Brazil, giant oil projects and the Majors

Resource capture strategies have shifted, probably forever. Faced with the threat of lower-for-longer prices and peak oil demand, E&P companies have reassessed their appetite for risk. One victim is exploration – the Majors have halved exploration spend since 2014.

The world will rely on oil for some time yet, and Big Oil needs to deliver supply if it is to stay in business. The hunt now focuses on lower risk sources that satisfy other criteria – low cost, long life and low carbon intensity.

BP for one is betting on technology as the answer. It’s targeting reserves replacement of 9 billion boe over the next decade and reckons two-thirds can be tech-enabled – by increasing recovery rates from its existing resource using EOR, digitalisation and application of artificial intelligence. Just 2 to 3 billion boe will come via the drill bit.

Discovered resource opportunities (DROs) fit into the low-risk bucket as a rule. Eni, BP, Total and ExxonMobil have accessed 11 billion barrels of reserves through DROs (mainly in the UAE and Oman) in the last five years. That’s 27% of total reserve additions, and more than conventional exploration in the period. Returns on DROs generally reflect the lower risk, ranging from 5% to 11% in recent Middle East awards.

Brazil features high on Big Oil’s list when it comes to accessible low breakeven oil barrels. No other non-OPEC country competes with Brazil’s sustained production growth which lasts well into the 2030s, driven by the development of multiple giant fields under reasonable fiscal terms. Big Oil sees Brazil as core to its future. So when a giant Brazilian pre-salt DRO is opened to tender you’d expect a who’s who of the industry to roll up.

The Buzios field is the ‘Koh-i-Noor’ of the pre-salt diamonds. Up for tender – 5.8 billion barrels of ‘surplus’ oil, with production expected to build to a peak of 1 million b/d in 2030, a rarity for any project these days. The headline full-cycle IRR of 15% is not to be sniffed at. Marcelo de Assis, Head of Latin America Upstream, includes both signature bonus and estimated past-cost reimbursement in his calculation.

Come the day on 6 November, no IOCs bid for the giant (or indeed the much smaller Itapu). Buzios attracted just one bid from operator Petrobras at the minimum government profit share, CNOOC and CNPC joining in with 5% each. We think three factors played a part in dampening enthusiasm.

First, the Majors already have robust production profiles well into the 2020s. They just didn’t need it, at least not at any cost. The Chinese NOCs, in contrast, face steep production declines within a few years.

Second, a lack of clarity on costs. The bid includes an estimate for past costs but nailing down what will be a large number (we assume US$24 billion) could prove contentious. Upward movement risks eroding the project economics.

Third, the development challenge. The industry is wary of giant projects, and the associated risks to execution, costs and reserves. Libra, another big pre-salt field, has not lived up to expectations. Last month, Shell, ExxonMobil, Eni, Total, CNPC and Inpex walked away from a big greenfield project in Kazakhstan when the economics didn’t stack up. These risks are amplified in Brazil where Petrobras as operator shoulders responsibility for developing multiple big projects simultaneously. Capital spend in Brazil on ultra deepwater projects will rise to a new peak of US$15 billion a year in the mid-2020s, up from under US$10 billion today.

It’s possible we’re not at the endgame for the Buzios JV. Petrobras could yet sell down its stake to IOCs on arm’s-length terms with no government involvement. And let’s be clear – Brazil is still hot. The Majors have big exploration positions; and Concession Round 16 in October attracted record signature bonuses and a raft of big bidders on acreage close to the pre-salt, among them Petronas, QPI (Qatar Petroleum International), Repsol and Chevron.

But the Buzios tender and lack of interest in acreage in the PSC Round 6 early in November underline the caution and capital discipline that are dictating IOC and NOC behaviour.

Striking the right balance between risk and reward has always been critical, but that balance has shifted. Other governments seeking to attract investment will do well to pay heed to the result. Brazil’s surplus pre-salt volumes were the last of the big oil DROs up for grabs, at least for the foreseeable future. Qatar’s North Field expansion, due for award in 2020, is the last big gas DRO in the offing and is the next test of Big Oil’s appetite.