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Big Oil sees big risks as it places big bets

Big Oil has always been a big gamble, with high stakes and the potential for big payoffs. And despite a recent stretch of winning hands and big pots, the risks haven’t gone away. If anything they’ve gotten bigger. By's John W. Schoen.
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Big Oil has always been a big gamble, with high stakes and the potential for big payoffs. And despite a recent stretch of winning hands and big pots, the risks haven’t gone away. If anything they’ve gotten bigger.

Those high stakes — and strategies for managing them — are the talk of a weeklong industry conference here that has attracted some 2,000 CEOS, analysts, investors, suppliers, consultants and press from 55 countries.

For over a century, oil companies have wagered billions of dollars punching holes in the ground, with varying odds and mixed success, hoping to find a new pocket of oil or natural gas that might be deliverable years in the future, at a market-driven price that would cover costs and generate a return on its investment.

Now, after its most profitable year on record, the oil industry faces some new risks — including the potential impact of a widening consensus that the use of its main product is responsible for irrevocably changing the planet’s climate.

Some companies seem to be embracing the challenge. Until recently, you wouldn’t expect to hear much about conservation or alternative energy sources in a roomful of oil executives. But those were hot topics at this week’s conference, “Strategies for a High Stakes World,” hosted by the consulting firm Cambridge Energy Research Associates. With energy supplies barely keeping up with the growth in the demand, even the optimists were quick with sobering reminders of scope of the task.

“People lose sight of the timing and the scale of infrastructure involved,” said David O’Reilly, Chevron CEO. “It’s a massive undertaking.”

To keep the world’s economic engine running, some in the oil industry are looking to develop alternative fuels — a notion that not long ago would have been dismissed as heresy here in the Oil Patch. But major investment is now pouring into production of corn-based ethanol and other biofuels; some $7 billion in venture capital last year, double the level of 2005. Since no one expects corn to supply enough biofuel to meet the White House target of 35 billion gallons of alternative fuel by 2017, the race is on to develop other feedstocks — from municipal waste biomass to so-called “cellulosic” ethanol made from grasses and other plant material. Far from a threat to their core business, many in the oil industry see an opportunity.

“The world is going to need every molecule (of fuel),” said Richard Zelensky, vice president of Chevron’s biofuels program. “There’s plenty of room for everybody.”

Brazilian energy giant Petrobras offered a glimpse at what increased reliance on petroleum alternatives might look like. Company CEO Jose Sergio Gabrielli told a luncheon group that at least 25 percent of all motor fuel sold in Brazil is ethanol, which his company has been producing from sugar cane for decades. Owners of flex-fuel vehicles can now drive past the gasoline pump altogether, he said.

“In Brazil, you can not put pure gasoline in your car,” said Gabrielli. “And every station has at least one pump that has pure ethanol.”

But even if the Bush administration’s aggressive biofuels targets are met, alternative fuels would displace only 15 percent of U.S. gasoline consumption within a decade.

And not all oil executives are eager to place big bets on biofuels. Exxon Mobil is devoting only a small piece of its research and development budget on new technologies for alternative fuels. Though recently appointed CEO Rex Tillerson acknowledged that biofuels will play an important role in meeting growing energy demand, he said his company would focus its energies on finding and developing new oil supplies.

“I’m not an expert on biofuels,” he told the conference. “I’m not an expert on farming. I don’t have a lot of technology to add to moonshine.”

The interest in alternative fuels comes just as the energy industry faces bigger risks and steeper challenges finding and developing new reserves to both replace declining output in aging fields and increase overall production to keep up with relentless growth in global demand.

Despite its record profits and hoards of accumulated cash, replacing those inventories is getting much more expensive. The cost of labor, equipment and supplies has jumped 53 percent since 2004, according to a new index developed by CERA. As companies push further offshore into deeper water, the cost of drilling rigs is up more than fourfold. Transportation and pipeline equipment has also become pricier. And an ongoing labor shortage — especially for workers trained in the latest technologies like

3-D seismic exploration and horizontal drilling — have brought escalating personnel costs.

Those higher costs are beginning to show up in the spending plans of major oil producers, according to Petroleum Intelligence weekly. The five Western majors spent $92.4 billion last year — 31 percent more than 2005. But most of them are lowering expectations for 2007 and cutting targets for the rest of the decade, according to the publication. And though they plan to spend $96 billion this year, that money will fund a shorter list of projects, according to PIW.

It’s also getting harder to places to invest, as some of the world’s biggest oil producing countries like Venezuela and Russian are now demanding better terms and renegotiate deals struck with Western producers when oil prices were low. Energy Secretary Samuel Bodman told the conference that roughly two-thirds of the worlds oil and gas reserves are in countries that “provide limited access or are completely closed to foreign investment.” National oil companies, he said, own about 50 percent of the world’s proven oil reserves.

"Moves to restrict foreign investment and increase the reach of state-run energy industries limit access to capital and to the expertise needed to unlock new resources," said Bodman.

With access to new oil fields restricted abroad, the oil industry continue to press for more domestic drilling, particularly in the so-called Outer Continental Shelf — areas that are currently off limits. The Bush administration is pressing for an inventory of those areas to determine how much additional oil could be developed. But so far, the idea of expanded drilling has gotten a cool reception from a Democratic Congress.

Meanwhile, just as high oil prices have brought a gusher of profits, Big Oil has been buffeted by blowback from angry consumers stunned by the surge in pump prices. It’s also sparked talk in Washington of slapping a tax on the industry’s recent windfall. Oil executives say that while voters may be angry about huge profits, they tend to forget that the oil industry has weathered rough patches as well.

“There are times like this when we do extraordinarily well,” said Tillerson, of Exxon Mobil, which posted profits of nearly $40 billion last year. “Which we’d better do because these times don’t generally last very long, and they have to take us through the time when we don’t do so well — so we can keep investing at these levels when some people would say it wouldn’t make a lot of sense to be investing.”