Peter Varadi Sees a Dim Future for the Oil Industry

The attached article by Peter Varadi presents a dim view of the ability of big oil companies to adapt to rapidly changing global conditions. It reflects his personal experiences as a solar energy pioneer and entrepreneur dealing with representatives of the oil industry, starting in the 1970s. The article was first published earlier this week in the e-journal Energy Post (www.energypost.eu.com) and is republished here as an important perspective on the future of an important part of the fossil fuel industry.

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Twilight of the Gods of Oil
by Peter F Varadi

For most of the past 40 years OPEC, the association of Big Oil exporters, and the Big International Oil Companies controlled our lives, but they have started on an inevitable decline, writes solar pioneer Peter F. Varadi. Competition from renewables and smaller players as well as tighter climate polices will make their business model obsolete. According to Varadi, their corporate culture makes it unlikely they will be able to adapt.

OPEC was initiated in 1960 by five countries and by the 1970s had 12 members who controlled the flow of oil and its price. Everybody remembers the 1973 oil crisis which ushered in a recession in the US and other countries. In the following years OPEC regularly made threats and on at least one occasion caused another crisis, in 1979. They forgot the age old saying that one should not make war with one’s customers. The customers will react somehow.

And they did – as is evident from the fact that today among the World’s top 10 oil producing countries only four are members of OPEC and the USA, which was the hardest hit by the 1973 “oil embargo”, now exceeds in oil production legendary oil producer Saudi Arabia by no less than 12.5% and the Russian Federation by 29%. Among the 20 oil producing countries with daily production over 1,000,000 bbl/day there are only 10 OPEC countries.

A case in point is Brazil, where crude oil production in 1980 was 182,000 bbl/day (barrels per day) and in 2014 catapulted to 2,950,000 bbl/day – more than is produced in the OPEC countries Kuwait, Venezuela and Nigeria.

The destructive effect of the “corporate culture” is to prohibit companies from moving into a new but related field

OPEC is at a point where it is falling apart. It consists now of a group of haves and have-nots. The have-nots want the largest, Saudi Arabia, to decrease production but they do not understand that we are not in the good old days anymore. There is now plenty of oil and the new exploration method, fracking, has turned the table around.

The conclusion is as, BP Chief Economist Spencer Dale said recently, “OPEC is simply powerless”. If this would be the script of a movie about OPEC, the next frame would have only two words “THE END”.

Corporate culture
The Big Oils, international oil companies ExxonMobil, Shell, Chevron, BP, Total and others have also gone past their zenith and started on their twilight journey. In the future they may either transform themselves (as some German utility companies are attempting to do) or become immaterial, as happened to companies such as Kodak, RCA, Xerox, Polaroid and many others – names the present generation does not even remember.

The similarity between these forgotten companies is that they all rode up to the top and then went down and became oblivious. The reason was not that people stopped making photographs or buying TV sets or making copies of their papers – the reason was that they started doing these things differently, and the companies’ “corporate culture” made it impossible for them to adapt.

Thus, for example, Kodak’s management and technical staff could not believe that digital imaging could even threaten the traditional film business. Their “corporate culture” did not let them do it and 124 years after it was founded it filed for bankruptcy in 2012.

There are many similar examples. The conclusion is that the destructive effect of the “corporate culture” is to prohibit companies from moving into a new but related field which ultimately could make their dominant business secondary or even obsolete. And that is happening now with the Big Oils.

Deeper and deeper
John D. Rockefeller’s oil empire was structured to control the oil refinery and distribution business. ExxonMobil, a descendant of Rockefeller’s Standard Oil, is still the largest refiner in the world. It is hard to pinpoint the time when oil companies started to concentrate on finding and producing more and more oil and gas. But by the 1960s they had developed expertise and money to carry out very large projects, which came to be the hallmark of the “corporate culture” of Big Oil.

The story of Shell’s “Polar Pioneer”, the oil rig used to start the exploitation of the very large oil resources in the Arctic, will be a famous milestone in the history of Big Oil

Drilling to find oil started 156 years ago in 1859 in Pennsylvania with the 69.5-foot (21.2 meter) deep “Drake well”. As demand increased the oil companies developed technology to find new oil and gas reservoirs. They had to go deeper and deeper to discover new oil formations, many of them offshore under deep sea water, and lately even in the Arctic. Today a great number of drilling rigs are being used which can operate in water deeper than one mile (1,600 meters) and can drill to a depth of 5 miles (9,000 meters) or below. In 2012 ExxonMobil completed the world’s deepest well on the Sakhalin shelf in the Russian Far East: 7.7 miles (12,376 meters) deep and 7.1 miles (11,426 meters) out under the ocean.

The cost of these deep and offshore drillings is unbelievably high. The daily rental cost of a deep water drilling rig used for example in the Gulf of Mexico is about $500,000 excluding other expenses. Because of their expertise and wealth, this type of drilling assured Big Oil a dominant position. The cost of drilling was immaterial because the upward elasticity of the price of oil seemed to be infinite.

The price of oil (per barrel) at the beginning of 2000 was $25. This lasted for 3 years when in 2003 it started to move higher. In 2005, it had doubled and 3 years later in 2008 doubled again and reached $100. From 2008 the price of oil fluctuated between $90 and $110. However, by the middle of 2014, the price started to decline sharply and by the beginning of 2015 it was $50 – half of what it was 6 months before. Since then it has been in the $35 to $50 range, which was the price of a barrel of oil 11 years ago (data: US Energy Information Administration).

Small club
The stability of the price of oil in the period of 2008 to mid 2014 prevailed in spite of increased usage in China and India and of interruptions from major suppliers such as Libya, Iran, Iraq, and Venezuela. These were counterbalanced by improved efficiency of products using oil, such as cars, switching from oil to natural gas in electric power stations and the beginning of the tightening of policies related to global warming. The high price of oil also encouraged more drilling and by now over 100 countries are producing more than 1,000 bbl/day.

But there was another reason why prices eventually came down, a new technology called “fracking” to extract oil and gas from shale, which started to be used on a large scale. Drilling for oil deeper and deeper at very challenging locations became extremely expensive in comparison. It required enormous amount of capital and therefore it was a small club which was able to do it. Fracking required little money and therefore lots of startups got in.

The question now is will Big Oil find new areas to grow?

Fracking experiments, the injection of fluid into shale beds at high pressure in order to free up petroleum resources (such as oil or natural gas) were started in the 1950s, but large scale utilization first occurred in 1968. It was then used mainly to improve the production of vertically drilled oil or gas wells. When it was realized that oil and gas inclusions in shale were in many cases horizontal and not vertical, horizontal “fracking” to create oil and gas wells was started in the 1980s but more generally used from 1991 on.

Nonetheless in 2010 still only a negligible amount of oil was produced in the US by fracking. Five years later, in the beginning of 2015, close to 50% of US production was from fracking. To appreciate how much oil is produced in the USA by “fracking” one should consider, that at the beginning of 2015 daily production was somewhat more than the production of two OPEC countries, Kuwait and Algeria, put together.

Polar Pioneer
Big Oil knew about this and could have easily branched into fracking when it was still in its infancy. But Big Oil’s “corporate culture” could not let them to believe that their well established and successful drilling technology could be affected by shale fracking. As Big Oil ignored it a number of small organizations were able to get started.

Shell, for example, ignored fracking for a long time. When they did get in, they were, as Karel Beckman writes in his recent article, “simply unable to survive in this kind of highly competitive market in which small, versatile players set the tone.” Please remember that Kodak also entered the digital camera business belatedly, but had to close it because similarly they could not compete with the many relatively small organizations which had entered that field.

It seems Mr. Tillerson was not informed that since 2000 over $500 billion was invested in solar PV alone

The story of Shell’s “Polar Pioneer”, the oil rig used to start the exploitation of the very large oil resources in the Arctic, will be a famous milestone in the history of Big Oil. Until the end of the summer of 2015, Shell’s management seemed to still believe in Big Oil’s motto: “Damn the cost of drilling and full steam ahead.” They towed the gigantic oil rig to the Chukchi Sea, offshore Alaska, and paid $620,000 per day during the summer drilling season, and $589,000 a day for the rest of the year, to lease the rig.

“Polar Pioneer” started drilling on July 30, 2015. But Shell obviously realized that under the new market circumstances the exploitation of Arctic oil will not be profitable and that this condition may last for a decade or more. On September 27 the company announced that it would pull back from oil exploration in Alaska and started to tow the Polar Pioneer back to Seattle. We can mark this date, September 27, 2015, as the day the twilight of Big Oil’s dominance started.

The question now is will Big Oil find new areas to grow?

At a loss
As Shell demonstrated the “corporate culture” of Big Oil makes it unlikely that it will be able to adapt to the world of “fracking”. Another problem is described in the recent book “The Price of Oil” by R.F. Aguilera and M.Radetzki. The world is headed for an era of oil “superabundance” in which the low price of oil will prevail and oil produced with oil rigs costing $500,000 per day can only be sold at a loss. This would mean not only loss of profit but also lower revenues.

The oil companies could reverse this trend and diversify into the field of renewable energy. But this will be difficult for them to do. I know this from my own experience. As I describe in my recent book, “Sun Above the Horizon”, around 1973 the oil companies got involved in the solar photovoltaic business. There were two reasons for this:

1. The fashionable doomsday reason: oil and gas will run out, solar energy is permanent. Oil companies should get in now (in the 1970s) to invest in the development of the continuation of their oil and gas business.
2. The other reason was that a few leaders of the oil industry correctly envisioned that PV, because of its decentralized nature, would become an independent parallel energy source to oil and gas.
The terrestrial PV industry was started in 1973 but by the end of 1983 the major PV manufacturers in the world were all owned by oil companies: AMOCO’s Solarex Corporation (USA); ARCO’s Arco Solar (USA); Exxon’s Solar Power Corporation (SPC) (USA); BP’s BP Solar International (UK).

The Paris climate agreement makes it clear that the world will not turn back on serious global warming policies

Ultimately all of them got out of the PV business. Why? The major reason is their “corporate culture”. To show the way they are thinking, this is what ExxonMobil CEO Rex Tillerson told investors on May 27, 2015, explaining why the company isn’t investing in renewable energy: “We choose not to lose money on purpose”.

It seems Mr. Tillerson was not informed that since 2000 over $500 billion was invested in solar (PV) alone, including by Warren Buffett’s MidAmerican Energy investment of $2.0 billion to buy the 579 megawatts Antelope Valley Solar Projects in California. Buffet is not known to lose money on purpose

As of losing money by investing in renewables, Mr. Tillerson was also a little bit misinformed. Solar PV manufacturer “First Solar Inc.” recorded sales in 2014 of $3,391,814,000 and made 8.5% profit which is a little more than the 8.1% ExxonMobil made in the same year.

So for Big Oil to get back now to PV is the same as getting into “fracking”.

Not many options
In the days when Big Oils calculated their odds in PV, their only risk was that they would lose their investment, which was not much more than the loss of a single dry hole. But even the minimum investment today for Big Oil is much bigger. Two big oil companies are now in the PV business but both are only minor participants.

Shell with Showa Shell Solar (Japan) was started in 2006, manufacturing the thin film CIGS solar cell/module. The company was renamed Solar Frontier in April 2010. Solar Frontier’s manufacturing capacity will reach over 1 GW in 2015, which is about 3% of today’s PV manufacturing. French Total invested 1.1% of their entire market capitalization to buy 60% of SunPower (a US PV manufacturer). Today, if Occidental Petroleum (OXY) were to buy 60% of SunPower (SPWR), Occidental would have to put up about 5.9% of its entire market capitalization. If OXY were to buy 60% of Solar City (SCTY), it would need to put up 7.2% of its market capitalization.

The Paris climate agreement makes it clear that the world will not turn back on serious global warming policies. There do not seem to be many options left for Big Oil. If they want to avoid the fate of Kodak, they could split up like German utilities Eon and RWE did, and shed their drilling business, in the same way telephone companies did with their land line business. After that in their twilight, they will have to compete in a brave new world.

Note:
Peter F. Varadi Peter F. Varadi is the co-founder in 1973 of SOLAREX Corporation, Rockville, MD (USA), which pioneered the utilization of solar cells (PV) for terrestrial applications. By 1978 it had become the largest PV Company in the world. He recently wrote a history of the early years of the solar industry, Sun Above the Horizon.
© Peter F. Varadi. All rights reserved