Changing times call for changing strategies and winning choices.

The death of exploration has been greatly exaggerated, but exploration, which has been the growth engine of the business, is maturing. Companies need to face this reality and adjust strategies or look to other business areas for growth. For the majors particularly, the exploration challenge is large and new thinking will be required for future winners.

From our analysis, we can summarize some of the recent trends in exploration. Since the mid-1990s:

* Global exploration has added value with average returns above 10%;


* Wildcat success rates have held steady at around 30%, but since 2001 companies have not replaced reserves through exploration;


* The average value of discoveries has fallen;


* All the value has been created in deepwater. Exploration elsewhere has destroyed value overall (except Kashagan);


* Performance has been very patchy with some good success, but more than a third of the most active 25 companies destroying value.



We expect 2003 to emerge a strong year for booked reserves when the reporting season comes this spring; however, a lot of the reserves booked will be gas - often found decades ago and now being commercialized. This will flatter the explorers but disguise the real picture.

The future of exploration

Life is now getting harder for the explorer. The amount of prospective new acreage being offered is shrinking. Finding big prospects early means remaining discoveries, in general, will be smaller and less profitable. Technology has helped define the subsurface better and has reduced the cost of developing more challenging fields. But, as technology has accelerated hydrocarbons discovery, it also has shrunk the amount of oil and gas that can be discovered.

Figure 1 shows the aggregate spending of the 10 largest western majors and the net present value of the discoveries they have made. After the good years of 1999 and 2000, values of discoveries have fallen steeply. Note also that aggregate spending has not reverted to levels before the mega-mergers.

Reserve replacement is a critical issue. A super-major like BP needs to add around 1.3

billion boe each year - more than 100 million boe each month - to sustain its position. Western majors need to find the equivalent of a UK North Sea every 18 months just to stand still. And most want to grow.

Of course, companies will continue to discover. Re-interpretation of mature basins will produce some more hydrocarbons. Politics and technology could bring opportunities in regions that have not yet been explored. The Alaska National Wildlife Refuse (ANWR) and the Arctic more generally could hold major reserves for the long term. New licenses in places like the Nigeria-Sao Tome Joint Development Zone offer potential but not enough to sate the appetite of the industry for long. And the potential of some of the new countries that are being targeted (Benin, Mauritania, Kenya) remains uncertain and may not be large. Two thirds of recent discoveries have been in deep water.

Recent exploration results have been disappointing for reserve replacement. Although many companies have replaced reserves in part by booking discoveries through commercializing existing fields, the true amount of oil and gas actually being found is considerably less. This means that the inventory of known reserves that have not been developed is falling. It is only a matter of time until the discoveries booked under the US Securities and Exchange Commission (SEC) method must reflect this.

Figure 2 shows the total reserve additions of the 10 largest western majors and contrasts their SEC-reported reserves for discoveries with reserves we believe they actually found each year. Although SEC filings have overstated what has actually been found in the last 2 years, many companies have done well through revisions by improving recovery from existing fields. Many also have inventories of discoveries that have yet to be commercialized - and, therefore, booked in the future. However, the bookings of recent years have depleted these inventories.

We believe that exploration cannot continue to be the main growth engine for the majors as it has in the past. That philosophy may work for smaller companies with fewer reserves to replace and where a medium size field could be a company-maker, but majors will have to find new ways to explore or find other ways to grow.

So what are the options for successful exploration? We believe explorers need to answer three key questions:

* What is our exploration for?
* How do we do the right things in formulating our exploration strategy?
* How do we do things right in implementing the strategy?

What is exploration for?

Finding the correct answer to this question is critical. Successful companies must be clear about the role exploration plays in their growth strategy. Is it increasing reserves? Replacing production? Adding value? Discovering gas close to markets? Finding reserves that can be developed rapidly? The answer "all of these" is not sufficient. Companies need to set and share clear priorities if they are to be successful. In our recent syndicated study "Value Creation Through Exploration" all the top performers had this clarity of purpose in exploration and senior management alignment about its role.

Doing the right things

As exploration gets more difficult, companies will have to review their strategies. A company might:

Move geographically. The focus of exploration continues to move around the globe and several regions are currently enjoying renewed interest. Examples include many countries along the Atlantic margin of Africa, the interior basins of central Africa, frontier Australia and deepwater India.

Explorers can also test fundamentally new plays without changing the geography - the deep gas plays of the Gulf of Mexico shelf or subsalt plays in the Gulf of Mexico or Brazil for example.

Know when to stop. Ultimately, exploration is not about adding volumes; it is about adding value. In our recent study, most companies made money out of only a small number of the countries where they were active and lost money in the rest.

It also showed that the area of greatest value destruction over the last 5 years has been the UK North Sea. Withdrawing completely from a mature area like the North Sea or parts of Latin America is a tough call, and 2004 may not be the year to make it. If a move must be made, management must decide when that time will come.

Be clear about the role of gas. Gas demand is rising rapidly in many parts of the globe. There are already significant discovered reserves of gas that have no market today. Companies that can combine their exploration skills with excellent marketing and commercial skills will have an advantage.

Doing things right

As well as doing the right thing, companies that succeed will:

Be more imaginative and creative in traditional areas. In the last decade, prolific new areas and cost reduction encouraged smaller staffs. With the new challenges in more mature exploration plays, companies need to find ways of re-emphasizing creativity in their exploration processes.

Deal better with difficult issues like politics and the environment. The industry should find ways to deal with problems of working is areas of political or environmental difficulty.

Understand how to work effectively with others. In much of the upstream business companies act in partnership with others. Being clear how to select partners and how to work with them effectively will bring competitive advantage.

Be relentlessly value driven. As basins mature and discovery sizes fall, unit costs will rise. Part of the answer may lie in evolving technology. Part may also rest with persuading host governments that the harsh fiscal terms of the best years need to be mellowed.

Improve prediction accuracy. Working to enhance the decision-making process and building better cases for exploration based on rigorous criteria will improve results. Within this, a thorough process of reviewing historical results and comparing them with predictions will improve future performance.

Be aggressive when new exploration acreage opens. Companies must be ready to move quickly when new exploration opportunities arise - identifying, selecting and ultimately accessing good acreage is key. And exploration can still deliver if new areas like the ANWR and Mexico open.

In addition to reviewing exploration strategies, companies need to develop other growth options. In particular, they must find ways to work profitably in areas with large reserves like Russia and the Middle East, monetize stranded gas and improve even further recovery from existing fields. Those companies that can solve the exploration dilemma as well as finding other avenues for growth will have the advantage.




Comments