OilVoice Magazine | April 2014

Edition Twenty Five – April 2014

US shale oil production costs on the rise Oil & Gas Boom 2014: Happy 65th, Hydraulic Fracturing Ukrainian crisis highlights political risk in long term gas sales Cover image by Berardo62

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Adam Marmaras Chief Executive Officer Issue 25 – April 2014 OilVoice Acorn House 381 Midsummer Blvd Milton Keynes MK9 3HP Tel: +44 207 193 1900 Skype: oilvoicetalk Editor James Allen Email: james@oilvoice.com Director of Sales Ayman Caan Email: sales@oilvoice.com Chief Executive Officer Adam Marmaras Email: adam@oilvoice.com Social Network Facebook

Welcome to the 25th edition of the OilVoice Magazine.

It's incredible how fast time has flown by, just last month we celebrated the 2nd year anniversary of the OilVoice Magazine. We continue to deliver you the best Oil & Gas content in the industry, seen featured in our Opinion & Commentary section, and we'd like to thank our carefully selected authors for their contributions over the last couple of years. If you're interested to know more about seeing your articles featured on OilVoice, please get in touch.

This month we have great articles from Evaluate Energy, FTI Consulting, Wikborg Rein, Blank Rome LLP and Practicus. We'd also like to welcome back some of our regular authors, including Gail Tverberg, Kurt Cobb and Andrew McKillop.

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Contents Featured Authors April’s featured authors

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Will OPEC collapse - Libyan P.M. flees to Europe

by Andrew McKillop

5

Ukraine, Russia and the nonexistent U.S. oil and natural gas "weapon"

by Kurt Cobb

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US shale oil production costs on the rise

by Mark Young

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Oil & Gas Boom 2014: Happy 65th, Hydraulic Fracturing

by David Blackmon

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Putin's energy stranglehold on Europe

by Andrew McKillop

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Skills and capability challenges facing upstream

by Giles Lewis and Jon Sasserath

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The Fracking Flip - U.S. Domestic Oil Production's Radical Transformation of the North American Tanker Trade

by Keith Letourneau and Matthew Thomas

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Ukrainian crisis highlights political risk in long term gas sales

by Dag Mjaaland and Aadne Haga

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Beginning of the end? Oil companies cut back on spending

by Gail Tverberg

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Featured Authors Andrew McKillop AMK CONSULT Andrew MacKillop is an energy and natural resource sector professional with over 30 years’ experience in more than 12 countries.

Mark Young Evaluate Energy Mark Young is an Energy Analyst at Evaluate Energy.

Kurt Cobb Resource Insights Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude.

David Blackmon FTI Consulting, Inc. David Blackmon is managing director of Strategic Communications for FTI Consulting, based in Houston.

Gail Tverberg Our Finite World Gail the Actuary’s real name is Gail Tverberg. She has an M. S. from the University of Illinois, Chicago in Mathematics, and is a Fellow of the Casualty Actuarial Society and a Member of the American Academy of Actuaries.

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Giles Lewis Practicus An experienced Market Researcher, Giles heads up Practicus’s Research capability globally, with a particular interest in Oil & Gas.

Jon Sasserath Practicus Jon has a deep background in Oil & Gas in both corporate leadership and consulting roles, with a particular interest in technology-enabled change.

Keith Letourneau Blank Rome LLP Keith Letourneau is a member of our Maritime Emergency Response Team (MERT). He focuses his practice on maritime and energy transactions and litigation matters.

Dag Mjaaland Wikborg Rein Dag Mjaaland is a Partner at Wikborg Rein's Oslo office and is part of the firm's Petroleum and Energy practice.

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Will OPEC collapse Libyan P.M. flees to Europe Written by Andrew McKillop from AMK CONSULT Inevitable Break-up of Libya Presaged by months of political infighting, and street fighting outside parliament, former Libyan prime minister Ali Zeidan fled from Libya, 12 March, according to newswires. Reuters explained his flight to Europe as due to parliament voting him out of office on Tuesday March 11, following his inability to stop rebels exporting oil independently. Reuters and other newswires added that the rebel forces set a 'brazen challenge to the nation's fragile unity', and had actively threatened Ali Zeidan with assassination, several times.

Zeidan stopped over in Malta for two hours late Tuesday before going on to "another (unspecified) European country", Malta's Prime Minister Joseph Muscat told stateowned television TVM. No European government had confirmed the arrival of the Zeidan 'hot potato' by Wednesday, but observers suggest Germany may be Zeidan's final destination.

The standoff for control of oil exports and revenues from exports has since the 2011 ousting and killing of Muammar Gaddafi intensified the longstanding regional and tribal faultlines in a country whose territorial integrity - like that of Iraq or Ukraine was always stronger on paper than the real world. Only due to Libya's role as a significant oil exporter, this de facto break-up of 'a country that never was' is treated with alarm in Western capitals, especially in oil import-dependent Europe.

Can Libya Unwind OPEC? Claimed bases for alarm over the prospect that Libya 'descends into anarchy' include the very hypothetical argument that a fragile new Libya ruled by rival militias grouped into Tripolitania and Cyrenaica - east and west - each with their own allied and dependent political factions in the still-transitional government, will undermine OPEC's unity. The argument continues by suggesting a divided Libya will be supported and opposed by different OAPEC (Arab OPEC) states, who may utilise the Libyan state of anarchy as a lever for their own infighting.

Backing this claim, OPEC full-plenary and other meetings, since 2011, have steered away from taking any decisions relating to Libyan oil production and export volumes.

A major reason for this is usually not discussed by the Western 'oil expert fraternity' but is very simple. Since 2011, Libya's oil production and export volumes have wildly

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varied, from as high as 1.6 million barrels a day (mbd) to nearly zero, but this has had no real impact on global oil prices, which remain high. In other words, global oil markets are very amply supplied. Removal of almost all Libyan supply, for relatively long periods measured in months, has been easily compensated by other exporters.

The only possible conclusion is there is incipient or real global oversupply - not shortage of oil.

Despite or because of this, Iraq like Libya is another 'too hot to handle' subject at OPEC meetings due to its own national territorial fragility, on one hand, and also due to Iraq's increasing oil exports, on the other. Including Kurdish production and exports, the former Iraq is rapidly moving back towards its previous peaks of oil production and export supply, dating from the 1970s. Western observers claim that OPEC member states will be unable to control and limit oil export supply when it is in excess, or compensate oil export shortfalls due to endemic political crisis in Libya and Iraq, when it is in deficit. OPEC will become unstable, and could even break up.

Other oil exporter states could then follow the Libya-Iraq models of nation-shattering.

The Libyan Breakdown Model Arguments backed by facts are easy to produce, that Libya's descent into anarchy will cause longterm, maybe irreparable damage to its oil industry, with a concomitant longterm reduction of its oil export capacity and oil exports. One counter-argument is that after break-up, former Libya's two main oil production and export regions, and especially Cyrenaica, can attract investment capital and oil industry know-how, and reattain the country's former total maximum export capacity of about 1.6 mbd. The only question would be the political implications and the timelines.

Claims that each new part of a two-nation Libya would be 'too small' as national entities, both politically and economically, can be dismissed by considering small or ultra-small but large or major oil exporter countries such as Kuwait, UAE, Oman, Brunei, Equatorial Guinea and others. In effect, oil production in and exports from small or very small countries is often easier, than in and from large countries.

Iraq's breakdown path is significantly different from Libya's, due to the historical fact of the Kurdish nation, and the endemic shia-sunni rivalry and armed conflict in 'rump Iraq'. Libya's national identity, we can easily argue, was even less credible than Iraq's, and only continued or was maintained due to the dictator, Muammar Gaddafi.

Also unlike Iraq, the historical antecedents of its breakdown into at least two separate and independent states or nations, can be traced back to at least the 1830s. The necessity or obligation for armed conflict in Libya, by the central or 'legacy government' in Tripoli, is far lower than the Baghdad's government need to use force to maintain the semblance of a united country - if only to attract oil sector financing and investment.

Libya's Parliament can be considered to have acted rationally after Cyrenaican rebels holding three key ports in the east disobeyed government orders and loaded a North Korean-flagged tanker with oil as part of their drive for political autonomy as much as for gaining oil dollars. The Parliament dismissed Ali Zeidan as incompetent.

Libya's state prosecutor Abdel-Qadr Radwan then issued a travel ban on Zeidan, also because he faces an investigation over multiple alleged irregularities involving

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the misuse of state funds.

Military Power is Final Arbiter Following the escape of Ali Zeidan, Libya's General National Congress or transitional government quickly named the Defence minister Abdallah al-Thinni as acting prime minister. Another replacement will be picked sometime later this year. Al-Thinni can however be considered as only the Defence minister and PM of Tripolitania, and faces the difficult task of trying to unite and lead a country that is deeply divided along tribal-political and regional-political faultlines, where not only Islamists oppose more European-oriented 'liberal' politicians such as Ali Zeidan.

Like large and increasing areas of Iraq, Libya has no effective police or political institutions. The Tripoli 'legacy government', like that of Baghdad is in permanent danger of running out of money because rebel activity at oilfields and export terminals chokes off vital oil revenues, the process being even further advanced in Libya, than in 'rump Iraq'.

The role of defence and military forces is certain to increase, in both cases. This week, in Libya armed clashes have broken out between rebels and pro-government forces in Sirte, the central coastal city dividing western and eastern Libya. Whichever way the armed forces tilt will decide the outcome in the Sirte case.

Also similar in these two open and fast-advancing processes of national breakdown, the final arbiter is military. Government spokesmen in Libya said on Tuesday that gunboats loyal to Tripoli had chased the North Korean-flag tanker along Libya's eastern Mediterranean coast and opened fire on it, adding the claim that Italian ships were aiding the effort, which was denied by Italy. As in the cases of Iraq and Ukraine, peaceful or armed separation into stable elements, of the now-unstable and unsustainable former Libyan state of Muammar Gaddafi, is almost certain.

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Ukraine, Russia and the nonexistent U.S. oil and natural gas "weapon" Written by Kurt Cobb from Resource Insights Commentators were falling all over themselves last week to announce that far from being impotent in the Ukraine crisis, the United States had a very important weapon: growing oil and natural gas production which could compete on the world market and challenge Russian dominance over Ukrainian and European energy supplies--if only the U.S. government would change the laws and allow this bounty to be exported.

But, there's one very big problem with this view. The United States is still a net importer of both oil and natural gas. The economics of natural gas exports beyond Mexico and Canada--which are both integrated into a North American pipeline system--suggest that such exports will be very limited if they ever come at all. And, there is no reasonable prospect that the United States will ever become a net exporter of oil.

U.S. net imports of crude oil and petroleum products are approximately 6.4 million barrels per day (mbpd). (This estimate sits between the official U.S. Energy Information Administration (EIA) numbers of 5.5 mbpd of net petroleum liquids imports and 7.5 mbpd of net crude oil imports. And so, to understand my calculations, please see two comments I made in a previous piece here and here.

My number is for December 2013, the latest month for which the complete statistics needed to make my more accurate calculation are available.)

The EIA in its own forecast predicts that U.S. crude oil production (defined as crude including lease condensate) will experience a tertiary peak in 2016 around 9.5 mbpd just below the all-time 1970 peak and then decline starting in 2020. This level is far below 2013 U.S. consumption of about 13.2 mbpd of actual petroleum-derived liquid fuels. (This number excludes natural gas-derived liquids which can only be substituted for petroleum-derived liquids on a very limited basis.)

So, when exactly is the United States going to drown the world market in oil and thereby challenge the Russian oil export machine? The most plausible answer is never. And, the expected 2016 peak in U.S. production is only about 1.5 mbpd higher than production today. That's really quite small compared to worldwide oil production of about 76 mbpd. And, there's no guarantee that the rest of the world isn't going to see a decline in oil production between now and then. So much for the supposed U.S. oil "weapon" taming the Russian bear.

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But what about natural gas? Surely, America's great bounty of natural gas from shale could challenge the Russians. Well, not really. It's true that U.S. natural gas production trended up significantly from its post-Katrina nadir in 2005. But the trend has now stalled. U.S. dry natural gas production has been almost flat since January 2012. The EIA reports total production of 24.06 trillion cubic feet (tcf) for 2012 and 24.28 tcf for 2013, a rise of only 0.9 percent year over year.

Not mentioned by any of the commentators touting the U.S. natural gas "weapon" is that U.S. natural gas imports for 2013 were about 2.88 tcf or about 11 percent of U.S. consumption. So, let me see if I understand this: The plan seems to be to import more so we can export more. And this would change exactly what in the worldwide supply picture?

Certainly, it is true that low U.S. natural gas prices have reduced drilling and exploration dramatically. But prices will likely have to rise above $6 and trend higher as time passes as the easy-to-get shale gas is used up and only the more costly and difficult reservoirs remain. Drillers don't keep drilling unless they can make money and that will require significantly higher prices.

And, here's the kicker. In order to ship U.S. natural gas to Europe or Asia, it has to be liquefied at -260 degrees F, shipped on special tankers and then regasified. The cost of doing this is about $6 per thousand cubic feet (mcf). So, the total cost of delivering $6 U.S. natural gas to Europe is around $12 per mcf. With European liquefied natural gas (LNG) prices mostly below this level for the last five years, it's hard to see Europe as a logical market. Japan would be a better target for such exports with prices moving between $15 and $18 per mcf in the last five years. But a U.S. entry into the LNG market could conceivably depress world prices and make even Japan a doubtful destination for U.S. LNG. And, what if U.S. prices rise significantly above $6?

But all this presupposes that the United States will have excess natural gas to export. As my colleague Jeffrey Brown has pointed out, "Citi Research [an arm of Citigroup] puts the decline rate for existing U.S. natural gas production at about 24%/year, which would require the industry to replace about 100% of current U.S. natural gas production in four years, just to maintain current production."

It seems that U.S. drillers are going to be very, very busy just keeping domestic natural gas production from dipping, let alone expanding it to allow exports. And remember, we are still importing the stuff today!

How many companies will actually risk the billions needed to build U.S. natural gas export terminals to liquefy and load exports that may never appear? I doubt that very many will actually go through with their plans.

What is truly puzzling is that all the information I've just adduced--except the cost of liquefying, transporting and regasifying natural gas--is available with a few clicks of a mouse and a little arithmetic performed on tables of data. I got the cost information on LNG from a money manager specializing in energy investments. And yet, commentators, reporters, and editorial writers don't even bother to check the internet or call their sources in the investment business.

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Perhaps the facts have become irrelevant. Only that would explain the current hoopla over the nonexistent U.S. oil and natural gas "weapon" in the face of the alltoo-obvious and readily available evidence.

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US shale oil production costs on the rise Written by Mark Young from Evaluate Energy It wasn’t too long ago that a high oil price and a falling gas price prompted many companies to abandon plans to develop major positions in shale gas plays and turn their attentions to the more lucrative shale oil deposits around the country. According to a new analysis of 2013 annual data from 20 US shale gas and shale oil producers

by Evaluate Energy, more and more of the companies that made this move could be vulnerable to rising costs in the near future, if the oil price should fall.

To show this, Evaluate Energy has selected 20 representative US companies whose production is either mostly or entirely from US shale gas or shale oil plays.

To download a free pdf with details of these 20 companies’ US shale acreage positions, as well as performance metrics, click here.

The production costs per barrel of oil equivalent (boe) for each company in the group is shown in the graph on the following page.

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Source: Evaluate Energy. The companies are sorted in order of the percentage of total US production that is made up by oil in 2013, starting with CONSOL Energy and Southwestern Energy, both at 0% oil, and ending with Northern Oil & Gas at 90% oil.

Production costs per boe includes production taxes and transportation costs where reported separately, as some companies combine all of these costs into one item.

It is clear from the graph that those companies producing mainly oil from shale plays have higher costs to contend with. The companies on the right hand side of the graph (those in orange) are all exclusively producing from the Bakken play and Magnum Hunter – the highest cost per boe of the “oil & gas” group – produces roughly 50% of its output in this play.

Overall, it is clear that oil producing plays cost more to operate in than gas plays on a per boe produced basis. Evaluate Energy’s annual results of operations data for the 14 out of 20 companies in the group whose 2013 production is oil-weighted or whose production weighting has shifted significantly in the last 4 years towards oil shows that production costs in shale oil plays are also trending upwards rather than coming down, seen on the following page.

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Source: Evaluate Energy. Production costs per boe includes production taxes and transportation costs where reported separately, as some companies combine all of these costs into one item.

The oil producing companies who make up the above graph all show an increase in production costs per boe produced from 2012 to 2013. Magnum Hunter is the only company here to show an overall downward trend over the entire 4 year period and this is due to the fact that the company’s high costs in 2010 and 2011 forced a rethink in strategy; the company sold its Eagle Ford oil-producing assets and thus afforded more weight to its gas-producing assets in the Marcellus play. Full analysis of Magnum Hunter’s strategy upheaval and how it has benefited the company is available in this article. These rising costs in shale oil plays revolve around the need or desire to keep increasing production and revenues with wells that only produce attractively for a very short period of time; efforts are needed to maintain economic production in existing wells for as long as possible, whilst all the time constantly drilling new ones.

However, these high and rising costs have only seen a handful of companies alter strategies away from certain plays so far. Two examples of this are Magnum Hunter and Resolute Energy, who sold its Bakken position for $70.1 million in Q2 2013 to focus on its Permian and Powder River basin properties. BP, albeit not a huge US shale acreage holder by any means, has seen fit to spin off its US onshore business segment into a separate company, in order to try and manage the costs and other difficulties this seemingly unique operating environment represents.

On the whole, however, companies appear to be happy to continue bearing the burden of these rising costs, as withdrawals and restructures have been few and far between. This is solely due to the fact that the margins are still there; in fact, margins

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per boe produced (revenue per boe less production costs per boe) have generally increased for each of the oil producers year-on-year since 2010 despite rising costs, whilst gas producers have seen a general downward trend.

Source: Evaluate Energy – “Margin per boe” in this graph is calculated by taking the US Sales Revenue per boe produced and subtracting the US Production cost per boe for each company. Production costs per boe includes production taxes and transportation costs where reported separately, as some companies combine all of these costs into one item.

Of course, while the margins are still there and increasing, the oil producing companies will not be overly concerned in the short-term by rising costs. Any fall in oil price, however, could leave them vulnerable in the long-term if they do not find a way to drive these rising costs down soon, so expect a full-scale offensive on costsaving efficiencies by shale oil producers in the US to accompany their drilling programmes in the coming years.

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Oil & Gas Boom 2014: Happy 65th, Hydraulic Fracturing Written by David Blackmon from FTI Consulting, Inc. This week, many people within and outside of the oil and gas industry are celebrating the 65th birthday of hydraulic fracturing. We'll join them, but this celebration is really technically coming two years late.

It is true that 65 years ago this week, Halliburton conducted the first commercially successful application of 'Fracking', as it has come to be known, in Stephens County, Oklahoma. But the process itself was actually invented and experimented with two years earlier by Stanolind Oil and Gas Company, in the Hugoton gas field in Kansas.

While those experiments did not appreciably stimulate the wells to which the technique was applied, this was the real birth of hydraulic fracturing, and since that time, the process has been safely and effectively applied to well more than a million oil and gas wells in the United States alone.

Regardless of which 'birthday' one chooses to acknowledge, hydraulic fracturing is now a veritable senior citizen among the vast array of technologies employed by the oil and gas industry. For the first 60 or so years of its life, the process was completely non-controversial. But then along about 2008, it began to dawn on agenda-driven media outlets and radical 'green' groups looking for a new controversy to stimulate fundraising that the marriage of hydraulic fracturing with horizontal drilling was beginning to create an oil and gas renaissance in the U.S. Out of that realization, the anti-Fracking movement was born.

The initial environmental motivation behind the movement was the fear that the new massive reserves of inexpensive natural gas would crowd renewables out of the power generation marketplace, which at least had the positive aspect of being a reality-based concern. So these groups and sympathetic media outlets embarked upon a strategy of turning hydraulic fracturing into a national boogeyman (such efforts always need a boogeyman to demonize, after all) complete with a new name 'Fracking' - that they sought to turn into a new cussword. And, to a large extent, they succeeded in that quest.

Knowing that hydraulic fracturing was a well-regulated, very safe process that had been around for many decades, and thus in and of itself would be very hard to demonize effectively, they also sought to confuse the issue by turning this new cussword into media shorthand to describe basically everything that takes place in the oilfield. And again, they have had great success in doing this, as pretty much every media outlet now associates - incorrectly - essentially anything that takes

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place in the oil industry, from drilling to processing to transportation to refining, with the cussword, 'Fracking'.

The anti-fracking movement has over the last few years morphed into a fully radicalized protest movement based pretty much entirely on fantasy-and-fear-based talking points that bear only an occasional, passing relationship with the truth. As we've pointed out before, this movement is now run and funded by the same activists and organizations who ran and funded the failed Occupy Wall Street movement several years ago. Same Usual Suspects, same dishonest tactics, different boogeyman to protest.

It's all such a shame and a waste of time and resources, an entire movement based on fear of abundant, plentiful and affordable energy, and on the demonization of an historically safe and effectively regulated industrial process. This movement spends tens of millions of dollars each year demonizing this process, media outlets spend millions reporting on the movement, including 'fracking' in every headline in order to generate more Internet hits, and the industry in turn spends tens of millions countering all the resulting propaganda. What a needless drain on the economy and society.

But the hydraulic fracturing process itself continues to produce results in a massive way. U.S. oil production is at a 40 year high, and this country will soon become the world's biggest oil producing nation. Where natural gas is concerned, Texas alone would rank as the third largest producing country on earth, behind only Russia and the rest of the United States. The displacement of coal by natural gas in the power generation sector has allowed the U.S. to reduce its carbon footprint back to levels not seen since the early 1990s, and the only response from the 'environmental' movement has been to complain even louder.

Indeed, the ongoing boom in oil and natural gas production made possible by 'fracking' has been the saving grace of the entire U.S. economy since the advent of the Great Recession in 2008. It is one of the great positive quirks of national fate that the drilling by Petrohawk of the first successful well in the enormous Eagle Ford Shale formation of South Texas came in the same month the stock markets collapsed, in October 2008.

Since that time, the oil and gas industry has produced millions of new, high-paying jobs, while the rest of the nation's economy faltered. The new availability of cheap, plentiful natural gas and refined products has produced similar booms in industries that use these products as feedstocks - chemicals, manufacturing, plastics, fertilizers and on and on it goes. Thanks to 'fracking', the United States is once again becoming a global manufacturing powerhouse. Not only are U.S.-based firms bringing back jobs that had moved overseas in the last two decades, but firms based in other nations are developing plans to invest billions in new American plants.

If the anti-'Fracking' movement had had its way, all of this would have been banned, and the U.S. economy would still be mired in a major recession, if not an outright economic depression.

Any major resource boom such as we are currently experiencing with oil and natural

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gas comes with a set of environmental and societal trade-offs. That's just the way the world works. Responsible members of society work with industries to find ways to manage and mitigate those impacts so that society as a whole can enjoy the fruits of the boom. Unfortunately, the anti-Frackers have chosen to take a different course.

So long as the money keeps pouring in to the coffers of these cynical 'green' groups, both sides will continue to waste significant resources on a debate based mainly on fantasy and misinformation. But the much-demonized 'Fracking' will continue for the foreseeable future, because on balance, it is unarguably a tremendous benefit for this nation.

So Happy Birthday, Hydraulic Fracturing, and bless the memories of the men and companies who made it possible more than six decades ago.

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Putin's energy stranglehold on Europe Written by Andrew McKillop from AMK CONSULT Outdated Geopolitical Musing March 17, world stock exchanges from Moscow to New York and Frankfurt to Shanghai gave a whoop of joy at the symbolic-only prospect of European and American 'hard hitting sanctions' being set against Russia for its Crimean action. The wait was over, the panic wasn't needed, at least not yet, so jobbers and traders got back to doing the thing they know best of all - talking up share prices. The media and press, however, did what they could to keep the story going, for example Garry Kasparov's raging in the 'Wall Street Journal', telling us that Putin 'is another Saddam Hussein or Slobodan Milosevic' and should be treated by the West the same way. Kill him!

The outdated geopolitical theories and rationales used to bolster the panic and rage

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were summarized and massaged into a would-be doctrine a long time ago, by Zbigniew Brzezinski the former US National Security adviser to Jimmy Carter. His theory basically claims that firstly the USSR, then the Russian Federation is using its energy resources to bring Europe to heel through energy dependence. Russia needs Ukraine for its energy dominance, as a 'pipeline corridor country' so the West and Russia have totally opposing goals in Ukraine and Crimea. This could mean war.

The first problem is the 'Ukraine energy corridor theory' is a major exaggeration.

Ukraine is a critical corridor country for gas supply to Europe, only. Oil has got almost nothing to do with it. Also, the gas pipeline transport role of Ukraine can only decline and will decline, particularly as the Nord Stream and South Stream gas pipelines, which completely avoid Ukraine, are completed and ramp up.

In addition LNG terminal financing, if not building, is now a fevered speculative boom spreading across Europe. Some countries including Poland and France intend to build enough LNG import capacity to cover their total gas needs, by or before 20172020. LNG supplies, almost by definition, will come from a large and increasing number of supplier countries, many of them 'exotic' such as Mozambique and Australia (and Russia and the US, but in Russia's case that is not exotic).

Whether Crimea rejoins Russia, or stays with Ukraine has less and less real world leverage and hold on European energy. The old geopolitical models and paradigms, which in any case were weak, are being superceded and replaced.

Energy Colony of Russia To be sure, Putin may have acted to force Ukraine to play the role of a Russian energy subsidiary, but if it was forced to play that role, this is not how journalists or Brzezinski want us to take it. Long running gas price and gas debt disputes between Russia and Ukraine - whatever its government - have been constant since Ukraine left the collapsed USSR in 1991. Major issues concerned the price Ukraine pays for its own gas, and accumulated debt on unpaid (and stolen) gas. One key reason Yanukovych was voted in by Ukrainians in 2010, and Tymoshenko was voted out, was her extreme radical and probably corrupt attempt to pay Russia a much higher price for domestic gas consumed by Ukraine, partly repay gas debt, and trade Russian-sourced gas in other EU markets. Her attempt using a murky Swiss-based trading and finance company created to those ends with a few chosen Ukrainian oligarchs was a total disaster, and Yanukovych largely profited from it.

Today's arguments coming out of Washington and London, Paris, Warsaw and Berlin claim that despite appearances, or reality, Ukraine's energy transport corridor role is poised to grow. The country will become more strategic, not less. Its role will expand. Ukraine will link oil and natural gas reserves and production in the Black Sea and Caspian basins, with Europe.

The exact opposite is at least as likely, not because of the new political uncertainty, but because European gas will be transported and sourced from and through different countries on an accelerating basis. One factor bolstering this counter argument is that European domestic shale gas development will move forward, as well as European LNG import development.

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The Russian energy dominance theory, and its subset of Ukraine's critical transport corridor role was cobbled during the Cold War era, and heavily used by Brzezkinski for his own political grandstanding. The theory seemed seductive to its writers, perhaps, but is light years away from the real world situation and the powerful global energy trends setting the future.

Taking only gas pipelines serving Europe, the total quantity of transport lines from a few inches diameter (the industry uses inches for measuring) to 4 feet diameter, both public and private, both national and international is so huge it can only be estimated. One guess would be about 400 000 kilometres. Only the much-larger area United States has more, at about 450 000 kilometres. When we add local (sometimes regional) gas distribution lines, for example in cities, the numbers can be doubled to near 1 million kilometres total.

This oversupply problem also concerns oil pipelines, you can be sure. Renovating and replacing, and simply keeping the lines operating and filled, is a major task.

To date, projected new east-west oil pipelines serving the EU states are almost absent. One reason is that Europe's oil demand, like its gas demand is on a downward track that all analysts agree 'has no light at the tunnel's end'. This could or might change, for sure, but since 2005 in some EU states - long before the 2008 financial economic crisis - and since 2009 for the rest, their national oil and gas demand has been declining, every year in the straight majority of countries. This trend is called structural, by more and more analysts. In some cases their oil and gas needs, today, are back to 2000-2003 levels, and declining, making their existing energy transport infrastructures more than sufficient.

When we look at electricity demand in EU28 countries, the 'decline paradigm' has been operating since the late 1990s in an increasing number of countries.

Oversupply One immediate result for oil is that European refining and oil transport capacity are both heavily surplus to needs. Analysts and sector specialists suggest at least 15%, even 20% of refinery capacity will have to be cut, trimmed, outplaced or shut down by 2020. Linked and associated oil pipelines, mostly local, will also have to go. Oil refining, in Europe, is a sunset industry heavily dependent on state subsidies in most countries and mostly unprofitable. Its needs for new pipelines is very low.

Transport infrastructures for oil supplied to European refineries are in surplus for another simple reason. The intensely developed 'legacy network' of oil shipping routes and maritime installations including mostly seaboard-located refineries, throughout Europe and across SE Europe and west Central Asia, makes oil pipelines unattractive - we mean unnecessary - so the financial investment rationale for new European oil pipelines very, very weak.

Europe's combined oil transport and refining capacities must fall - not increase. Put another way, who wants to finance new oil pipelines for uncertain and unlikely needs, when new large diameter oil pipelines cost $7.5 million-per-kilometre?

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Only the many projected - but few financed and built - new gas pipelines in the wide area spanning the Caspian, south and east Europe, and the MENA region are potential but small scale game changers. Small scale means their capacity to capture more than 5%-10% of the EU's total 600 billion cubic metres annual gas consumption, which is declining, is either low or zero. Apart from the Nord Stream and South Stream gas pipelines, building progress with new gas lines is slow or very slow, in part because of the existing high level of 'legacy infrastructures' and falling gas demand.

The essential point is that Ukraine's role in European oil transport is close to zero, and its role in European gas transport, although still significant, is declining.

Massaging this reality into a major geopolitical crisis is at worst war-hungry political grandstanding, and simple ignorance at best.

The Image of Scarcity Also massaged into the media and worked by grandstanding politicians eager to pick a fight with Russia, perhaps confusing it with Mali or Iraq, the image of gas and oil scarcity always gets a major stand-in role. Some journalists have even claimed this scarcity was another reason Ukraine's PM Viktor Yanukovych rejected the EU association-partnership deal he was on the point of signing, in the weeks before he was overthrown by the Kiev Flash Mob. Apart from Putin's offer of a one-third (33%) cut in the extreme gas price that Yanukovych's hapless predecessor Yulia Tymoshenko tried to force on Ukainians, and the $15 billion state debt repurchase offer by Moscow, his government also turned down US Chevron Corp's and European Shell's fuzzy-edge but claimed-as-enticing proposals to accelerate investment in shale gas and shale oil E&P (exploration & production) in Ukraine.

The argument is these proposals, if they ever became plans, could or might at some unspecified future date also have included oil pipeline construction activity, some of it in Ukraine, able to bring new non-Russia gas and oil to 'energy-starved Europe'. The proposals were backed by Washington and the EU, so when Yanukovych turned them down he was obviously acting to artificially maintain energy scarcity in Europe, to the benefit of Putin.

In fact hydrocarbons E&P is powering ahead in the region without any special needs for increased US or EU political support to energy corporate investment and activity.

Reported by media including the UK 'Independent' and energy sector 'Offshore' magazine, US Exxon and Russia's Rosneft have made encouraging finds in Crimean and Russian offshore areas, while in the Romanian sector test drilling by Austria's OMV found interesting deposits, so much so that the majors are bringing in the panoply of deepwater drilling technology. Other majors cited by the specialty press that are either already operating onshore and offshore in Ukraine and Crimea, or are considering near-term action, include Spanish, Chinese, French and Malaysian companies, among others. Canada's Trans Euro Energy has already found commercial resources of natural gas on the Crimean mainland, underlining the distinct prospectivity and probable large gas and condensate potentials in Crimea.

Available public data only concerning Ukrainian and Crimean conventional onshore

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gas resources published by the IEA, EIA, CIA, European Commission, and energy majors indicate the country (or 2 countries) have around 1.25 trillion cubic metres of conventional gas - about 120 years of Ukraine's bloated national gas consumption.

However, the country's gas production peaked in 1975 and has declined ever since.

Very basically, and impossible to be ignored (even by geopolitical 'hawks') this has nothing to do with resource scarcity or Ukraine 'depending on Russian gas'. Ukraine has profited from ultra-cheap Russian gas - and even forgot to pay for it! Why produce it at home?

Eastern Ukraine's giant Donbas coal field is estimated by many analysts as holding very impressive quantities of coalbed methane, with published outline estimates from the US EIA and other sources extending well above 1 trillion cubic metres. The coal field is also deep, due to depletion, incurring high coal production costs and methane or coal dust explosion danger for miners, making coalbed methane extraction, instead of physical coal, the logical future path. Onshore shale gas potentials in the region, including Ukraine and Crimea are also probably large or very large. There is no shortage.

Scarcity is Off the Menu The Brzezinski line of patter has the article of faith that both oil and gas resources are limited and declining, but natural gas resource scarcity does not apply in the Black Sea-Caspian Sea region. This is also shown by the massive gas discoveries, and start of production, from Azerbaijan's gas and condensate fields. In the eastern and southern Mediterranean, gas E&P continues to make large new finds and extend previously-known offshore gas and condensate reserves, for example offshore Israel and Cyprus. Further away, in east Africa, truly gigantic offshore stranded gas resources have been discovered offshore Mozambique and Tanzania, since 2009.

The argument that Russia is making an 'energy resource and transport corridor grab' in Crimea and perhaps subsequently in east Ukraine, driven by energy scarcity among other factors, is therefore impossible to take seriously. Another key reason includes the huge amount of cash already invested by Moscow, in oil and gas E&P in the region. This has helped accelerate - not hindered - discovery and development.

In theory at least, this would heavily play against Russia's ability to get the whip hand on this large region's large proven and potential reserves and so doing, dominate the energy importers of Europe. In other words, Russia like other players is speeding hydrocarbons E&P - and is hard to portray as a geopolitical power trying to limit E&P with the sole intent of profiting from scarcity.

Especially in the Ukraine case, the scarcity theme has also been projected on gas and oil pipeline and transport capacities and oil and gas infrastructures in the region.

While this applies to some extent in the east of the region, Caspian Sea and onshore, it is easier to talk of overcapacity and oversupply in the west of the region.

Ukraine, notably, is oversupplied with massive but outdated and badly maintained gas pipeline and gas storage infrastructures, while it is undersupplied with gas and oil E&P financing and technology, to develop its own domestic reserves.

In the Caspian, as Italy's ENI and its consortium partners (Shell, Exxon, Total,

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Conoco, the Kazakh government and Impex) have found in their Kashagan project, extreme high costs and a harsh environment, plus a lack of infrastructures have heavily slowed down development of this giant oil and gas field. In the region's west and Black Sea, these barriers are lower, and timelines for projects to reach export status will be shorter, making it even harder to portray Putin's strategy as a resource grab.

One clear bottom line is that simply due to the region's gas resource endowment, and its energy infrastructures including pipelines, Gazprom will soon have no other option than to cut gas prices. Supply from non-Russian sources will grow, and prices will fall. This is hard to portray as a 'resource grab' profiting from scarcity!

Resource Scarcity Fears and Geopolitical Musings From the right distance away, from roughly 8000 kilometres in Washington that is, in the 1990s, Brzezinski could announce that both eastern and western Europe are energy resource depleted regions, in which Russia's Vladimir Putin would later make a thinly-disguised energy resource grab. More than 15 years ago, Zbigniev Brzezinski was advising US political leaders that the 'real meaning of the Cold War' was an attempt by Russia to make Europe dependent on Russian energy and cut off western Europe's access to energy resources and energy transport routes of the Black Sea, Caspian Sea and Central Asia.

We can note Brzezinksi in the 1990s did not include the Suez Canal, because that theory of Russian conspiracy to cripple Europe's oil transport security, by supporting Egypt's Nasser, was put to bed long ago. Today, his 1990s-vintage theories also need putting to bed - or in the document shredder.

US energy corporations, to be sure, are still interested in eastern Europe-Central Asia, but since the 1990s the often extreme high costs, lack of infrastructures, and unpredictable local political partners - usually recycled Soviet era party bosses now calling themselves 'democratic' - have tamed US and international energy corporate hopes - and their willingness to spend in the region. To be sure, the western fringe of this large region, including Ukraine, is better served with energy infrastructures, but as present events show, political turmoil and unpredictability still runs high, and at least as important, Ukraine already has more gas infrastructures than it needs.

More important for US energy corporations who were drawn to the region, their own shale gas and shale oil revolution is led by and focused on North America. Home is best.

US Big Energy's political masters, in Washington, may still be steeped in Cold Warvintage geopolitics and Peak Oil energy resource shortage themes, but these are not the reality on the ground. Since at latest the period from 2005 to date, outlooks for hydrocarbons reserve discovery, and output development and growth have radically increased on an almost worldwide basis - including SE Europe and Central Asia. At the same time, only taking Europe, its oil and gas demand trends are on a sustained downward track, meaning the continent has overcapacity of its existing energy transport and refining infrastructures. This is the real European energy problem, today.

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Europe's key trade surplus status with Russia is also a major factor heavily shading the Cold War geopolitical musings of Brzezinski. EU trade surplus with Russia basically means that Europe trades manufactured goods and services, for Russian energy. This commercial interdependence of Europe and Russia makes it unrealistic to imagine that Washingtonian paranoia has any rational basis, suggesting again that the EU, sooner rather than later, will shelve its talk about sanctions against Russia and support to the anti-Russian aggressivity of the new and instant Kiev 'government'.

As we know, political shadowboxing and geopolitical musing can fly far over the cuckoo's nest, tempting would-be Great Statesmen or women to raise their stupidity quotient, even further. To be sure, the financially overheated SE European and Central Asian 'energy and pipeline play' will likely suffer from the recent and present turn of events in Ukraine and Crimea, but this will have little effect over time on hydrocarbon E&P and infrastructure development in the region. Among other real world results, this certainly implies a downward trend for both oil and gas prices in Europe.

View more quality content from AMK CONSULT

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Skills and capability challenges facing upstream Written by Giles Lewis and Jon Sasserath from Practicus

Purpose This report aims to explore and explain the capability challenges now facing the Upstream Oil & Gas industry. A product of detailed discussions with numerous industry leaders, it highlights the principal approaches the industry is taking to tackle these problems and suggests further required changes.

Method Practicus's research function has contacted over 350 senior leaders from across Upstream, including Operational, HR and C-Suite professionals. We have taken a holistic view of the global Upstream industry and our research engagements have included IOCs, mid and smaller operators, Oil Field Services companies and expert consultants to the industry from all the major oil producing regions of the world. The research has been supplemented with quantitative data produced over the last 10 years. The aim of this research has been to create a detailed picture of the way capability challenges are manifesting within the Upstream industry and to suggest positive steps to address them.

Overview 'We have been watching this issue develop over the past 20 years and it is definitely there and it is definitely getting worse.' - Regional General Manager (Global Services Company) The 'Great Crew Change' has been a much-discussed subject within the Upstream industry for some time, but it is clear that the skills and capability challenges facing it are very real and in general are not being tackled effectively. This is an area of acute concern for many and is having a real impact on business operations.

With some businesses expecting a peak exodus of experienced talent in the immediate future, it is clear that the industry needs to understand and address this problem seriously. Even for those who expect to be less impacted by this issue the knock on effect will be significant and should be considered.

This is a complex problem that is difficult to tackle and has proven easier to ignore in the past. However, for some it is beginning to have a serious effect on their business; for others those impacts may yet be further down the line but are no less

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real. Some organisations are making concerted efforts to address these problems but few feel they are doing enough to avoid them altogether.

Historically, the issue been seen purely as a 'people' problem to be tackled by HR. In the majority of businesses this prevails. However, it is clear that the solution requires a more joined up approach, with the problem properly acknowledged as a business capability issue and a response driven from the top.

Effectively addressing this problem for the long term requires a shift from capability and expertise as individual capital, vested in individual employees, to organisational capital, embedded in the processes and culture of the business. This requires a blend of people, process and technology initiatives alongside a context of wider cultural change to create environments where knowledge sharing is rewarded, naturalised and expected.

'A crucial battle is about mind-set and culture first of all. There is more process needed around developing and transferring knowledge and skills.' - HR Director (Global Services Company) The Upstream industry is diverse, both in global spread and in the nature of its component companies. Different parts of the industry are experiencing different aspects of this problem and there are differing scenarios for the various constituents of the industry. The problem is impacting in slightly different ways on each but broadly the core issues and approaches are the same.

The roots of the problem 'The industry in general has struggled to see training and development as an investment rather than something it must do.' - Independent Consultant The capability challenge is a complex, multi-faceted problem for which there is no single, immediate solution. Addressing the issue effectively requires a significant commitment for the long term and a holistic approach to delivering real process and cultural change.

Across the industry, the following core issues create the capability challenge:

Each of these component issues is discussed in more detail on subsequent pages.

Later in the report you can find a summary of approaches and solutions to address each one of them from the research.

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Addressing the skills bleed 'There is now an acute lack of skills and depth of competency is eroding.' - CEO (Global Services Company) The 'Great Crew Change' is the tip of the iceberg A significant proportion of the Upstream workforce is moving inexorably towards retirement, creating a substantial bleed of knowledge and expertise as these individuals leave the industry. Many companies are fast approaching a peak skills exodus and not enough has been done to address this. The capability drain is exacerbated by the lack of experienced workforce sitting behind them and the growing need for new and highly specialised capabilities driven by changes in the way the industry identifies and accesses reserves.

An unprecedented capability gap looms. More experienced talent is becoming rarer amid a general skills shortage. This is the most obvious part of the problem, but considering its causes exposes wider issues that lie beneath the surface. The whole problem must be addressed.

'There is still a lot of tough oil out there but this needs high technology and very experienced, specialised people. The problem is going to compound with time.' Exploration Director (Global E&P Company) Bridging the widespread capability shortages and retention challenges There is a shortage of technical (engineering, geoscience) skills and organisations across the industry struggle to attract and retain talent. Fewer young people are taking engineering and science-based degrees and fewer still see Oil & Gas as an attractive career opportunities.

Competition for key skills can be fierce, driving up the cost of securing the right capability and making it equally difficult to hang on to. Much of the industry is able to access the new talent it needs but is often paying an escalating premium to secure these skills.

'The size of many of the projects we are working on now are unprecedented. There are serious challenges around finding the right people to fill these projects.' - CEO (Global Services Company) Growing ties with learning institutions, becoming more active in schools and universities and improving the perception and understanding of the industry among upcoming talent is a key part of the solution to attracting the next generation. Oil & Gas is not a sunset industry - there are real opportunities for graduates. The industry also needs to work with governments to address the wider shortage of technical / engineering skills.

Recruiting experienced talent with relevant skills from other industries (e.g. military and aerospace) and training them is also a popular initiative for bridging the capability gap. However, this is not a total solution in itself.

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'Building the right behaviours is key so that people naturally pass on their knowledge and mentor others. A crucial battle is about mind-set and culture.' - Head of Talent (Global E&P Company) There are significant shortages in soft skills- mentoring, coaching, leadership, strategic and management skills particularly. This is an 'on the tools' industry for many, and collaboration and knowledge sharing are not naturalised. The global nature of the industry complicates this as many operations are in countries where businesses of global scale are rare and in order to operate credibly on the world stage there are significant challenges around identifying and developing the right capabilities in-region - both technical and soft skills. Recognising this is an important step - integrating technical training with soft skills development is an important part of the answer.

Fast tracking talent is insufficient As the veteran workforce retires, it exposes an acute capability gap in the 10-15 year experience segments across the global Upstream sector. This dearth is the result of previous underinvestment in talent and the industry's history of periodically cutting the workforce.

This is not new but current initiatives to bridge this gap as retirees leave are not universally effective. Fast-tracking upcoming talent, encouraging mentoring activity and buying in short-term capability are all initiatives in play but none wholly address the overall problem of transferring knowledge from the individual to ownership by the business.

The days of huge ex-pat reward packages and jobs for life are largely gone and as locations become increasingly remote or harsh it is becoming harder to secure the level of capability that is needed globally. Improving mobilisation programmes, understanding and responding to the drivers and aspirations of talent and embracing technology that facilitates new ways of remote working and virtual teams will help to address this.

'Instead of taking people to the work, sometimes we need to take the work to the people. But mobilising people virtually needs the right systems and the right attitudes. It means more travel but less relocation.' - General Manager, Engineering (Global E&P Company) Securing niche skills as demand peaks As the business of extracting Oil & Gas becomes more technically challenging, the demand for highly specialist capabilities will increase faster than the talent pool available. There is a core challenge around how to manage peaks in demand for emerging capabilities - particularly if the skill capacity remains untested and an unprecedented demand is on the horizon. Investing in developing capability and in institutionalising this knowledge will help to reduce this risk.

'There are new and complex skill requirements driven by changes in the way we extract oil and new technologies and techniques to do so. These are becoming more

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specialised and complex and may be very scarce.' - Independent Consultant M&A activity and joint ventures have long been a method of gaining access to capability without having to buy it in directly. Organisations need to recognise where the acceptable balance lies in developing in-house capability, partnering with other businesses and load balancing with contractors. These activities are likely to continue to be seen as an option across the industry. Indeed we would expect to see an increasing emphasis on this as a part of the answer.

Towards a longer term solution The issues we have described are all inter-related and the tendency currently is for organisations to view them as purely 'people' challenges. This is overly reductive and restricts the organisation's ability to effectively tackle the problem. Initiatives to address these issues tend to focus on plugging short term capability gaps and relying on the experience of individuals. This is especially risky in an industry where retention is a core challenge.

A more holistic, long-term approach is required that is fully integrated with the wider business strategy. Businesses need to shift to a longer-term mind-set and find ways to transfer the knowledge, experience and capabilities of key individuals through process and cultural changes - facilitated in part by technology - into organisational knowledge and capability. There is a growing issue of a dearth of technical skills globally and this will impact on a number of industries, including Oil & Gas. This will increase competition and therefore these challenges cannot be ignored.

Effective knowledge management and transfer 'There is a lot of talk about knowledge management but no-one has really solved this. We need to work out how to encourage people to share knowledge in a sensible and accessible way and how to make this a natural part of the business culture and process.' - General Manager, Engineering (Global E&P Company) The industry is not currently realising the potential of knowledge management and transfer initiatives that could play an important role in creating a solution to the problem and help to grow organisational capability.

Talent and capability development, particularly outside of IOCs, is often hugely fragmented and there are real challenges around how to formally develop capability.

Transforming knowledge from individual to organisational capital How to shift knowledge from individuals within the workforce to embedding it in the organisation is one of the most important challenges facing the industry. Businesses have not effectively captured the knowledge of their employees and turned it into organisational capital, meaning that capability walks out of the door as people leave.

Attempts to capture this knowledge have been ineffectual or fragmented in their implementation to date. Many organisations rely heavily on contract resource to provide capability for when they need it but this is only a short-term fix. This contracted capability remains with the individual and is often not retained effectively

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when they leave.

Fragmented training and development Larger organisations can have sophisticated training programmes but struggle with retaining the capability they have invested in. For many, intensive training drops off after an initial period while developmental needs remain. Developing further structured training could help retain upcoming talent after the initial honeymoon period.

However, training and development programmes often separate the technical competence from the behavioural and soft skills needed. Training is not always followed up and coached in effectively, meaning potential gains are lost.

Understanding behavioural and technical competencies required for the specifics of Upstream environments and ensuring a joined up training programme - including real world experience - are significant areas for improvement.

Mentoring is a significant part of the solution for many organisations. But mentoring is difficult to get right - this is an unexpected role for many veterans and one for which not all are equipped.

Knowledge Management Tools Remain Underdeveloped There is a general level of cynicism towards knowledge management tools. This is a result of a lack of understanding of their potential, the complexity of systems and previous fragmentary or ineffective implementations.

Many organisations are wrestling with how to drive meaningful engagement with these systems and gain employee and business buy-in. Making knowledge management mechanisms easy and intuitive is a core challenge, but the industry has much to gain from developing effective central repositories of knowledge and rewarding knowledge sharing and engagement. The most effective processes are those that encourage further learning collaboration on a person-to-person level and that use a variety of media to drive engagement. In reality, existing knowledge management mechanisms are rarely developed, embedded and enforced effectively.

Driving regular meaningful engagement and maintaining data quality are key concerns, as is ascribing ownership of these systems, but effective implementation can provide real benefit in addressing the capability challenge.

Knowledge management initiatives tend to have been too haphazard in their implementation and not driven from the top, creating a fundamental lack of understanding of the value these can bring. A lack of leadership and belief in knowledge management tools exacerbates the problem, as does uncertainty about who owns the tools and how to manage them effectively. This is a key missed opportunity for addressing the capability problem.

As the industry turns to mentoring and training programmes to address these issues, there needs to be a broader cultural change from an industry of time-earned, 'on the tools' expertise to one where knowledge and experience is shared and rewarded.

Knowledge sharing and collaboration cultures need to be developed where they do

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not exist and normalised. Technology and knowledge management tools will assist this process change but they need to be effectively developed, implemented and established with leadership from the top.

A 'heads down' approach that needs to change 'There is no plan to replace these people - beyond poaching them from competitors.'

- General Manager (Global Services Company) Will we always be able to buy capability for when we need it?

The 'boom and bust' cyclical nature of Oil & Gas has created a very reactive and short-termist relationship with resource, with a heavy reliance on contractors and spiralling costs of attracting talent. The industry has tended to cut vast swathes of the workforce in a downturn, trusting that it can buy in what it needs when it needs it.

Again, this ensures an emphasis on individuals as the locus of capability.

'You can't plan for succession effectively when people are liable to leave at any time.

Opportunities for growing knowledge and transferring experience are being lost all the time.' - Independent Consultant The industry is too reactive and focussed purely on 'now' rather than planning for the future. Endemic short-termism has eroded in-house capability development and training programmes and ensured a low level of talent commitment and retention. It has created an environment where there is very little investment in developing organisational capability and knowledge transfer mechanisms. As a result, depth of competence is diminishing.

This has resulted in a high cost associated with buying in expertise in times of need.

Load balancing with contractors is an understandable solution, allowing organisations to flex their workforce depending on what they need at a given time, but when relied upon to the current degree it ensures that core expertise is not developed, retained and owned by the business. Many organisations rely on buying in short term capability that they should be developing internally for long-term advantage.

The cyclical nature of the industry and the accompanying 'knee jerk' reactions to deliver short-term fixes doesn't allow organisations to develop and embed capabilities effectively. Salary escalation is a significant problem - even if you are offering exposure to leading edge projects and have a compelling employer value proposition.

'The industry is very fragmented in its approach and needs to think in a more connected way.' - HR Director (Global Services Company) There is a growing acknowledgment of the need to adopt more of a 'heads up' and integrated approach to long term capability planning and some businesses are starting to address this. This is no mean feat in an industry as global and diverse as Oil & Gas, particularly since the 'heads down' view is so entrenched. Upstream as a whole is poor at planning beyond immediate delivery cycles and this is a core root

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cause of the capability challenge. Longer term planning is more sophisticated within the larger businesses and IOCs, as you would expect, but there is significant room for improvement even here and an over-reliance on contract resource still hampers the development of organisational capability and truly effective knowledge transfer.

Some HR functions are developing increasingly sophisticated approaches to workforce planning but in general this is still an ongoing challenge. The long range view needs to be addressed beyond an HR environment and integrated with wider business strategies.

The industry in general is poor at collecting and analysing data about internal capability and using this for long-term planning and this is a major area for improvement. Organisations that are developing their abilities in this space will be at a definite advantage.

Companies need to find where their acceptable balance is between building and institutionalising internal knowledge and experience capabilities and on retaining the flexibility afforded them by using outsourced talent.

The industry in general needs to adopt more of a long term approach to strategic planning. Companies that successfully do this quickly will accumulate the greatest benefit and will likely gain an additional protection for long-term profit.

The way forward: solutions and approaches This section summarises the ways forward discussed in previous pages and provides additional insight on solutions arising from the research.

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Develop, extend, improve and better integrate mentoring programmes.

Select mentors and pair with key developing talent. Improve understanding of mentoring and what makes a successful mentor.

Provide training for how to mentor.

Develop and extend reward mechanisms.

Naturalise and embed mentoring cultures and effectively communicate the value of continuous knowledge sharing.

Fast track upcoming talent.

Develop and populate matrix of capability/experience needed for key roles, enabling better structured training - both technical and behavioural.

Identify how to (safely) accelerate graduate and career converter learning more effectively.

Recruit career converters from allied industries and train them to fill the gap building relationships with these donor industry sectors.

Accumulate capability through JVs & M&A. Flexible working arrangements for veterans- phased retirement programmes.

Develop training/mentoring hubs or centres of excellence globally.

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Develop more sophisticated understanding of in-region talent and complicating cultural factors to enable better identification of key individuals, development opportunities and current/future capability gaps.

Work collaboratively with other Oil & Gas companies, industry bodies and governments to develop methods to reverse the decline in technical (e.g. engineering) skills and engage future generations of potential talent.

Develop document writing and reporting processes to ensure key knowledge is stored, and develop more user generated content across the workforce in various formats, e.g. video, audio, presentations, written documents, photos etc. Maintain data quality.

Drive engagement and embed knowledge management systems, e.g. 'lessons learned' capture mechanisms. This should be a two-way learning and sharing process, not just veterans educating new talent.

Identify 'at risk' knowledge and break this down into particular elements.

Identify where these sit and then capture them.

Rationalise the boundaries between developing in-house capability and relying on contractors.

Cultural change: grow and normalise knowledge sharing to create collaborative cultures - focus on developing and training knowledge sharing and mentoring behaviours. Normalise and reward these. Give a heavier weight in performance objectives towards knowledge transfer and collaboration behaviours.

Identify subject matter experts across the business; task them with sharing their knowledge across a range of formats and reward them for this.

Assess where the gaps are - what capability needs to be developed in-house?

Actively plan to transfer this from contractors and key individuals.

Work collaboratively with other Oil & Gas companies, industry bodies, governments and learning institutions to improve industry reputation for the long term.

Move to a more structured approach to long term planning - predict where gaps will be and identify key individuals the business needs to retain and transfer capability from. Identify key local talent in-region and structure plans to develop/retain this.

Improve global mobilisation programmes. To do this organisations must build a more sophisticated understanding of talent and its drivers within different segments of the workforce - cultural, geographical, generational - as well as defining the appeal and challenge of the regions in which the business operates. Organisations must better identify development opportunities and

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create more committed and contextualised approaches for talent/capability development in their core regions.

Develop and extend structured training beyond initial early career period.

Adopt new ways of working- facilitated by technology' that take the work to the people as much as possible (e.g. remote management and monitoring).

Pursue joint ventures and M&A that enable the accumulation of capability.

Develop more sophisticated understanding of drivers of key talent and variations between different regions; use this insight to develop initiatives to develop and retain it and develop a more sophisticated and segmented employer value proposition.

Standardisation of processes; identify where opportunities for standardisation lie and link strongly with knowledge management mechanisms.

Create capability development centres of excellence and training hubs to develop internal capability - graduate, mid-career and leadership development.

Identify the capabilities that will be needed in the future and when. Track these and better identify opportunities for talent development and knowledge transfer. Develop processes and approaches to embed emerging capabilities and secure them as organisational capital.

Understand the existing capability in-house (and understand how that manifests itself in various regions, e.g. taking into account cultural differences and behavioural differences) - develop actionable and measureable strategies for retaining, developing and sharing this knowledge.

Identify key learning institutions and donor sites of future talent in particular territories and build relationships with these, e.g. military headcount reductions and specialist learning centres.

Develop more advanced succession planning and workforce management approaches - collecting, analysing and utilising more workforce data in more sophisticated ways .

Acknowledge that addressing these challenges requires a long-term commitment and investment - a mindset and cultural change will be required to address this, and it will need to be led from the top down.

Create centres of excellence for long-term development, sharing and transfer of knowledge.

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Develop and populate a matrix of capability/experience needed for each key role to structure training around both technical and behavioural needs.

Diagnose how training fails. Diagnose where we can improve our understanding of the technical skills and behavioural styles needed for the particular environments of Upstream. Is this a feature of training? Is training followed up and trained in effectively? Does it separate technical/behavioural?

Is the team engaged or just individuals? How much new knowledge is retained and how can we improve this?

Fully integrate training with knowledge management systems. Better understanding of the workforce (generational, geographical, cultural) will allow the identification and introduction of more personalised and contextualised learning opportunities. Technology will facilitate this. Improve documentation and knowledge sharing- diaries etc.

Integrate various training programmes/units and make them less modular and siloed - promote continuous training across the business with consistent approaches, evaluation and reward.

Combine this with real world experience. Training will only have impact if it is then applied on the job. Harness individual motivation, leadership and peer support to make this happen.

Provide top-down leadership and communication of the value of knowledge management tools.

Diagnose how previous implementations have failed and create plans to avoid these pitfalls. Work more collaboratively with knowledge management suppliers (internal or external) to better communicate needs and ensure more mechanisms are truly fit for purpose, with a degree of flexibility baked in to allow for regional differences in requirements.

Define who owns knowledge management systems and assess how to drive meaningful engagement across the workforce (multimedia, collaboration across generations and understand how different generations engage) integrate with training and mentoring programmes and person-to-person knowledge transfer.

Under investment in knowledge management tools Make it easy to use knowledge management systems and make benefits real.

Personalise and contextualise learning. Take advantage of existing and emerging technology to vary and improve learning/sharing opportunities.

Identify new learning and development opportunities and how to embed these in business processes.

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Conclusions The capability challenge is a complex and difficult issue that will require a range of actions to address it. Making a range of blended people and knowledge management interventions, and developing a culture of knowledge sharing and collaboration are important parts of a solution.

More process is needed around developing and transferring internal capability and experience to embed high level skills within operating procedures, transferring individual capital into organisational capital and reducing the risk of relying on individuals who are difficult to retain. Long-term and genuine cultural change is required to create environments where knowledge sharing is expected and normalised.

A strategy will be most effective when these interventions are blended together and combined with a shift to longer term planning and strongly linked with the wider strategies of the business.

The problem needs to move from being purely an HR 'people' issue and the solution needs to be seen as a mix of people, process, cultural and technological solutions working together. The solution needs to be driven from the top, with senior leaders making a visible commitment to this amid a wider industry acceptance of and commitment to address these challenges.

Addressing the Capability Challenge          

No single solution is apparent. Successful approaches will include a range of activities: Engage future talent; grow ties with learning institutions and sell the Oil & Gas sector Extend and better integrate training and mentoring programmes Pursue M&A and joint ventures Improve mobilisation programmes and embrace new ways of working Invest in and commit to knowledge management tools Create sharing and collaborative cultures Improve longer term capability planning Provide top down leadership and acknowledgement of capability challenges Recruit and upskill career converters with relevant skills from allied industries

Final thought 'The industry is at a tipping point. The peak of retirees is approaching. Has the business done enough? Has the industry done enough?' - HR Leader (IOC) It is clear that the majority of businesses have now acknowledged these issues to a degree and are at varying stages of addressing them. Most feel that the industry has awoken to the capability challenges it is facing and is starting to move in the right direction. However, there is also a strong current of feeling that not enough is being done and further solutions are needed. From the discussions we have had with industry leaders over the past few months the view within HR is broadly more

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positive, with a feeling of moving in the right direction. This is not always reflected in views across the wider business though, with some respondents painting a bleak picture of an industry blindly marching towards impending disaster.

There is no shortage of discussion around the 'Great Crew Change' and related challenges but the causes and effects of the problem are not being addressed consistently or often coherently.

Key individuals are very focussed on the day-to-day delivery of their role, and frankly the capability challenges are very difficult issues to tackle. For many these are still purely HR problems that are being addressed through limited succession planning and knowledge transfer mechanisms that often remain ineffective, ad hoc and disconnected with the wider business context.

Across the industry there is still a general lack of top-down leadership on these issues. Trying to cling on to an exiting workforce is clearly not a long-term solution to a serious problem. It's astonishing how this capability and experience is being lost to the industry as individuals retire, and this is creating a frustrating scenario.

The 'Great Crew Change' is real and is upon us. The industry is at a crucial decision point in how it addresses this issue. Actions that are taken now will have long term impacts on the future of the Oil & Gas industry and shape the key players within it.

Practicus can help Our expertise within organisational change and transformation, combined with our deep understanding of the Oil & Gas industry, allows us to rapidly assess where positive, tangible changes can be made within your business that will improve the way you handle your own unique capability challenges.

Working in partnership with you and your teams, we can identify key areas where we can help, then design and implement a tailored series of interventions that will deliver real value to your approach to this problem.

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The Fracking Flip U.S. Domestic Oil Production's Radical Transformation of the North American Tanker Trade Written by Keith Letourneau and Matthew Thomas from Blank Rome LLP A flurry of recent economic data and activity suggests that U.S. tanker markets, both Jones Act and international, are riding swift new market currents that were unforeseen just three years ago. The White House announced on November 14, 2013, that the United States for the first time in nearly two decades is importing less foreign oil than we are producing domestically. By the end of FY-2014, imported crude-oil shipments are expected to fall below 7.0 million barrels per day (bbl/d). As recently as the summer of 2010, imports reached nearly 10.0 million bbl/d. Domestic production is up 39% since 2011 and now exceeds 8.0 million bbl/d. The U.S. Energy Information Agency estimates that in 2013 the United States became the world's top oil and natural gas producer, exceeding the production of both Russia and Saudi Arabia, and is poised to become the leading crude producer next year.

The increase is largely due to the rapid development of advanced drilling techniques, including horizontal drilling and hydraulic fracturing (fracking) in Texas, North Dakota and Pennsylvania.

In the process, domestic production has flipped the crude oil import market on its head and accelerated the construction of U.S. built tankers for the coastwise trade.

The Jones Act mandates that only U.S.-owned, -built and -flagged vessels carry cargo between points in the United States. Approximately 42 tankers currently ply the Jones Act trade. At least eleven product tankers, with options for quite a few more, are currently under construction at the Aker Philadelphia and General Dynamics-NASSCO San Diego shipyards, though the first of these are not expected to come on line until 2015. As well, new domestically-built, crude-carrying integrated tugs and barges are under construction. Meanwhile, charter rates for domestic tankers are reaching market peaks.

Yet, while coastwise tanker owners demand ever higher freight rates with domestic production accelerating, charterers are not sitting idle as they consider alternative modes of transport. Unprecedented investments in rail, pipeline, and terminal capacity are underway, fueling growth in Gulf Coast refining capacity and bringing

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new life to East Coast refining centers, where many facilities are better suited to light-shale crudes. The Philadelphia area alone is seeing an unprecedented influx of hundreds of thousands of barrels of Bakken crude every day, bound for local refiners. In addition, although much is made of the U.S. becoming a net exporter of refined products, sourcing products from overseas via foreign vessels remains an important strategic option for charterers.

Looking ahead, the outlook for the U.S. tanker markets hinges not only on the continued domestic production boom, but also on regulatory and political developments in Washington, particularly with regard to the decades-old ban on exporting U.S. crude oil. The 1973 Arab Oil Embargo prompted Congress to pass legislation that bans the export of U.S. crude, except to Canada, with only narrow and largely untested exceptions. In an effort to lift the ban, certain oil industry proponents contend that it has outlived its usefulness, artificially depresses prices, discourages investment in new production, exacerbates the U.S. trade deficit and violates World Trade Organization export restriction rules. Not all U.S. oil industry businesses support lifting the ban, however. Some domestic refiners urge keeping the ban in place, as domestic crude production has sparked a boom in refinery investment, and lifting the ban could see the spread between U.S. and global prices (the Brent-WTI gap) narrow or disappear. Their unease is understandable; all investors in this sector - shipowners, refiners, terminals, pipelines and other infrastructure - are struggling to weigh the risks and uncertainty caused by the unpredictable long-term outlook for the U.S. crude export ban.

On January 31, 2014, Congress held the first hearing about the crude export ban in a quarter century. Alaska Republican Senator Lisa Murkowski, Ranking Member of the Senate Energy and Natural Resources Committee, is currently the most vocal proponent of lifting the ban arguing that it adversely affects U.S. productivity and contributes to supply disruptions. Proponents of lifting the ban received a boost in recent days, when Democratic leadership announced that Sen. Mary Landrieu, another supporter of crude exports, was tapped to take over as chair of the Senate Energy and Natural Resources Committee. She and Sen. Murkowski will provide powerful bipartisan Senate leadership on this issue. At the CERAWeek Energy Conference in Houston on March 3, 2014, Sen. Murkowski proposed a three-part plan to gradually lift the ban through executive action. Several members of Congress, including Democratic Senators Ed Markey and Robert Menendez, oppose lifting the ban because of the gasoline price effect, and it appears unlikely that Congress will tackle this divisive issue head-on this election year. The Obama administration has gone to some lengths to avoid articulating a position, or even acknowledging that it is actively rethinking the ban. However, Commerce Department and other officials have worked with individual companies to clarify and apply little-used exceptions to the crude ban. For example, as news outlets have noted in recent days, the Commerce Department appears to have begun licensing shipments of Canadian crude for shipment from U.S. ports, and much attention is being given to how the administration will apply its 'public interest' exception authority to provide for physical swaps of equivalent import and export volumes.

While the clamor for reforming the crude ban has escalated in recent months, calls for reexamining the Jones Act have been more muted. An unintended consequence of the Jones Act is that it costs more to transport crude from Texas to New York than

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it does from Texas to Canada because of the significant difference in freight rates between U.S. and foreign tankers. Refiners on the East Coast are paying far more to obtain domestic crude from the Gulf Coast than their Canadian counterparts. This has led groups such as the American Fuel and Petrochemical Refiners to call for changes to the coastwise laws; however, there appears to be little interest in Congress or the Administration at this point for such an initiative. While there is always talk about changes to the Jones Act, seeing is believing.

The exponential growth of domestic oil and gas production is also shifting the landscape of import and export tanker activity. During the past forty years, domestic refiners have imported a substantial amount of crude via tankers to provide feedstocks for their terminals. That demand increased the size of crude tankers and led to an offshore lightering trade in the Gulf of Mexico that employs smaller 70,000 deadweight ton (dwt) tankers to offload crude from 200,000 (and larger) dwt Very Large Crude Carriers (VLCC's) and carry that imported crude to domestic refineries for conversion. With the advent of domestic fracking, it is conceivable within the next few years for many U.S. refineries to reverse that process in large measure such that they will be refining primarily domestic crude. In 2014, the U.S. is expected to import 3.6 million bbls/d less crude oil by sea than at the import apex in 2005. That equates to an astounding 1.3 billion barrels less per year, or - conservatively - enough crude oil to fill a 200,000 dwt VLCC more than a thousand times every year. This import decline is likely to continue until the U.S. reaches its maximum crude oil productivity.

The net effect is that crude imports will travel elsewhere, and domestically refined products will dominate the export market. Charter rates for foreign-flagged tankers carrying foreign crude sailed in the doldrums for much of last year with too many ships ordered before the recession hit, though a number of companies including Euronav and Teekay are investing in a crude-market turnaround. Foreign crude carriers enjoyed a tremendous spike in rates at the end of last year, which allowed owners to breathe a sigh of relief; however, expectations in the charter trade are that rates will settle back down this year to levels more akin to 2013. Unless Congress lifts the ban on exporting domestic crude, rather than crude carriers, the U.S. market will demand ever more tankers that can carry substantial quantities of refined product. The United States is currently exporting more than 3.5 million bbls/d of such products. Charter rates for these product tankers are increasing accordingly.

The rise of domestic crude production is literally changing the course of foreign crude carriers away from North America, while promoting a surge in domestic crudetanker capacity and boosting the export of refined products. In just a few short years, domestic fracking has fundamentally altered the tanker trade to this continent and the shoreside infrastructure that serves it, and it would seem there are more changes to come.

Sources: Law 360 - Murkowski Offers Crude Oil Export Roadmap (4 Mar 2014); Roll Call - Oil Export Debate Renews Fight Over Protections for U.S. Shipping (4 Feb. 2014); E&E Daily, Energy Policy: White House leaves door open to revising crude export limits (31 Jan 2014); MARAD statistics, United States Flag Privately-Owned Merchant Fleet, 2000-1014; Bloomberg, Oil-Tanker Recovery Trails Market With U.S. Export Ban: Freight by Isaac Arnsdorf (9 Jan. 2014); Tradewinds article, Valero Defends Ban (8 Jan. 2014); Bloomberg, Unforeseen U.S. Oil Boom Upends Markets

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as Drilling Spreads by Asjylyn Loder (8 Jan. 2014); Oil &Gas Journal, Murkowski: Ban on US crude oil exports should end soon by Nick Snow (8 Jan. 2014); Reuters, Lisa Murkowski Urges Review of Oil Exports Ban by Valerie Volcovici (7 Jan 2104); Law 360, US Trade Gap Narrows as Exports Hit $195B, Oil Imports Drop edited by Philip Shea (7 Jan. 2014); U.S. Energy Information Administration (EIA), U.S. crude oil production on track to surpass imports for first time since 1995 (26 Dec. 2013); Bloomberg, Oil Industry May Invoke Trade law to Challenge Export Ban (5 Nov. 2013); Journal of Commerce, Could Crude Oil Put the Jones Act into Play? By Peter Tirschwell (30 Oct. 2013); EIA, U.S. expected to be largest producer of petroleum and natural gas hydrocarbons in 2013 (4 Oct. 2013); EIA, Oil and gas industry employment growing much faster than total private sector employment (8 Aug. 2013); Reuters, Analysis: Shale oil storm blows U.S. tanker trade out of doldrums by Anna Louie Sussman (1 Jul. 2012); EIA, A number of western states increased oil production since 2010 (21 May 2013); EIA, Abundant U.S. Supply, low demand could cut dependence on liquid fuel imports (17 Apr. 2013); Reuters, Analysis Texas oil sails to Canada, refiners fume over tanker law by Jonathan Leff and David Shepard (1 May 2013).

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OilVoice Magazine | APRIL 2014

Ukrainian crisis highlights political risk in long term gas sales Written by Dag Mjaaland and Aadne Haga from Wikborg Rein Russia supplies around one third of Europe's gas, and around half of that gas passes through Ukrainian territory. The political crisis in Ukraine, not least Russia's recent involvement, has therefore highlighted the issue of political risk in gas sales, with some nervous price movements seen in European gas trading markets and importers rushing to reassure markets and customers that supply interruptions are unlikely. But long term gas sales to Europe have shown surprising resilience against political risk in the past, perhaps due to the particular level of mutual dependence between the parties to long term gas sales agreements, but also to the benefits of increasingly diversified supplies and competition.

At a global level, this situation is also relevant for Asian gas buyers, who import LNG also from countries which have seen political unrest in the past, but also systematically diversify their supplies and seek to adapt their historical supply arrangements to new realities, in particular in terms of price.

European long term gas sales have been exposed to political risk since the beginning of cross-border sales in the early 1960s, when the Dutch Government took an active role in managing the Dutch super-giant Groningen field. The Dutch government's changing policies, from conservation to increasing sales, and from the invention of the oil-link to liberalization, have had a major influence on the European gas market. Political risk increased with Soviet gas exports to Western Europe beginning in the late 1960s and early 1970s. In the 1980s, the Reagan administration imposed an embargo on the sales of gas compressors to the Soviet Union, and attempted to speed up the development of Norway's super-giant Troll field to limit Soviet exports. The collapse of the Eastern Block in 1989 and of the Soviet Union in 1991 created new political risks, as much of the pipelines between Russia's gas fields and the markets of Western Europe suddenly were in non-aligned and independent States. In 2006 and 2009, disputes between Russia and Ukraine reduced transit volumes to Europe.

Long-term gas sales have, however, proven themselves impressively resilient against political risk. The Reagan administration's attempts at curtailing Soviet gas sales in the 1980s were unsuccessful. The countries of the former Eastern Block quickly transformed their former barter arrangements for Soviet gas into long-term contracts in line with the concepts in Western Europe during the transitional years of the 1990s. The Ukrainian transit disruptions in 2006 and 2009 were short-lived and had commercial price disputes at their core. Recent improvements of infrastructure

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and coordination, as well as increasingly diversified supplies contribute to the European importers' recent reassurances that supply interruptions due to the Ukrainian crisis are unlikely. The German border price dropped below spot prices in late 2013 as buyers and sellers have realigned their relationships in the light of European gas market liberalization.

In a comment to the current crisis in Ukraine, Fridtjof Nansen Institute Senior Research Fellow Arild Moe notes that the mutual dependence created by gas supplies is a stabilizing factor. On the one hand, gas supplies may raise opportunities for games and pressure, but on the other hand strong common interests tie the countries together. The parties' mutual dependence on each other is also a main underlying characteristic of long-term gas sales agreements. Both parties have to make major investments, and the lapse of an agreement will create major challenges for both parties, who may not be able to find alternative partners on short notice. This mutual dependence forms the background for the peculiar combination of rigidity and flexibility found in most long-term gas sales agreements, where the buyer has a long term obligation to pay for large volumes of gas which cannot be terminated, but only at a fair price which adapts to changes in the market.

In our opinion, this strong combination of mutual dependence and flexibility has contributed to the gas industry's ability to weather the political crises of the past, and will contribute to Asian gas buyers' efforts to update their supply arrangements to new realities, like today's waning relevance of oil as a competitor to gas.

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Beginning of the end?

Oil companies cut back on spending Written by Gail Tverberg from Our Finite World Steve Kopits recently gave a presentation explaining our current predicament: the cost of oil extraction has been rising rapidly (10.9% per year) but oil prices have been flat. Major oil companies are finding their profits squeezed, and have recently announced plans to sell off part of their assets in order to have funds to pay their

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dividends. Such an approach is likely to lead to an eventual drop in oil production. I have talked about similar points previously (here and here), but Kopits adds some additional perspectives which he has given me permission to share with my readers.

I encourage readers to watch the original hour-long presentation at Columbia University, if they have the time.

Controversy: Does Oil Extraction Depend on “Supply Growth” or “Demand Growth”?

The first section of the presentation is devoted the connection of GDP Growth to Oil Supply Growth vs Oil Demand Growth. I omit a considerable part of this discussion in this write-up.

Economists and oil companies, when making their projections, nearly always make their projections depend on “Demand Growth”–the amount people and businesses want. This demand growth is seen to be rising indefinitely in the future. It has nothing to do with affordability or with whether the potential consumers actually have jobs to purchase the oil products.

Kopits presents the following list of assumptions of demand constrained forecasting.

(IOC’s are “Independent Oil Companies” like Shell and Exxon Mobil, as contrasted with government owned companies that are prevalent among oil exporters.)

Thus, it is the demand constrained view of forecasting that gives rise to the view that OPEC (Organization of Petroleum Exporting Nations) has enormous leverage. The assumption is made that OPEC can add or subtract as much supply as much as it chooses. Kopits provides evidence that in fact the Demand view is no longer applicable today, so this whole story is wrong.

One piece of evidence that the Demand Model is wrong is the fact that world crude oil (including lease condensate) production has been nearly flat since 2004, in a period when China and other growing Eastern economies have been trying to motorize. In comparison, there was a rise of 2.7% per year, when the West, with a

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similar population, was trying to motorize.

Kopits points out that China’s big source of oil supply has been US main street: China bids oil supply away from United States, to satisfy its needs. This is the way that markets have made oil available to China, when world supply is not rising much.

It is part of the reason that oil prices have risen.

Another piece of evidence that the Demand Model is wrong relates to the assumption thatsocial tastes have simply changed, leading to a drop in US oil consumption. Kopits shows the following chart, indicating that the major reason that young people don’t have cars is because they don’t have full-time jobs.

Kopits makes a comparison of the role of oil in GDP growth to the role of water in plant growth in the desert. Without oil, there is less GDP growth, just as without

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water, a desert is starved for the element it needs for plant growth. Lack of oil can considered a binding constraint on GDP growth. (Labor availability might be a constraint, but it wouldn’t be a binding constraint, because there are plenty of unemployed people who might work if demand ramped up.) When more oil is available at a slightly lower price, it is quickly absorbed by markets.

“Supply Growth” is the limiting factor in recent years, because the amount of extraction is rising only slowly due to geological constraints and the number of users has risen to the point that there is a shortage.

Experience of Major Oil Producing Companies Kopits presents data showing how badly the big, publicly traded oil companies are doing. He looks at two pieces of information:  

“Capex” – “Capital expenditures” – How much companies are spending on things like exploration, drilling, and making of new offshore oil platforms “Crude oil production” -

A person would normally expect that crude oil production would rise as Capex rises, but Kopits shows that in fact since 2006, Capex has continued to rise, but crude oil production has fallen.

The above information is worldwide, not just for the US. At some point a person might expect companies to start getting frustrated–they are spending more and more, but not getting very far in extracting oil.

Kopits then shows another version of Capex history plus a forecast. (This time the amounts are labeled “Upstream,” so the expenditures are clearly on the exploration and drilling side, rather than related to refineries or pipelines.)

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The amounts this time are for the industry as a whole, including “NOCs” which are government owned (national) oil companies as well as IOCs (Independent Oil Companies), both large and small. Kopits remarks that the forecasts shown were made only six months ago. When talking about the above slide Koptis says, People in the industry thought, “Capex has been going up and up. It will continue to do very well. We have been on this trajectory forever, and we are just going to get more and more money out of this.”

Now why is that? The reason is that in a Demand constrained model for those of you who took economics–price equals marginal cost. Right? So if my costs are going up, the price will also go up. Right? That is a Demand constrained model. So if it costs me more to get oil, it is no big deal, the market will recognize that at some point, in a Demand constrained model.

Not in a Supply constrained model! In a Supply constrained model, the price goes up to a price that is very similar to the monopoly price, after which you really can’t raise it, because that marginal consumer would rather do with less than pay more. They will not recognize [pay] your marginal cost. In that model, you get to a price, and after that price, there is significant resistance from the consumer to moving up off of that price. That is the “Supply Constrained Price.” If your costs continue to come up underneath you, the consumer won’t recognize it.

The rapidly growing Capex forecast is implicitly a Demand constrained forecast. It says, sure Capex can go up to a trillion dollars a year. We can spend a trillion dollars a year looking for oil and gas. The global economy will accept that.

I quote this because I am not sure I have explained the situation exactly that way. I perhaps have said that demand had to be connected to what consumers could afford. Wages don’t magically go up by themselves (even though economists think they can).

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According to Koptis, the cost of oil extraction has in recent years been rising at 10.9% per year since 1999. (CAGR means “compound annual growth rate”).

Oil prices have been flat at the same time. On the above chart, “E&P Capex per barrel” is pretty much the same type of expenses as shown on the previous two charts. E&P means Exploration and Production.

Kopits explains that the industry needs prices of over $100 barrel.

The version of the chart I have up is too small to read the names of individual companies. If you would like a chart with bigger names, you can download the original presentation.

Historically, oil companies have used a discounted cash flow approach to figure out

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whether over the long term, pricing for a particular field will be profitable.

Unfortunately, this “standard” approach has not been working well recently.

Expenses have been escalating too rapidly, and there have been too many new drilling sites producing below expectation. What Kopits shows on the above slide is the prices that companies need on different basis–a “cash flow” basis–so that each year companies have enough money to pay today’s capital expenditures, plus today’s expenses, plus today’s dividends.

The reason for using the cash flow approach is because companies have found themselves coming up short: they find that after they have paid capital expenditures and other expenditures such as taxes, they don’t have enough money left to pay dividends, unless they borrow money or sell off assets. Oil companies need to pay dividends because pension plans and other buyers of oil company stocks expect to receive regular dividends in payment for their equity investment. The dividends are important to pension plans.

In the last bullet point on the slide, Kopits is telling us that on this basis, most US oil companies need a price of $130 barrel or more. I noticed that Brazil’s Petrobas needs a price of over $150 barrel. (OSX, Brazil’s number two oil company, recently went bankrupt.)

In the slide below, Kopits shows how Shell oil is responding to the poor cash flow situation of the major oil companies, based on recent announcements.

Basically, Shell is cutting back. It no longer is going to tell investors how much it plans to produce in the future. Instead, it will focus on generating cash flow, at least partly by selling off existing programs.

In fact, Kopits reports that all of the major oil companies are reporting divestment programs. Does selling assets really solve the oil companies’ problems? What the oil companies would really like to do is raise their prices, but they can’t do that, because

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they don’t set prices, the market does–and the prices aren’t high enough. And the oil companies really can’t cut costs. So instead, they sell assets to pay dividends, or perhaps just to get out of the business. But is this sustainable?

The above slide shows that conventional oil production peaked in 2005. The top line is total conventional oil production (calculated as world oil production, less natural gas liquids, and less US shale and other unconventional, and less Canadian oil sands). To get his estimate of “Crude Oil Normal Decline,” Kopits uses the mirror image of the rise in conventional oil production prior to 2005. He also shows a separate item for the rise in oil production from Iraq since 2005. The yellow portion called “crude production forward” is then the top line, less the other two items. It has taken $2.5 trillion to add this new yellow block. Now this strategy has run its course (based on the bad results companies are reporting from recent drilling), so what will oil companies do now?

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Above, Kopits shows evidence that many companies in recent months have been cutting back budgets. These are big reductions–billions and billions of dollars.

On the above chart, Kopits tries to estimate the shape of the downslope in capital expenditures. This chart isn’t for all companies. It excludes the smaller companies, and it excludes the National oil companies, so it is about one-third of the market. The gray horizontal line at the top is the industry consensus back in October. The other lines represent more recent estimates of how Capex is declining. The steepest decline is the forecast based on Hess’s announcement. The next steepest (the dotted gray line) is the forecast based on Shell’s cutback. The cutback for the part of the market not shown in the chart is likely to be different.

Oil and Economic Growth Kopits offers his view of how much efficiency can be gained in a given year, in the slide below:

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In his view, the maximum sustainable increase in efficiency is 2.5% in nonrecessions, but a more normal increase is 1% per year. At current oil supply growth levels, OECD GDP growth is capped at 1% to 2%. The effect of constrained oil supply is reducing OECD GDP growth by 1% to 2%.

Conclusions

While demand constrained models dominate thinking, in fact, a supply constrained model is more appropriate in recent years.

We seem to be short of oil. Whenever there is extra oil on the market, it is quickly soaked up. Oil prices have not collapsed. No one is nervous about a price collapse.

China recently has been putting little price pressure on the market–its demand is recently less high. Kopits thinks China will eventually return to the market, and put price pressure on oil prices. Thus, oil price pressures are likely to return at some point.

Gail’s Observations An obvious point, which I thought I heard when I listened to the presentation the first time, but didn’t hear the second time is, “Who will buy all of these assets on the market, and at what price?” China would seem to be a likely buyer, if one is to be found. But when several companies want to sell assets at the same time, a person wonders what prices will be available.

The new strategy is, in effect, maintaining dividends by returning part of capital. It is clearly not a very sustainable strategy.

It will take a while for these cut-backs in Capex expenditures to find their way

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through to oil output, but it could very well start in a year or two. This is disturbing.

What we are seeing now is a cutback in what companies consider “economically extractable oil”–something that isn’t exactly reported by companies. I expect that what is being sold off is mostly not “proven reserves.”

In this talk, it looks like lack of sufficient investment is poised to bring the system down. That is basically the expected limit under Limits to Growth.

In theory, if an expansion of China’s oil demand does bring oil prices up again, it could in theory encourage an increase in drilling activity. But it is doubtful that economies could withstand the high prices–they are already having problems at current price levels, considering the continued need for Quantitative Easing to keep interest rates low.

A recent news item was titled, G20 Finance Ministers Agree to Lift Global Growth Target. According to that article, Mr Hockey said reaching the goal would require increasing investment but that it could create “tens of millions of new jobs”.

The cutback in investment by oil companies is working precisely in the wrong direction. If these cutbacks act to cut future oil extraction, it will bring down growth further.

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