Primarily activities .1 Exploration

Troels Hedegaard & Morten N. Nielsen

6.5.1 Primarily activities

Troels Hedegaard & Morten N. Nielsen Obviously, the price of oil is exceedingly volatile and can quickly turn successful projects into failed ones, but other technical and non-technical risks could potentially influence the portfolio.

Figure 26 - Examples of Risk Factors

Source: Handout Maersk

After disappointing results in its exploration efforts, the company decided in 2015 to reduce its efforts by a large degree and instead focus on using its capital to buy existing oil fields (Friis, 2015 September 10).

However, even eliminating the exploring process by buying existing oil fields is risky business for Maersk.

In 2014, the company suffered impairment losses when it had to write down the Brazilian oil fields that it had previously purchased by approximately $1.3 billion. The incident perfectly illustrates the risk of an oil field with seemingly promising prospects at first, turning out to be less than what was hoped for (Rossau, 2014 July 8). Additionally, the volatility of the oil market affects all investments within the industry, especially when obtaining oil fields from external sources. The risk premium paid for these fields in order to avoid assuming the risk themselves, places additional pressure on forecasts of future profit margins. If the price of oil is lower than expected, purchased fields are in increased danger of turning into bad investments.

MOG experienced such a scenario in 2015, when the company had to let many employees go due to disappointing profitability in a project in Angola as a result of decreasing oil prices. The deep-water project entailed high production costs and thus required a higher oil price to be profitable (Raun, 2015 September 16).

Conclusively, although efforts at exploration in previous years proved successful, recent failures combined with increased risk from a volatile market has forced MOG to acknowledge that, at the moment, exploration is not a core competence of the company. Instead, it takes advantage of financial flexibility and pursues a strategy of acquisitions (Interview: Adam Newton). This allows it to focus on what it is good at, while lowering the overall risk exposure during a period of less than favorable market conditions.

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6.5.1.2 Field Development

When a promising field is identified and the decision to move forward has been made, the field development process is begun. This entails making a development plan containing the number of wells to be drilled to reach the production objectives, determining which recovery techniques to utilize, the type and costs of equipment required and the treatment systems needed to preserve the environment (IFP, 2016). It is in the development field that approximately two-thirds of total CAPEX is incurred, and the associated risk increases significantly throughout the process. The costs of field development vary depending on the size and physical environment of the discovery, but could range from a few million USD to as much as tens of billions.

Figure 27 - Cash Flow during Oil Production

Source: Handout by Maersk

The entire process from access to production generally takes 7-15 years, the success of which is not only contingent on capital and patience, but also largely determined by technical skills and capabilities. It is therefore important for MOG to realize if this is a core strength or not. If that is not the case, the company might be better off purchasing a license instead, thereby significantly reducing the risk of throwing money at non-value adding projects.

Field development is a critical part of the value chain, and an area in which a competitive advantage can be obtained through the right technical capabilities. MOG has several decades of experience operating in the tight oil fields of the North Sea, for which the company developed innovative tools and techniques to increase production. These capabilities were then adapted to the complex Al Shaheen field in Qatar that now produces 300,000 barrels a day – a field that other companies had shunned (MOG, Company Profile).

6.5.1.3 Production

The production system is where the business transforms inputs into outputs. The process can occur either offshore or onshore. Contingent on the volume of the reservoir and the physical conditions it can take

Troels Hedegaard & Morten N. Nielsen anywhere between 5 and 50 years to recover all crude oil from the field, although the typical production period lies somewhere between 15 and 30 years. OPEX during this period is considered low (IFP, 2016).

The lifetime of the field is composed of several phases. Following immediately after field development is a period of production increase, in which extraction becomes more efficient. Then production stabilizes for a period of time after which injection of water, gas or chemical products is needed to maintain satisfactory production levels. As the reservoir approaches end-of-life, production declines progressively. Additionally, as the field matures and equipment grows older the need for maintenance and manpower increases (IFP, 2016). Adam Newton explains how MOG has achieved a reduction in production costs per barrel of oil, while actually increasing production at the same time:

“We have reduced the operating per barrel cost by about 30 % while at the same time raising production overall. So that is telling you two things, either we were operating at ridiculously high cost to start with or that we are doing some of the right things that are enabling us to run the business better. We have also done the best safety performance that the business has ever had over the last 12 months.”

It seems that one of MOG’s core strengths lie within the production process, in which it continuously lower operating expenses while increasing output. Considering the lengthy duration of the production phase, decreasing costs is of great importance to the overall profitability of a project. The company confirms its success within this process in its most recent annual report:

“(…) Positively impacted by a higher average entitlement production and lower operating and exploration costs (…)” (Annual Report, 2015)

Figure 28 - Maersk Oil Operations Excellence

Source: MOG Capital Markets Day (2015)

The graphics depicted above reflects the efficiency with which the company produces crude oil. While the base production decreased throughout 2014 and 2015, total output actually increased due to the so-called

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‘Operations Excellence’ combined with the utilization of infill wells. The latter refers to additional wells built within existing well patterns in a field (OilVoice, 2016). This decreases average well spacing, shifting the formation-fluid flow, thereby accelerating expected recovery and estimated ultimate recovery (Infill Drilling Glossary). Additionally, MOG has kept a long-running focus on EOR. Using advanced techniques such as water flooding and gas injections, the company has been able to both accelerate production and increase the oil and gas recovery factor (MOG, EOR). These techniques have been widely applied in MOG projects in countries such as Qatar and Kazakhstan (MOG, Improved Enhances Oil Recovery).

Graham Slack explains how MOG is generally well positioned to deal with the challenges of low oil prices, relative to competitors. Through increased cost-focus, efficient production and risk management, the company has achieved a break-even price significantly lower than many competitors, although the current extreme-scenario prices are also a challenge for Maersk:

“We have been public around this, a break-even around 50. So relative to some of the majors they are actually pretty well positioned, but of course prices are not at 50 so that's still under-water you could say.

but compared to some of our competitors and certainly some of the majors who have taken big bets, even larger bets on expensive assets. Relatively well positioned“

6.5.2 Support Activities