Oil majors’ business model under increasing pressure

Gorgon, a massive liquefied natural gas project off the north-west coast of Australia, is one of the wonders of the modern age. Its $54bn price tag makes it — in nominal terms at least — one of the most expensive engineering projects ever completed.

It could also be a monument to a fading era, the last hurrah of Big Oil.

With US crude hitting 12-year lows last week, some in the industry are asking whether the business model of large international oil companies such as Chevron, ExxonMobil and Royal Dutch Shell the three principal partners in Gorgon, is fundamentally flawed.

Due to dispatch its first LNG cargo soon, Gorgon is the type of project that justifies the existence of large oil companies.

Chevron, which is leading it, is one of only a handful of businesses that have the technical capabilities and financial strength to take on a challenge of that scale.

After the plunge in crude prices, however, such ambitious investments in LNG, deepwater exploration and Canada’s oil sands are becoming increasingly scarce.

Morgan Stanley analysts calculate that just nine large projects, out of more than 230 awaiting a green light worldwide, are “realistic candidates” for approval this year.

They could include BP’s $10bn Mad Dog 2 deepwater oil project in the Gulf of Mexico, and Italy-based Eni’s offshore Zohr gas discovery in Egypt.

Total of France plans to approve no projects at all.

Across the industry, some $400bn in expected investment has been cancelled or delayed.

When executives from the large oil companies talk about the industry downturn, they generally frame it as a temporary condition. Because crude at below $30 per barrel is much too low to incentivise investment, they say, the oversupply in the oil market will correct, and prices will rebound to levels that will allow them to make respectable returns again.

The chief executives of BP and Shell both argued at their companies’ 2015 results this month that the oil market could come back into balance this year. As Bob Dudley of BP put it, his expectations about prices were “lower for longer, not lower forever”.

But what if they are wrong? Philip Verleger, an energy economist, argues that “nightfall is coming” for big oil companies, threatened on one side by the rise of renewable energy and climate policies that will curb the growth of fossil fuel demand, and on the other by the smaller, nimbler companies that lead the shale oil and gas industry.

“The companies that are wedded to high-cost projects, like deep water in Brazil, are going to have to take some large write downs,” he says. “The likelihood that those investments are going to pay off over the next 20 years is extremely low.”

Companies that put their hopes in a strong rebound in oil “aren’t going to make it”, he adds.

While the oil price is likely to increase sooner or later, many industry executives and analysts believe a sustained recovery will prompt a rapid revival in shale drilling in the US, bringing on additional production and in effect putting a ceiling on prices.

In this view of the world, the price crash has been like an asteroid strike: agile shale producers can survive, but the lumbering dinosaurs of big oil are doomed.