Streetwise Professor

September 28, 2014

Discounting Sechin, and Making Perfidious Exxon Suck It Up

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 7:13 am

Igor Sechin has made a breathless announcement of a discovery of oil in the Kara Sea:

Exxon Mobil Corp. and Russia’s OAO Rosneft have found major amounts of oil and natural gas at their first well in the Arctic, Rosneft said Saturday, offering a glimpse of the potential buried beneath the ice-studded waters north of Siberia.

. . . .

“This is an outstanding result of the first exploratory drilling on a completely new offshore field,” Igor Sechin, Rosneft’s chief executive, said in a statement. Rosneft praised other western partners including Schlumberger Ltd., Halliburton Co. and Weatherford International PLC.

Sechin said the field would become the Arctic equivalent of Saudi Arabia, in terms of reserves.

To which I say: not so fast. First, this is the first well and the full analysis of the results has barely begun, let alone been completed. Second, the area is huge, and a single well cannot provide more than a rough estimate of the productivity of the entire field. Third, ExxonMobil was far more circumspect:

“We have encountered hydrocarbons but it is premature to speculate on any potential outcome regarding the University-1 exploration well,” Alan Jeffers, an Exxon spokesman, said Saturday

Fifth, even if the size of the reserves is similar to those in Saudi, the cost of getting at them, and the technological and logistical challenges of exploiting them, are far greater: even with such assistance, Arctic drilling is a fraught enterprise (just as Shell). Development and production will require the assistance of the “western partners” that Sechin praised, and that assistance is on hold for who knows how long as a result of sanctions. No doubt Perfidious Exxon will be pulling out all the stops to get the sanctions lifted, but betting on that is even more dicey than Arctic oil exploration, at the present political juncture.

But most importantly, one must heavily discount Sechin’s happy talk due to these very same political circumstances. He needs to put on a bold front to counter negative news about the company and its prospects in the aftermath of sanctions. Further, to the extent that he can convince the west that a bonanza awaits only if sanctions are eased he can increase the odds of a lifting of the sanctions. He thus has an even greater incentive to exaggerate than would normally be the case, and note that he is not operating under the same legal restrictions on making forward looking statements as a US CEO would (which could explain Exxon’s reticence, despite the fact it also would like to advance arguments that would undermine the sanctions regime).  Exaggerations therefore are basically costless, and could have a big positive payoff to the extent they are believed. All the more reason not to believe him.

Exxon’s complicity here is disturbing. Understandable, but disturbing. It is dealing with the devil, and although the deal benefits shareholders, these benefits pale with the costs resulting from bolstering a revisionist, revanchist, and expansionist gangster state, and the capos who benefit directly from it. This is a case where state action is warranted on public goods grounds.

Indeed, the more Rex Tillerson squeals, the stronger my conviction that the sanctions are a good idea. Exxon will reap only a fraction of the benefits of cooperation with Rosneft: the larger fraction will accrue to Rosneft and the Russian state, and thereby fuel its predations, and those in the power structure that are the residual claimants. In this case, what’s good for Exxon is good for Putinistan, which given the malign consequences of the latter is precisely why the former should have to suck it up.

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7 Comments »

  1. What was very unusual about Sechin’s remarks is that he named the western service providers as well as ExxonMobil. This is without precedent for a chairman talking about an exploration well. My take is that he is thumbing a nose at the US and EU sanctions to the effect of “Look, you’ve applied these sanctions but still all these companies are working with us.” He is calling the US and EU on their impotence, especially in contrast with the situation in Russia with Bashneft, where everyone can see just how much control the government has over companies.

    Comment by Tim Newman — September 28, 2014 @ 7:42 am

  2. @Tim. Yes, it is interesting. Seems to me that Igor is attempting to use those companies (not that they would resist) to put pressure on the US to eliminate the sanctions.

    I would appreciate your professional take on the accuracy of Sechin’s predictions about the size of the find, based on the information that is likely to be available at this stage of the exploration process.

    My thought was that it was almost certain that they would find “hydrocarbons”. FFS, they’re not going to spend $700 million unless they were highly confident of finding something. But what additional information would be produced by the completion of this well? How long will it take to evaluate it fully? How much can it reveal about the rest of the apparently huge field?

    The ProfessorComment by The Professor — September 29, 2014 @ 12:25 am

  3. I would appreciate your professional take on the accuracy of Sechin’s predictions about the size of the find, based on the information that is likely to be available at this stage of the exploration process.

    This is outside my area of expertise (I’m an engineering and construction man) but a single exploration well won’t tell you much. It will tell you if you’ve discovered hydrocarbons or not, and give you an indication as to the size of the column, but not much more. The next stage would be to drill a series of appraisal wells – usually about 3-5 – in locations which you hope will give you a representative picture of the reservoir. Once you’ve done this, and a lot of guesswork, you can determine whether the discovery is commercially viable (and start booking reserves to the SEC, IIRC). He’s over-egging this for sure: finding hydrocarbons in an exploration well is of course good, but companies usually downplay such discoveries because – as has been shown time and again – the results from the appraisal wells might reveal that the discovery is non-commercial. Even once you’ve drilled your appraisal wells there is still some risk: I know at least one project where the appraisal wells hit the sweet spots leading to an overestimation of the production rate, and the FPSO built to exploit them was vastly overdesigned in terms of capacity. The timescale between exploration well and appraisal wells and results is anywhere between 2-5 years. I doubt we’ll know what’s really there for 2-3 years yet.

    Comment by Tim Newman — September 29, 2014 @ 12:51 am

  4. I propose a model for Putin’s foreign policy that is an extension of discussion here and provides an alternate explanation for those who believe Putin is trying and struggling to adopt Western ideals. I realize it sounds trivial but is consistent with his policies and I believe contains an element of truth. I call it the Dojo model and in this context Ukraine is a Dojo. Consistent with his martial arts training Putin subscribes to the following from Sun Tzu-

    “Water shapes its course according to the nature of the ground
    over which it flows; the soldier works out his victory in relation
    to the foe whom he is facing.”

    Those who believe Putin is only struggling to become another member of the global community and seeking a modicum of respect are wrong. He will always look for the take down and choke hold but never challenge a strength with a weakness. His only objective is to win the tournament.

    Comment by Nadsat — September 29, 2014 @ 3:01 am

  5. What Tim said in #3: proven reserves – and to the SEC, probable and possible reserves matter not – can only be booked when the reserve auditor is provided with a detailed schedule of output and costs proving these reserves can be economically produced. Rosneft put its “resource” estimate post-drilling at 700 mln bbl of oil (gas is going to be a nuisance, I suspect), which probably refers to the technologically extractable amount either from that well alone or, more likely, from that one and other, yet undrilled, appraisal wells. But even assuming the extra wells are successfully drilled, Rosneft will need to show it can order and install a production platform at an acceptable cost and then be able to load ice-resistant tankers on a workable schedule. Obviously Tim should know immensely more about that from his Sakhalin experience – the climate in the north of Sakhalin is sub-Arctic but still much milder than the Kara Sea.

    Anyway, Rosneft’s own vision for the Kara Sea project has production starting in the early 2020s.

    The US government initially ordered US companies to wrap up sanctioned activities by Sept. 26, then granted a two-week extension to ExxonMobil. Technically, none of the contractors seems to be violating the sanctions. The big question now is whether Schlumberger will be allowed to analyze data from the well for Rosneft.

    Comment by Alex K. — September 29, 2014 @ 3:45 am

  6. 700 mln bbl is relative peanuts if the location is very remote. Nothing at all like Saudi Arabia (many billions of bbl). If the oil find is geophysically supported (i.e. the oil is distinct on seismic), then the estimates post the 1-st well can be pretty accurate (within a factor of 2, when this is done correctly). This is roughly similar to BP’s Thunderhorse: http://en.wikipedia.org/wiki/Thunder_Horse_Oil_Field

    To produce this one would need some serious hardware with long lead times. Under the sanctions it ain’t gonna happen …

    Comment by oiler — September 29, 2014 @ 8:46 pm

  7. But even assuming the extra wells are successfully drilled, Rosneft will need to show it can order and install a production platform at an acceptable cost and then be able to load ice-resistant tankers on a workable schedule. Obviously Tim should know immensely more about that from his Sakhalin experience – the climate in the north of Sakhalin is sub-Arctic but still much milder than the Kara Sea.

    Correct!

    Comment by Tim Newman — September 30, 2014 @ 3:31 am

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