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The AAPG/Datapages Combined Publications Database

Houston Geological Society Bulletin

Abstract


Houston Geological Society Bulletin, Volume 47, No. 1, September 2004. Pages 45 and 47.

Abstract: Positioning For Exploration Success in the Upstream Petroleum Business

By

Brian Maxted
Kosmos Energy LLC

As a result of the drop in oil prices during the mid-1980’s worldwide exploration activity decreased significantly. Further commodity price drops in the late 1990’s compounded this situation as companies in the oil and gas sector saw their valuations reduced and had to respond to shareholder demands for stock price increase through a combination of superior financial returns and long-term resource base growth. Portfolio management (with the divestiture of assets which did not meet internal growth and value hurdles), optimization of operations to reduce costs and minimization of expediture have all been undertaken to maximize value by increasing cash flow, net income and earnings, as well as enhancing metrics. Maximizing reserves to provide options for future production growth was accomplished in two ways: first, inorganically through mergers and acquisitions and/or asset purchases; secondly, organically through exploitation.

Exploration conducted during this time primarily involved low risk, step-out drilling. Thus, as a strategy to organically replace and grow reserves and production, exploration has been secondary except for those companies which did not have the optional to grow inorganically due to balance sheet size or leverage. As a consequence reserve replacement from exploration during the last decade has declined considerably and now only accounts for a relatively small proportion of produced oil.

Today the industry is in a new era, one of higher commodity prices. Prices have risen due to longer term, below-ground concerns and, additionally, for oil, prevailing above-ground supply threats. This has led to recent shareholder value appreciation. Companies have to continue to focus on returns, maximizing production and minimizing costs and expenditures for short-term value. An inorganic strategy, however, to deliver future value and growth is threatened by today’s higher prices (which have inflated acquisition costs) as well as by uplifted operating expense, thereby reducing return and increasing risk and exposure to future lower cycle prices. It will also be affected by an ever-maturing resource base, a limited opportunity set and high competition.

For these reasons, as well as current market sentiment of not rewarding growth without value, M&A transactions have reduced significantly. Some companies may still either take advantage of current prices and sell or wager on future prices and acquire. Some asset trades are likely to continue as portfolios are rationalized rather than liquidated. However, exploitation and low risk exploration is now the principal operating strategy. Notwithstanding, many companies are currently using excess cash flow to pursue stockholder value increase through financial strategies of paying down debt and buying back stock.

While companies and their shareholders have benefited recently from the commodity price increase and though overall higher prices may be the future norm, they will no doubt continue their cyclicity. Thus, companies cannot depend solely on future price increases to deliver continued value growth. It will be the companies which are able to progressively increase reserves and production at a competitive unit cost and with high value metrics that will survive and prosper. This performance will be delivered by one or both of two operating strategies. These include further industry consolidation coupled with exploitation and new exploration.

To date, however, companies have not re-directed their efforts to focus on value creation and growth through exploration. For many upstream companies exploration still remains a secondary strategy as evidenced by the still-suppressed activity and expenditure indicators. The forthcoming exploration challenge is further compounded by the ever increasing difficulty of our function, as we pursue new petroleum systems, fairways and/or plays.

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Unfortunately, exploration is a risk business and, as history has shown, it offers a greater chance of failure than success and more losers than winners. The consistent creation of value through successful exploration with the drill-bit is the aspiration of all but the feat of only a few. As explorers we are obligated to regain the confidence of management and shareholders, re-position exploration as the primary business development strategy and create our own future.

The presentation reviews where high volume and value oil may be expected to be found in the future and considers the factors which combine to characterize and differentiate failed exploration, the “accidental” or “occasional” oil finder and the “true” or “serial” one. The speaker addresses the organization and its culture, its people and their behaviors, the technical and business decision-making process, and team and individual roles, together with personal competencies.

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