it’s also getting more expensive relative to natural gas. Regarding commodity price, the ratio between oil and natural gas has risen from 8.6 in 1994 to around 18 today. Through our recession, the oil price has showed notable recovery compared to natural gas. The price of oil (West Texas Intermediate) is up about 56 per cent from the beginning of the year while the price of natural gas (Henry Hub) has fallen a further 25 per cent, continuing to languish based on demand woes and oversupply (which is due to the success of E&P companies in developing various shale plays such as the Barnett, Fayetteville and Haynesville). The price has slowed U.S. activity considerably as rigs for oil are down 49 per cent from a year ago while natural gas directed rigs are down 54 per cent based on the latest numbers from Baker Hughes rotary rig count. However, the international rig count has fallen by less than eight per cent from a year ago illustrating the resiliency of the global oil market during times of heightened price volatility.

Survey data reveals operational trends based on company size

In the 2008 IPAA Producer Profile Survey, just over 14 per cent of all respondents (IPAA members) answered that they operated internationally. This number shows an increase compared the previous 2000 IPAA Producer Profile Survey that showed 12 per cent of international activity. Unsurprisingly, size certainly factors into the decision as 50 per cent of responding large independents (classified as having over 250 full time employees) were active overseas compared to eight per cent of medium-sized independents (20-249 employees) and five per cent of small-sized independents (1-19 employees).

Fourteen per cent of total respondents indicated that they were planning on pursuing international opportunities over the next five years. Certainly the playing field has become more competitive with aggressive NOCs and international oil companies (IOCs) entering the fray but opportunities will be available, especially for the leaner and more flexible independent players. This year at the annual NAPE® International Forum (one of the largest industry networking and prospecting expos) an extra room had to be added to accommodate a record level of companies searching for farm-out partners. Again, the larger companies appear more inclined to consider the addition of international operations to their future portfolio. The breakdown was 38 per cent for large independents, 11 per cent for medium independents and eight per cent for small independents.

Determining the right international market niche

Remember the above rule ‘small percentage of their exploration budget for large potential reserve payoffs?’ On a median basis the respondents possessing international reserves indicated that ten per cent of their reserve base was outside of North America. The IPAA International Activity Survey revealed that “the interest in prospects of less than 50 MMboe (million barrels oil equivalent) is a key niche for IPAA members.” However, from that floor there is considerable upside. IHS research attributes independents with “generating more than half of the high impact prospects (larger than 250 MMboe) identified over the past three years.”

In addition to Canada, Latin America continues to be a popular destination for international activity. A recent study by Global Pacific Partners noted that approximately 200 independent producers (from all countries) held 21 per cent of total production and reserves in Latin America compared to 66 per cent for the national oil companies and 13 per cent for the majors. Hemispheric proximity makes sense logistically in addition to South America’s prevalence of onshore and marginal plays: “Independents are focused on Colombia, Argentina and Peru where opportunities are medium-sized, acreage turnover is good and fiscal terms are appropriate for the opportunity set.” These are examples of areas where independents can most effectively utilize their relative competitive advantage against other players.

In regard to the single biggest hindrance to operating internationally, political uncertainty and capital outlays were at the top of the list. For the large independents, the biggest issue was political uncertainty (at 57 per cent) with tax structures at 14 per cent. For medium independents, capital outlays joined political uncertainty at 33 per cent. For the small producers, political uncertainty was top at 32 per cent, followed by capital outlays at 28 per cent and information at six per cent. The issue of capital outlays has become more pertinent over the past year given the stresses incumbent with the ongoing financial crisis and the ramifications on credit status and balance sheet strength. As noted in the IPAA Primer on International Petroleum Taxation, “The larger field-size distribution overseas is attractive but many independent oil companies are hesitant to confront strange and complex fiscal systems and governmental relationships.”

The types of projects being pursued depend largely on the size of the company but the focus is largely on onshore E&P and production enhancements. In aggregate, E&P onshore received 77 per cent (with multiple responses allowed) compared to 35 per cent for production enhancement, 27 per cent for redevelopment/refurbishment and 13 per cent for E&P offshore. For the large independents, 71 per cent were focused on the E&P onshore and 43 per cent had E&P offshore in their portfolio. For the medium companies, 95 per cent focused on E&P onshore, while 43 per cent were active in production enhancement and 29 per cent in redevelopment/refurbishment. In the smaller tier, 76 per cent were active in E&P onshore, 40 per cent in production enhancement and 27 per cent in redevelopment/refurbishment.

Project economics – Someone may be eyeing your prospect

Whether onshore Colombia or offshore West Africa, independents have remained active in searching for and developing the global exploration hotspots. Prospects for mergers and acquisitions will potentially evolve in this low commodity price environment. Independents with large cash coffers will search for cheaper and potentially distressed assets, especially in areas where they can high-grade their existing operating portfolio. In addition, NOCs are increasingly looking to partner with firms that possess business and marketing expertise, a talented work force and the cutting edge technology. In many cases, the independent is very well-positioned for a farm-in opportunity.

During the current economic climate, all players are recalibrating to the changing vicissitudes of a weakened price and softened demand environment. Some areas will recover more quickly than others based on a host of commingled factors. IHS found that in 2008, increased E&P activity in Australia, the Far East and Latin America were offset by decreases in the Middle East, the CIS and Europe. Dr. Pete Stark noted that “With longer project cycles and substantial government participation, international E&P activity is not likely to decrease as much as North American activity will drop in response to the recession and lower oil and gas prices. Nevertheless, the longer that negative global Gross Domestic Product and low oil prices prevail, the more severe will be the negative impacts on international E&P activity.” Given the long lead times necessitated by oil and gas projects, timing will be critical as independents plan their future capital expenditure plans.

The successful independent has a critical role to play in securing future energy supply for the global marketplace. This means that the independent will need to invest in production capacity at home and abroad to help reduce the impact of future supply crises and price spikes. Economic stability and energy security have become further intertwined and independents can help provide jobs and fuel that will lessen our dependency on less than friendly exporters. Tomorrow’s successful independents operating overseas will be the companies that recognize the evolving playing field, maintain flexibility and adapt their programs to address the realities of the new world order. American independents have a great amount of experience to build upon and are up for the challenge.

By Frederick J. Lawrence, Vice President – Economics & International Affairs
Independent Petroleum Association of America