FRACTIONAL FLOW

Fractional flow, the flow that shapes our future.

A CLOSER LOOK AT SOME RECENT DEVELOPMENTS OFFSHORE NORWAY

In this post I present a closer look at 4 developed discoveries (of a total of 10) that started to flow as from 2012 and their production as of September 2013 as these have been reported by the Norwegian Petroleum Directorate (NPD).

A common feature for several of the recent developments offshore Norway is that they have estimated recoverable reserves ranging from 10 – 100 Million Barrels of Oil Equivalents (MBOE) and are expensive to develop and generally developed with sub sea completed wells flowing back to an existing (host) installation for processing. The host installation normally provides for essential services for the operations of these sub sea installations. These discoveries typically annual flow are 15 – 25% of estimated recoverable reserves at some kind of plateau and enter into steep declines as they become 50 – 60% depleted. Normally these developments reach expected plateau a few months after they start to flow.

Several of the recent smaller developments* on the Norwegian Continental Shelf (NCS) have so far under-performed with regard to expected production. So far these have resulted that some companies have taken some write downs, and others will have to accept considerably lower returns on their investments.

The presented 4 developments were now expected to flow a total of 90 – 100,000 BOE/d. Actual data from NPD show that these 4 developments had an average total flow of 13,000 BOE/d for August and September 2013.

*) By smaller developments are here meant discoveries with estimated recoverable reserves  below 100 Million Barrels Oil Equivalents (MBOE).

This is worrisome for several reasons:

  • Write downs and lowered returns impact the companies’ financial abilities to develop future capacities and to carry through planned exploration activities.
  • Write downs destroy shareholder value.
  • If there is a general trend with weakened profitability and/or losses from smaller developed discoveries (which for some time has been dominant on NCS), this may lead to future revisions of the criteria the companies use for commercialization of these. In other words more experiences confirming the uncertainties surrounding smaller discoveries could push the commercial break even price lower, thus deferring developments of such discoveries that already are within the companies’ portfolios.
    This may fly under the radar coverage with the euphemism “targeting financial performance”.
  • To finance these developments, the companies took advantage of their debt carrying capacities and took on more debt. The companies thus bet their future on households and sovereigns (already overstretching their debt carrying capacities) being able to continue to take on more debt to pay for more expensive oil and natural gas so that the companies can retire their debts as these mature.
  • Apart from price, production flows have a considerable impact on companies cash flows and profitability. In the short to mid term it is more about the flows and less about the stocks.
  • The developments of these smaller discoveries have so far reduced the decline in total production from the legacy installations on the NCS as can be seen in figure 1. For some time these smaller developments also hid the “The Red Queen” effect from NCS discoveries brought to flow since 2002, refer also figure 2.
  • A more reserved attitude of the companies towards future developments of the discoveries made (and to be made) due to financial considerations, sets up the potential for a near term further acceleration of the decline in total NCS crude oil production.

This also illustrates that future developments now appear to be at the crossroads with what price the oil companies need for development of discoveries with what the consumers will continue to afford.

Figure 1: Development in crude oil production from the Norwegian Continental Shelf (NCS), split on fields flowing prior to January 1st 2002 (green) and discoveries developed to flow as from 2002.

Figure 1: Development in crude oil production from the Norwegian Continental Shelf (NCS), split on fields flowing prior to January 1st 2002 (green) and discoveries developed to flow as from 2002.

The new developments have now reduced the annualized total decline in crude oil production from NCS to just above 7%, refer also to figure 2. Discoveries/fields flowing prior to 2002 has seen a decline in their total crude oil production of more than 70% since 2002.

In this post it is used Barrels of Oil Equivalents (BOE) and conversions as proposed by NPD which is an industry standard. Depending on what category of petroleum these BOE are made up of there is a wide range of prices that they fetch in the market. A BOE of Natural Gas Liquids (NGL) and/or natural gas (in the European market) obtains now a price of around 60% of that of a BOE of crude oil (and for crude oils there is a wide range of benchmark prices).

Figure 2: Development in production from NCS discoveries brought to flow as from 2002.

Figure 2: Development in production from NCS discoveries brought to flow as from 2002.

Since 2002 around 40 new discoveries were developed to flow which gradually grew to a total production of around 0.7 Mb/d (Mb/d; Million barrels per day) by 2009, a level that was sustained for around 3 years. Since 2012 the additions of new developments were not able to sustain this plateau, very much illustrating that these developments had entered “The Red Queen” stage.

GENERAL FOR THE 4 DEVELOPMENTS PRESENTED

Since 2012 and as of September 2013 a total of 10 discoveries on NCS were reported by NPD to have started to flow.

It is hard to come by forecasts on the financial performance of individual developments as companies/owners do not publicize this kind of information.

This post is based upon reserves estimates and actual production data published by the NPD and data on investments of completed developments published by NPD in a recent evaluation report.

Where estimates on break even prices are presented these are at a 7% discount rate pre tax and based upon NPD reserves data as of end 2011, expected production profiles (plateau levels as published by the companies), typical declines and estimates on investment as per the referred NPD evaluation report.     

For each of the presented developments there is one figure that shows the actual production as from start of flow and as of September 2013 as these were reported by NPD. A grey line/area in these figures shows expected (plateau) production as this has been presented by the companies.

For developments with reported flows of 12 months or more the 12 Month Moving Average (12 MMA and black line in the figures) was added to describe the annualized flow trend.

Each discovery has an accompanying figure that shows developments in year end NPD estimates of recoverable reserves. Reserves estimates are always burdened with uncertainties and thus subject to revisions as more data become available and experiences are gained.

The development of a petroleum discovery is normally based upon a large set of expectations about reservoir behavior (production profile), investments (including operational costs), product prices and a rate of return. The oil companies are in the development and production of petroleum to make a profit.

Mother Nature often throws in the proverbial wrench (or several) to ridicule initial assumptions about reservoir behavior and expected production. Presently and still with limited production histories the revisions to the initial assumptions start to diverge considerably from those that formed the basis for the sanctioned developments. This may of course work both ways, but for several recent offshore developments on NCS it now appears as actual data (as in more) suggest that most revisions to reserves and (future) flows will be to the downside.

Our society functions from net energy flows made available to it primarily from fossil fuel stocks. To the oil companies the flows are important as these generates the financial cash flows which becomes the foundation for their financial health and enables investments in new capacities to both offset declines from maturing fields and provide any growth in supplies to meet expected growth in demand and an effort to maintain affordable price levels.

GAUPE (Lynx)

Figure 3: Development of petroleum production by category for the Gaupe development.

Figure 3: Development of petroleum production by category for the Gaupe development.

The Gaupe field apparently did not reach expected production plateau before it went into terminal decline.

Figure 4: Development of NPD estimates by vintage for recoverable reserves by category for the Gaupe development.

Figure 4: Development of NPD estimates by vintage for recoverable reserves by category for the Gaupe development.

The estimated sanctioned break even oil price for Gaupe was around $50/Bbl to meet a (pre tax) return of 7%.

Gaupe had an estimated development cost of $400 Million (2,380 MNOK).

Based upon NPD’s reserves estimates as of end 2012 the estimated nominal gross value for Gaupe is $280 Million (1,680 MNOK).

As of September 2013 a total of 2.9 MBOE had been recovered from Gaupe of a total NPD estimated recoverable of 4.4 MBOE as of end 2012.

As production experiences were gained from Gaupe the NPD estimated recoverable reserves became subject to a 85% downward revision from 2011 to 2012 as shown in figure 4.

MARULK

Figure 5: Development of petroleum production by category for the Marulk development.

Figure 5: Development of petroleum production by category for the Marulk development.

The Marulk development initially performed better than expected. Note how Marulk immediately reached expected plateau production.

Marulk had an estimated development cost of $750 Million (4,476 MNOK).

The estimated sanctioned break even oil price for Marulk was around $35/Bbl to meet a (pre tax) return of 7%.

According to NPD Marulk has in the recent months seen reduced output due to technical issues.

Figure 6: Development of NPD estimates by vintage for recoverable reserves by category for the Marulk development.

Figure 6: Development of NPD estimates by vintage for recoverable reserves by category for the Marulk development.

The trend in lower NPD estimates of recoverable reserves for Marulk is within what normally should be expected.

OSELVAR

Figure 7: Development of petroleum production by category for the Oselvar development.

Figure 7: Development of petroleum production by category for the Oselvar development.

Oselvar did not reach expected plateau and the owners have taken some financial write downs.

Oselvar had an estimated development cost of $850 Million (5,120 MNOK).

As of September 2013 Oselvar had produced petroleum for a gross value of around $160 Million.

Figure 8: Development of NPD estimates by vintage for recoverable reserves by category for the Oselvar development.

Figure 8: Development of NPD estimates by vintage for recoverable reserves by category for the Oselvar development.

SKULD

Figure 9: Development of petroleum production by category for the Skuld development.

Figure 9: Development of petroleum production by category for the Skuld development.

Skuld is struggling to reach expected plateau which according to NPD is due to technical issues.

Skuld had an estimated development cost of $1,700 Million (10,147 MNOK).

The estimated sanctioned break even oil price for Skuld was around $35/Bbl to meet a (pre tax) return of 7%.

The lower initial output comes with the potential for lower returns.

Figure 10: Development of NPD estimates by vintage for recoverable reserves by category for the Skuld development.

Figure 10: Development of NPD estimates by vintage for recoverable reserves by category for the Skuld development.

BRIEF SUMMARY

Common for the 4 presented NCS developments are that they were sanctioned on expectations about a “low” break even price and thus the potential to become very profitable. As these developments now are struggling to reach expected plateau and/or sustain the plateau, it should be expected that this has the potential to significantly lower returns or even worse, make the developments subject to future reserves and financial write downs.

Costly developments of discoveries that now under-perform should be worrisome for everyone affected. The converging realities of debt saturated consumers (households and sovereigns) and oil companies with heavy debt burdens struggling with profitability bears with it the prospects of some different supply, demand and price dynamics that may, as of yet, be poorly understood, but some outlines may now emerge as reported by Bloomberg in this article:

“The Washington-based IMF forecasts oil prices will slump 7.7% next year while non-fuel commodities will drop 2.9% in dollar terms. It also projects governments will keep cutting budgets, with the aggregate deficit of advanced nations at 4.5% of gross domestic product this year and 3.6% next year.”

Lowered deficits equals lower debt growth that feeds deflationary forces. Dismal production performance is apparently not the only threat to the profitability of the expensive newer developments.

5 Responses

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  1. […] A Closer Look At Some Recent Developments Offshore Norway […]

    Blowout week 46 | Energy Matters

    Sunday, 17 November, 2013 at 19:29

  2. I think you run a very intelligent blog Rune, credit for that. Even more interesting to see that one of the fields you mention (Gaupe) this week was reported to be closed down 7 years in advance of projected life-time, an economic disaster.

    Indeed interesting now is that the economic crisis is about to hit Norway as well. To blame is that home buyers have to have 15% own equity instead of 10%, also it will be sligthly more expensive for the banks to finance due to more own equity will be required. Not 1 single line about why current investments are not possible in the long run as less and less hydrocarbons are being produced (and will be produced). Not 1 single line….. Interesting.. I wonder when media will take realize that Norway is not different compared to the rest of the world. Meanwhile I invest in hydropower in Hfslund and Arendals Fossekompani, hope they will be good investments in the future.

    Eilertrules

    Tuesday, 26 November, 2013 at 22:35

    • Hello and thanks for nice feedback.

      Recent developments offshore Norway are increasingly marginal and were realized thanks to a high oil price. The write downs some developments have taken (there could be more in the future) reflects the high risks associated with these developments another point of view might be that these developments were misallocation of capital.

      Norway is presently and in many ways different from other countries in that respect that apart from high incomes from petroleum related activities (of which the surplus does not enter the economy, but is put into a sovereign wealth fund) and high investments in petroleum developments, the Norwegian households through their debt acquisitions and consumption has fueled the activities of the Norwegian economy. Norwegian households have during the recent 12 – 15 years annually consumed 12 – 15% more (on average) than their disposable income and have now one of the worlds’ highest debt rates.

      The households’ growth in debt has IMO greatly contributed to the recent years’ high level of activity in the Norwegian economy, an effect that appears to have been poorly understood. How much remaining debt capacities and/or abilities to take on more debt the households have, remains to be seen. The Norwegian economy very much behaves like any other economy where economic growth is dependent on growth in debt. The main difference is that in Norway the private sector represented by the households became the facilitator for growth in debt.

      As debt growth slows down or reverses (deleveraging) this will be deflationary. As investments in petroleum related activities and petroleum production declines the compounded mutual reinforcing effects (from households deleveraging and reduced petroleum activities) has the potential to become bigger than anyone expected (“no one could see it coming”) and anyone can handle to fully offset.

      Rune Likvern

      Wednesday, 27 November, 2013 at 15:43

      • I totally agree. Not really a black swan but a grey one.. As Boom Bust usually writes, chief economists et. Al uses rulers of the past in order to predict the future. As you write at some stage the debt will reach the roof and one day people will start deleveraging. However I’m not sure whether this deleveraging will be diret or indirect. Norway is not an unique example (except plenty of debt is private instead of public). I can imagine many countries will begin a helicopter process giving money to people financed thorugh higher deficits (and debt/GDP will decrease as GDP due to higher inflation, not real economic growth). One will see.

        Eilertrules

        Thursday, 28 November, 2013 at 11:21

  3. This is a follow up comment to Eilertrules recent comment.

    IMO GDP is a flawed metric and using debt/GDP ratios are deceptive. The ratio of debt to revenues gives a more realistic impression of the debt overhang. Countries that now see their GDP shrink while still using more debt (in a bid to restart growth) albeit at lower amounts, experience their debt/GDP ratio going ballistic.
    Debt was/is used in a bid for economic growth and create (illusory) wealth. This can go on until it can not.

    All debts will be paid, the question is how?

    Some of the major central banks are now engaged in debasing their currencies in a “beggar thy neighbor” style. The developments in Japan are interesting to follow as they are trying to increase their exports through currency manipulation while the costs of Japan’s energy imports now puts their trade balance in negative territory. Other countries struggling will try to copy Japan’s recipe.

    What we witness is the effects of so called linear thinking, what lies ahead is a discontinuity which is hard to predict when it will occur and the cascading effects from it.

    Quantitive Easing (QE; monetization of debt) and interest suppression has proven not to benefit main street.

    Rune Likvern

    Thursday, 28 November, 2013 at 14:03


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