Commercial Realities in Deep and Ultra Deepwater

Dr Andrew J Latham Principal Consultant Energy Research Wood Mackenzie Limited Edinburgh UK +44 131 243 4408 andrew.latham@woodmac.com

Abstract
The positive full-cycle value of exploration success in deepwater is clearly evident. Exploratory drilling is expensive, but the wells have discovered huge reserves and average finding costs are still small. However, there is now some evidence that success rates in conventional deepwater (< 1,500 metres) have peaked. Faced with this situation, explorers can opt either to chase smaller prospects within the main plays, or to seek new plays elsewhere around the world, or to move out into the ultra deepwater. Most of the leading deepwater companies seem to prefer the latter option. High hopes for exploration in waters deeper than 1,500 metres have made this the fastest growing area since 1998. Only a small fraction of deepwater fields have been quickly developed. Companies need to balance their pressures to accelerate projects against the likely benefits of waiting for and contributing to technological advances. Nevertheless, capital investment in deepwater fields continues on an upward trend, both globally and individually within each of the major deepwater arenas. Many of the large deepwater projects require capital budgets exceeding two billion dollars. Economies of scale mean that such costs are usually not excessive on a per barrel basis. The future emphasis in deepwater is increasingly towards field development and production.

Deepwater Rewards Justify the Risks

Deepwater exploration and production has generally offered a highly attractive balance of risk and reward for investors. Wood Mackenzie has examined the full cycle returns that are being achieved in the worlds leading deepwater provinces. Figure 1 shows compound full cycle IRR for deepwater E & P by country and average deepwater project IRR by country. The full cycle IRR includes licence signature costs and exploration and appraisal costs. We calculate that IRRs achieved since 1990 have averaged some 19%. These IRRs are much higher than typical returns achieved from upstream activity overall during this period which would generally be in the range of 10-12%.

Figure 1. Full Cycle and Average Project IRR by Country

60% 50% 40% IRR (%) 30% 20% 10% 0% Eq. Guinea Mauritania Nigeria Philippines Brazil Angola Full Cycle IRR Project IRR

US GoM

Cote d'Ivoire

UK

Indonesia

Ireland

Egypt

Congo

Exploration Trends
Exploratory drilling in deepwater is expensive relative to shelf and onshore areas. However, deepwater wells have added high reserve volumes by comparison with exploration wells elsewhere. Hence unit finding costs to date have generally been small. Exploration activity has increased sharply in recent years (Fig. 2). This activity, in terms of number of exploration wells completed, is now largely in water more than 1,000 metres deep. Exploration drilling in the bathymetric range of 400-1,000 metres has already peaked, at 82 wells completed, back in 1998. Drilling in more than 1,000 metres water has continued to increase with over 130 such exploration wells completed in 2001. There has been substantial exploration success in deepwater every year since 1996 (Fig. 3). Since 1998, significant reserve volumes have also been added each year in ultra-deepwater (more than 1,500 metres). Our data show that the volume of reserves being discovered per well has been clearly on a downward trend since 1998/9. This trend is seen equally in both conventional deepwater (400- 1,500 metres) and ultra-deepwater (>1,500 metres). There are still giant fields being discovered but many smaller and higher-risk prospects are now being drilled.

Australia

Norway

Brunei

Italy

Figure 2. Exploration Wells Completed in Deepwater

200 2500m + 2000-2499m Number of Exploration Wells 150 1500-1999m 1000-1499m 400-999m 100

50

0 1974 1979 1984 1989 1994 1999 Com pletion Year

Figure 3. Exploration Success Trends in Deepwater

10000 Reserves Discovered in Year (mmboe) Reserves added in 400-1500m w ater Reserves added in >1500m w ater mmboe discovered per well 8000 Reserves added/w ell in 400-1500m w ater Reserves added/w ell in >1500m w ater 150 200

6000

100 4000 50

2000

0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Leading Deepwater Companies

In terms of deepwater field portfolio value, three companies are clear leaders, namely BP, Petrobrs and Shell (Fig. 4). BP is ranked highest overall with a remaining PV at the start of 2002 of over US$24 billion. Ultra-deepwater fields are still very much the domain of the five super majors and of Petrobrs. Most of the mid-sized and smaller deepwater companies have almost none of their asset value in ultra-deepwater. Two exceptions are BHP Billiton and Unocal by virtue of their equity in the Mad Dog, Neptune and Atlantis fields in the US Gulf of Mexico (Unocal in Mad Dog only). However, many of the smaller players have recently invested heavily on ultra-deepwater acreage and are evidently hoping to continue the early success of the super majors.

Figure 4. Remaining PV by Company in Deepwater*

$25,000 $20,000 $15,000

$10,000 $5,000 $0 ExxonMobil ChevronTexaco TotalFinaElf BP Petrobrs Shell

ENI

Norsk Hydro

BHP Billiton

Murphy Oil

Kerr-McGee

Dominion

Unocal

Conoco

Enterprise

Marathon

Statoil

* Discounted at 10% nominal to 1/1/2002.

Deepwater Investment Trends

Capital expenditure on deepwater fields has been on a steep upward trend throughout the previous decade (Fig. 5). During 2001, more than US$11 billion was spent on deepwater developments worldwide. This does not include exploration and appraisal costs. Ongoing development of existing fields and sanction of new projects will see this investment grow to some US$15 billion by 2003. The geography of investment is becoming more diverse. During the 1990s the great majority of capital spending was in either the US Gulf of Mexico or in Brazil. These two countries continue to be important, but are being joined by Angola and Nigeria as key markets. Average capital costs in deepwater show a downward trend, albeit with wide data scatter (Fig. 6). The mean capex/boe is now slightly less than US$4.00 versus more than US$6.00 a decade ago (in real 2002 terms). This is interpreted to reflect the benefit of technological advances. These benefits have more than outweighed the fact that projects now tend to be in deeper waters or to be otherwise more challenging than earlier fields.

Amerada Hess

BG

1 5 0 3 0
45 00 1

Remaining PV (US$ million)

Project lead times, from field discovery to first oil or gas production, have become shorter. Fields discovered in the late 1990s are, on average, onstream within five or six years (Fig. 7). A decade earlier, this average lead time was nearer eight years. This is an area where there is potential for further improvements as deepwater infrastructure continues to develop.

Figure 5. Deepwater Field Capital Investments

$16,000 $14,000 $12,000 Capex (US$ million) $10,000 $8,000 $6,000 $4,000 $2,000 $0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 US GoM UK Philippines Norw ay Nigeria Mauritania Italy Indonesia Eq. Guinea Egypt Cote dIvoire Congo

Figure 6. Capital Cost Trends in Deepwater

$14.00 $12.00 $10.00 Capex per boe $8.00 $6.00 $4.00 $2.00 $0.00 1980

B i l A t
2010 2015

1985

1990

1995

2000

2005

Production Start (year)

Figure 7. Project Lead Time Trend in Deepwater

18 Lead time (years from discovery to first production) 16 14 12 10 8 6 4 2 0 1975

1980

1985

1990

1995

2000

Discovery year

Conclusions
The economics of deepwater are still highly attractive for investors. Exploration activity remains high and continues to deliver success on a scale that few other plays can match. Ultra-deepwater has been an important new area for exploration but success here has not been as substantial as that of conventional deepwater (400-1,500 metres). Success trends, as measured by average reserves discovered per well exploratory well, are downward in both conventional and ultra-deepwater. The future emphasis in deepwater is increasingly towards field development and production. Capital investment is still on an upward trend. In terms of unit costs, average capex/boe shows a clear downward trend. This is a very positive observation, which implies that technological improvements have more than offset the industrys moves into deeper waters and to otherwise more challenging projects. A second highly positive trend is that project lead times are shortening. This is a key factor behind the excellent fullcycle economics achieved in deepwater.