The International Fund owns three quite different oil-services businesses. Two of them are especially tethered to the deep and ultra deep water drilling and extraction industries.
This whole sector is on the nose because the cost of exploring and producing in deep, inhospitable ocean environments is very high. Even with the oil price around US$100 a barrel, ultra deep water oil plays are, for the most part, not making or expected to make a lot of money. Multinationals like Shell and BP, and national oil companies like Statoil, have recently cut capital spending plans in response.
We think that’s a cyclical rather than permanent shift. Globally, deep water drilling is one of the key providers of new oil supply, and deep water drillers need higher prices to bother. But if they don’t bother, there goes many of the additional barrels the world wants or needs. Lack of new oil supply is likely to result in higher oil prices and more deep water drilling. And the deeper that drilling and production goes, the more need for specialist expertise—such as provided by the companies in our portfolio.
Mexico offers an interesting case study. Over the past decade, Mexican oil production is down about 30%, from 3.5m to 2.5m barrels per day. Partly, that’s blamed on a rusty monopoly (Pemex) which both abused its monopoly position and was abused as a political cash cow.
But a large part of the decline was probably inevitable. The massive Cantarell Field, a shallow water supergiant among the top 10 oil fields ever discovered, is way past its prime. Production from this field alone peaked at 2.1m barrels per day in 2003 (about 2.7% of global oil production) and has since collapsed—today it produces about 0.4m barrels daily.
The point of this isn’t to get too caught up in peak oil pessimism. As oil prices rise, new supply will come from fracking and conventional drilling, augmented by alternative energy supply such as gas and increasingly solar. And demand will continue changing and adapting. As the Mexican experience shows, individual fields experience more abrupt declines than nations, and nations more abrupt declines than planets. The world will adjust, painlessly or otherwise.
But the situation in Mexico highlights some important points, factors which play to the advantage of our deep water oil services investments.
Firstly, Mexico is opening up its oil industry. A 75-year old Pemex monopoly was workable when the oil flowed freely. Oil no longer flows freely, yet the country has become accustomed to the benefits of substantial oil production. That means more foreign oil companies and probably more Gulf of Mexico deep water drilling.
Secondly, it reaffirms how jarring the impact could be when even bigger supergiant fields reach their peak. One day, Kuwait’s Burgan oil field and Ghawar in Saudi Arabia—the world’s largest field by a long way, producing around 6% of global daily supply—will peak then decline, meaningfully although hopefully not quite as dramatically as Cantarell. And when that happens, the world will scramble for new supply.
Some of it will come from new technologies like fracking, alternative energy supplies and demand adaption. But we’re willing to bet that the global deep water industry will also get a boost. By then, if not sooner, today’s pessimism regarding the sector will long be a memory.
Peak oil is not the main part of the thesis behind our oil services investments. But it could be a nice contributor to the upside case.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.