Mega-operators, investors in Kazakhstan face dwindling income, rationalise costs

A global slump in oil trade prices has by and large been held responsible for dwindling incomes to the oil multinationals who are investing their dozens of billions into ongoing and pending “giant” projects in Kazakhstan. A partial recovery of oil prices, along with a partial rehabilitation of the ailing US dollar on international currency markets, has raised hopes that the Kazakh commodity life line can be preserved. But if to some extent the sky remains the limit, the sky has also come down for the hose community and caution remains the magic word to save the future.

by Charles van der Leeuw, KZW senior contributor

Mega-operators, investors in Kazakhstan face dwindling income, rationalise costs“Energy demand is weak,” the new head of the Royal Dutch Shell, Peter Vosser, put it bluntly in his first comment on half-year results reported in the last week of July. “There is excess capacity in the market, and industry costs remain high. Conditions are likely to remain challenging for some time, and we are not banking on a quick recovery. Shell is adapting to this new situation, and we must do more. We are sharpening our focus on delivery and affordability.” Nevertheless, the company keeps building up an extra million barrels-per-day production capacity around the world. Start-ups during the first half of this year included Sakhalin-II in Russia’s Pacific region, and among the finalising stages in the plan is the coming on stream of Kazakhstan’s Kashagan field and adacent blocks in the Caspian Sea. However, the top executive stressed that this can only be achieved under severe expenditure constraint, as Vosser puts it: “Taking new steps to reduce our costs, combined with Shell’s financing capabilities, allows us to continue with our investments for medium term shareholder value, despite today’s tough market conditions.”

With this, the tune for the rest of the year and probably considerably beyond has been set – not only for the world’s leading oil and gas multinationals but also for the countries where they operate – and among those, Kazakhstan not in the least. Shell has the key operator, in a tandem with Kazakhstan’s state oil and gas company Kazmunaygaz, of Kashagan’s multi-company consortium following the ousting of Eni from the position of project operator. The Anglo-Dutch giant also has a mid-size exploration project further to the south, off the coast of the Mangistau peninsula in the extreme southwest of Kazakhstan. Kashagan is under renegotiation with the host-country in order to bring an exploration and development budget that has soared to a hilarious 136 billion US dollar over the last couple of years, along with multi-year delays in the deadline for the fields’ commercial start-up, down to the “acceptable” level of around $90 billion.

In terms of sector breakdowns, the good news for the world’s leading oil-producing countries such as the Russian Federation, Kazakhstan and the members of the OPEC cartel remains that upstream activity has not changed is role as the main money-maker in the oil industry. Thus, the Royal Dutch in the first half of 2008 derived almost two-thirds of its earnings, or just over 11 billion US dollar, from exploration and production of crude oil and natural gas. In the same period of 2009 the amount was down to merely just over $3 billion, but against total net income of $5.637 billion, the proportion is only (relatively) slightly down and roughly remains in the same order. “[Upstream] earnings [in the second quarter of this year] compared to the second quarter of 2008 reflected the impact of significantly lower oil and gas prices on revenues, lower oil and gas production volumes, higher exploration expenses and non-cash pension charges, which were partly offset by lower royalty and tax expenses,” Shell’s report reads.

The last observation is particularly important for the company’s home and host countries, both of which can expect lower income from oil and gas acitivity for some time to come – even though companies’ cost cuttings also reduce tax deductions. Nevertheless, Shell maintain sits scheme to build up production capacity of another million barrels of oil equivalent per day on top of its output of 2.96 million barrels in the first half of 2009 into the new decade. In the first half of this year, exploration activities led to the addition of 700 million barrels of oil equivalent to its existing reserves.

Likewise, Chevron, which holds a 50 per cent interest in Kazakhstan’s largest oil field Tengiz on the Caspian shore and also acts as its operator, has increased its capital expenditure, in the order of 80 per cent of which goes into upstream activity, from 10.3 US dollar to $11.4 billion from the first half of 2008 to the same period this year, with a breakdown of $6.5 billion in the first and the remaining $4.9 billion in the second quarter. Worldwide, the company’s production in the first half stood at 2.568 million barrels of oil equivalent per day, including 1.655 million barrels or crude oil.

One indication that at least some upstream oil producers may have been hit hard by falling crude price benchmarks but that the toughest blows have been received midstream in net consumers of oil can be found in the results of ConocoPhillips. The Houston-based American company is a stake holder in Kazakhstan’s Kashagan consortium but also a major shareholder of Lukoil, Russia’s largest private-owned oil producer which also has control over a number of hydrocarbon assets in Kazakhstan. ConocoPhillips’ overall revenue dropped to just over half its level in the first six months of this year from the same period of last year. Net income fell to hardly more than one fifth of its previous level, with both items showing similar trends over the first half and the second quarter – thereby indicating that the end of the hard times is not yet in sight.

However, regarding earnings from Lukoil there has been a change for the better in the air. Whereas over six months this year ConocoPhillips’ net income from its Russian venture was down to half its level over the first half of 2008, in the second quarter came close again to that of its on-year previous level, down by no more than around 12 per cent from $774 million to $682 million. It illustrates that partnerships for the oil-multis in oil-producing countries does have its spin-off – something for both the global oil business and upstream host countries to keep in mind.

But remarkably enough, not all global oil operators have seen their midstream sectors being hit hard. In the case of Chevron, which in the first half of 2008, due to high crude oil and other commodity prices, witnessed net losses in its midstream and petrochemical sectors of $482 million and $835 million respectively, resulting in upstream income amounting to $12.376 billion and topping its $11.143 billion overall earnings. In the first half of this year, upstream and overall earnings were dramatically down but in terms of proportions back to normal, standing at $2.788 billion and $3.582 billion respectively.

Cutting costs on all possible operational levels appears to be on top of the agenda in all globally operating oil majors, if one should believe their comments on recent results, even though the effects on overall capex tend to vary. ConocoPhillips has cut its capital expenditure budget on exploration and development of new deposits worldwide, including that of Kashagan, from last year’s 19.9 billion US dollar to $12.5 billion for this year. “In addition, ConocoPhillips is on track to hit its previously stated goal of reducing pre-tax costs by $1.4 billion this year,” the Houston Chronicle in a report dated July 29 quoted its president and CEO Sigmund Cornelius as stating. “At the end of June, the company had cut costs by $900 million, helped by a combination of market factors like lower energy costs, more favourable foreign currency exchange rates and operational efficiencies.”

Economicals also dominate Shell’s reporting over the first half of 2009. Capital investments in upstream projects for this year stand around $31 billion, and are to be reduced down to the order of $28 billion for 2010. Moreover, in June this year the company announced a new “restructuring programme”. The plan has already resulted in cutting jobs on management levels by 20 per cent “… and substantial staff reductions are likely” – in the plan’s explanation’s words. To put it plainly: in the air are more job cuts, along with non-redundant managing staff’s increased work and responsibility portfolios – or even more plainly: work harder or get sacked.

As for Eni, in which the Italian state has a blocking share and is also the largest single shareholder and which remains along with British Gas the operator of the Karachaganak field, mainly prone to gas and gas condensate in the northwest of Kazakhstan close to the Russian border, its results are not much different in terms of trends and proportions than those of its peers. With oil and gas production slightly down both over the second quarter and over the first half of this year, capital expenditures on exploration and development have by and large been upheld at slightly below 3.7 billion euro and 6.85 billion euro respectively.

Variables in reports into the current year show that not all oil companies have the ability to cope with new market imperatives. For all it matters, ExxonMobil’s report over the first six and the second three months of the year remains the perfect example of how proportions matter in mega-business. Both over the first quarter and the first half, revenue dropped and costs were cut. But in the case of ExxonMobil, the cost-versus-revenue ratio narrowed by around minus 50 per cent, thereby causing sharper drops in gross operating profits than in sales income. In other words: trends in sales costs have failed to keep pace with those in sales revenue – a result of what gives a strong impression of sluggish, bureaucratic management at a time market developments require maximum assertiveness from management teams.

Market prices for crude oil in the world dropped dramatically by about two-thirds from their summer peaks within hardly more than a fortnight in the second half of October last year, and only started to recover in the following early spring. It remains a bit curious that oil companies have not posted much better revenues on upstream sales in the second quarter of this year than they did in the first one. This could reflect storage building during the first quarter as prices were low, putting pressure on crude supply sides which drove prices subsequently up. On a slightly longer run, however, thus created prices hikes cannot hold. As though to confirm this assessment, Eni in its second-quarter report has put the price of Brent at no more than $48 for the current year on average.

Oil futures in Europe have remained heavily overpriced during the first quarter and through most of the first half of the year. One-month contracts for Brent traded at a record premium in the order of 14 per cent (see table) as of the end of 2008. At the end of March, the difference had narrowed to about 8 per cent. At the end of June, it was hardly more than one US dollar per barrel – something traders can live with although it still fails to make futures trade as such profitable. The fact that by tradition, and still today to large extents despite periodical intrusions of speculators from the outside, most of the steady players on futures markets are oil companies themselves by proxy does not diminish the structural exposure to risks of fluctuations, and losses have to be swallowed as such.

Prices for natural gas on both sides of the Atlantic tumbled dramatically through the first half of the current year. During the first three months, the spot price for gas FOB Zeebrugge was cut down to half of its settlement as of December 31, 2008 – only to drop further to a mere 25.8 pence per British thermal unit through the first quarter and 4 per cent more through the month of July. The summer slide in pricing may well be seasonal, as gas is used much less for transportation than for heating. Milder winters, according to current outlooks, in years to come are likely to keep gas prices below previous levels whatever the world’s economy will be doing – thereby turning gas producers into early victims of the global warming process.

The overall outlook for oil-producing countries given a glimpse through the results of major global operators so far this year gives a clear message. Demand is down, and affordability on the sales side has, for the first time after a long period of heads in the clouds, started to count. The days consumers were ready to pay whatever was charged to fill their tanks and keep their gas on are over. For producing countries like Kazakhstan, host to both operative and prospective income resources on oil and gas, it means accepting terms that include cost rationalisation measures.

The consequences are multiple and tend to be ambiguous. Domestic contractors who want to cope with foreign competitors’ attractiveness will have to realise that, as always but now more than ever before, the quality-price matrix is shifting towards the latter parameter in terms of competitiveness. For the public sector, royalties are set to dwindle in spite of higher oil market prices. This to some extent brings production sharing schemes back in vogue, since the risk they bear turns into benefit under favourable market conditions. Fixed royalties, however, will become harder to negotiate with operators. For Kazakhstan, to summarise, the last word is finally back to the party on the other side of the globe which has stopped being a moron: the consumer.

(in million US dollar unless otherwise indicated)

company revenue net profit
Chevron 81,000/40,000 5,975/1,745
Eni (in m.euro) n.a./2,180 3,437/832
Royal Dutch Shell 131,419/63,882 11,754/3,903
ConocoPhillips 71,400/35,400 5,439/1,298
ExxonMobil 138,072/74,457 11,905/3,946

source: company data

(in million US dollar unless otherwise indicated)

company revenue net profit
Chevron 146,000/85,000 11,143/3,582
Eni (in m.euro) n.a./7,620 6,758/2,736
Royal Dutch Shell 245,721/122,104 20,955/7,419
ConocoPhillips 126,300/66,200 6,578/2.138
ExxonMobil 254,926/138,485 23,077/8,648

source: company data


company oil gas oil equivalent
Chevron 1.807mbd 5.005bncfd 2.568mbd
Eni 1.000mbd 4.472bncfd 1.784mbd
Royal Dutch Shell 1.604mbd 8.676bncfd 3.100mbd
ConocoPhillips*) 0.859mbd 5.051bncfd 2.314mbd
ExxonMobil 2.411mbd 9.904bnmfd 3.990mbd

*) 2nd quarter 2009

source: company data

(prices in USD cent unless otherwise indicated)

date 31/12’08 31/03’09 30/06’09 31/07’09
Brent 1-month ICE 4559 4923 6930 7170
Brent spot 3988 4615 6813 7134
WTI 1-month NYMEX 4450 4966 6989 6945
WTI spot 3927 4969 6984 6928
HH gas NYMEX 562.2 377.6 383.5 365.3
Euro spot Zeebrugge (p/btu) 65.50 32.00 25.80 22.80

source: FT/Reuters