May 11, 2005

Seven Trillion Dollars

An especially clear and informative Special Report on Oil in last weeks Economist (subscription only)
Official American estimates suggest that over the past 30 year OPEC's machinations transferred over $7 trillion in excess profit from consumers to producers. And the cartel's coffers are still overflowing: OPEC's oil-export revenues have shot up from about $100 billion in 1998 to perhaps $340 billion last year.
Feel good about that? What's the authors take on the biggest reason we may run out of oil? Not because we'll drain the Earth's supply but rather:
That points to the most explosive criticism levelled at the oil majors: that they no longer have the capacity to innovate. A few decades ago these firms were fiercely proud of their proprietary technologies, which they believed gave them a competitive edge. But during the 1990s most majors slashed funding in this area, leaving service firms such as Schlumberger and Halliburton to pick up the slack . Ten-dollar oil killed upstream research,” says one executive. Ivo Bozon of McKinsey, a consultancy, reckons that the majors slashed upstream R&D spending from $3 billion in 1990 to below $2 billion in 2000 (both in current dollars). Over the same period, the service companies increased their investment in research from $1.1 billion to $1.7 billion. The sharpest cuts, adds Mr Bozon, were made by American companies. These guys need to explore, but they don't know how to do it any more,” complains Roice Nelson of Geokinetics, which makes reservoir visualisation software for the oil industry. Mr Nelson helped found Landmark Graphics, an industry pioneer in imaging software, so his criticism stings. He notes that the industry sacked many of its best-qualified technical staff, and that relatively few college students now are going into petroleum engineering. “We'll be working till we're past 80,” he sighs
the innovation is now taking place a smaller, more nimble risk-tolerant firms.
The majors now realise that this shift away from technology, once their core strength, was a mistake that has benefited three groups of rivals: the service companies, the “mini-majors”, and the NOCs. Mr Lesar at Halliburton is delighted: “There's been a fundamental shift in ownership and development of technology from the majors to the service companies.” The problem is that the service companies are less capable of investing for the long term, because their balance sheets tend to be weaker than the majors'. Moreover, they need their customers to adopt those technologies to make them commercially viable—but the majors have proved gun-shy. The shift in innovation has been a boon to smaller oil companies, which are not so risk-averse. Especially since the wave of mergers, the majors need mega-projects with long lives to replace reserves. That has made them wary of trying new technologies. Chevron's Mr Robertson says that taking a flier on a project with a long lead time and high investment is simply too risky for his firm. Mr Farris, Apache's chief executive, takes quite a different approach: “We go to the service companies and say, ‘What have you got?' Hell, we'll spend money to try it.”
I'll buy the first part of the concern ... the smaller innovators can only go so far until a Major buys into the idea, if not, a good idea could die. But I still think large companies are inefficient at R&D, and discourage their own entrepreneurs by score-keeping and bean counting. Read Clayton Christensen.