The last decade has ushered in very significant change around the world, certainly in the world economy, and for our industry,” Chevron Corp. Chairman and CEO John Watson said. “In the last 10 years alone, the world has added the equivalent of another United States, in terms of GDP growth.
“That is tremendous growth for the world,” he continued, particularly considering the fact more than half of the growth occurred in what he characterized as “the developing world.”
Most significant, Watson continued, is that growth has propelled three-quarters of a billion people to move into the middle class. Watson was addressing delegates and guests at the recent IHS Energy CERAWeek 2014 in Houston, focusing his keynote address specifically on the occurrences of the past 10 years in the energy sector, and how it has impacted not only the United States but the world as well.
The China syndrome and related increases
“Three-quarters of a billion,” Watson re-emphasized. “When that many people move into the middle class, it translates to increased demand for goods and services and, of course, energy.”
Watson attributes much of this economic growth and its resultant boom of the middle class to the emergence of China’s own middle class.
“But it has come at a pace that’s surprised me,” he admitted. “If you think back to more than a decade ago, the world was caught a little bit flat-footed, with respect to the pace of development in China. Forecasters underestimated China’s growth by perhaps a third, and with that we underestimated the growth in energy demand.”
This “underestimation” resulted in a narrowing in the spare capacity in the oil business.
“Spare capacity went from about 5 million barrels a day, down to about one,” Watson said. “And, as you would expect, when spare capacity diminishes, we see rising prices. And so, oil prices have risen three-fold in the last decade.”
This triple increase in prices initially benefitted many, with many resource holders benefitting; OPEC revenues, alone, increased by more than $500 billion between 2004 and 2012.
“With that increase in revenues, governments began implementing new policies to make sure they were positioned to share in the prosperity, and participate in the growth that came with the incentive to produce more oil and gas,” Watson observed.
Some countries, including the United States, kept incentives in place for the private sector to continue to produce and develop resources.
“We had a range of policy responses that were put in place,” Watson said. “What was clear was there has been an investment boom that has taken place in the oil and gas business, and with that we have seen increased demands for the goods and services associated with our industry.”
Historically, Watson pointed out, sharp increases in the demand for goods and services, lead to rising costs.
“Labor and capital costs associated with the upstream business have more than doubled in the last 10 years,” he said. “Cambridge Energy has an index of upstream costs, and they have in fact more than doubled in that time period. So while we’ve seen investments increase in companies like mine, and others, we have also seen a sharp increase in costs.”
Entities ranging from energy companies, to governments, to service partners and, finally, to consumers, are facing what Watson frames as a “new reality” in the energy sector.
“That new reality has many forms,” he explained. “Essentially for a company like mine, and many others, $100 a barrel is becoming the new $20 in our business. This is the base case that underpins many of the investments that are being made by the industry, for those incremental barrels that are going to supply the growing demand the world is seeing.”
Watson added many resources exist that may be developed for less than $100 a barrel but, increasingly, they are originating from more expensive sources, including deepwater, LNG and other “capital-intensive expenditures with long lead times.”
“Profits the industry will be developing to meet customer demand are bigger and more complex than ever, in harsher environments, with long lead time,” he said. “In fact, we’re seeing a cost squeeze that is facing many in our industry.”
Chevron is “fortunate,” Watson added, in that the company is one of the most profitable of the major oil companies, as measured by profit-per-barrel, pointing to Chevron’s “great queue of projects” for investment opportunities.
“We can afford to be choosy, and we are,” he said.
While Watson expected some of the company’s projects to go to a final investment decision more quickly, he revealed some of those projects, including a real estate project in the waters off the United Kingdom are “being slowed” to assure a “cost/revenue equation balance.”
“That’s a good project,” he said. “It will eventually go, but we’re recycling that project to get that cost balance right.”
The cost of doing business
Citing the market for offshore rigs, Watson said costs have increased more than five-fold in the past 10 years.
“The backlog associated with major capital projects, and their related goods and services, have also increased significantly, up 60 percent just since 2009,” he said. “The supply chain needs to address these constraints if we’re going to be able to economically produce the resources the world needs.”
Re-emphasizing the sweeping “new reality” theme and its impact for suppliers and companies, Watson extended that new reality paradigm to its impact on governments.
“Resource-rich countries around the world are recognizing they need to be competitive to attract capital and investment,” he stated, reminding that “no shortage of resources” to be developed exists on a global scale.
“The constraints tend to be above ground,” Watson said. “It’s very encouraging to see governments like Mexico and Argentina improving the fiscal terms creating access for companies like mine and others, so resources can be developed economically and efficiently to benefit those governments, as well as the investors that choose to invest in them. It does take responsible and stable government policies to help stimulate that economic investment.”
Watson revealed Chevron and its partners are currently investing more than $80 billion in Australia on two large LNG projects.
“We have the confidence to do that because Australia, of course, has been a stable government with stable policies for many years,” he said.
The necessity for conditions must be right, beyond “fiscal terms,” Watson said, for companies like Chevron to invest in them.
“The countries that will draw capital are those that have a strong preference for upholding rule of law, creating transparent regulations, supporting straightforward permitting processes and access to resources, maintaining favorable tax environments and the like,” he explained.
Governments in consuming countries around the world are facing challenges balancing economic security and environmental objectives, and must rise to the need to develop policies that are both sustainable and economically sound, Watson said.
Consuming governments around the world subsidize customers in their countries by more than $500 billion a year — a level Watson does not believe is sustainable indefinitely.
“Countries like Indonesia, that have gone from being a net exporting country to a net importing country when it comes to oil, are seeing just that,” he said. “They’ve had to raise prices to their consumers to reduce the subsidies that are costly to their government.”
Renewable energy subsidies totaled $100 billion in 2012 for fairly small amounts of energy, Watson said, with countries like Germany and the United Kingdom recognizing the costs of those subsidies and responding by rolling them back.
“Markets work in the energy system, and governments are recognizing that,” he said.
The consumer factor
A new reality also exists for consumers in both consuming and producing countries: the reality energy is becoming more expensive.
“Consumers are the ultimate party that has an interest in energy policies and their effectiveness,” Watson said. “If $100 is the new $20, consumers will pay more for oil. Natural gas, moving via LNG, will take robust pricing in order for projects to move forward. And renewables that are drawing subsidies in this country and elsewhere will also result in more expensive electricity to the consumer.”
Ultimately, consumers will pay for, or benefit from, the range of policies that governments choose to enact, Watson said, adding he does not foresee a change in the patterns he described. “I do expect to see more growth in the world economy,” he qualified.
“And I do expect to see more and more people benefitting from free trade and free economic policies,” he said, as more and more of the world’s citizens move into the middle class.
With a forecasted 40-percent increase in energy demand occurring over the next 20 years, Watson said it will take “all forms of energy” to meet the demand.
“I do think there are abundant resources around the world to be developed and, in our industry, we have the geology, we have the technology, we have the know-how,” he concluded. “If we can get all the policies right above the ground, we’ll be in a position to invest and meet the needs of a growing world.”
For more information, visit www.ceraweek.com/2014.
