A Beginner’s Guide to Oil and Gas

By Ingrid Wadman

On 4 October, Nikki Jones, researcher/writer on global energy, gave her third talk in a series of seven on energy and climate change at the Salt Café on St George’s Road, south of Brandon Hill Park.

The aim of the talk was to give an overview of the oil and gas industry, and the many challenges it currently faces –  not an easy task considering the enormity and complexity of the worldwide trade network. However, during a couple of hours we were presented with a thrilling lecture, full of remarkable facts, explaining the current crisis in the industry and posing the question of whether companies can change and become part of the solution or whether ‘business as usual’ is inevitable.

Natural gas has complications

The talk started with an explanation of the impact of US shale production, the dominant ‘story’ in the oil and gas world at the moment.  Nikki explained the different sources of gas and the fact that until the beginning of the century it was often seen as a no-value by-product to be vented or flared. However, with the development of Liquefied Natural Gas – an energy intensive process that super-cools gas to a liquid and allows sea-transportation in specially built ships, many new gas fields have been developed around the world. Massive multi-billion dollar investments have been made, giving gas a new status and turning oil companies into ‘oil and gas’ companies.

However, within just a few years, small companies in the US sparked the shale revolution. As depicted in the film Promised Land, they used every means possible to secure access to reserves, but as production increased, they suddenly realised that together they were destroying the gas prices, making their own investments potentially unviable. They had also removed the market for which much LNG had been developed.

Worldwide over-supply has cut gas prices and to make matters worse, it appears that the ‘glut’ will be prolonged as more new supplies come on line from Australia, East Africa, Iran, Russia and the Eastern Mediterranean. Billions of pounds worth of projects have been cancelled but the market is not expected to correct till the mid 2020s at the earliest.

The mystery of the oil price

The gas glut persuaded many US drillers to move to ‘wet wells’ in search of oil and since 2010 US oil production has risen markedly. This too has had a knock-on effect around the world, causing an over-supply of around a million barrels per day and cutting the global price by $60 – $70. This prolonged price drop has made many expensive operations (in the Arctic, tar sands and ultra-deep water) unprofitable and again, billions of pounds worth of investments have been written off.

However, as Nikki explained, supply and demand are not the only factors involved in setting the oil price. Brent, the leading international benchmark, is itself often distorted by purely local factors. Price distortions and volatility have been exacerbated by the massive influx of funds into commodity markets since the early 2000s as traders have found oil a particularly good asset to speculate upon and asset managers have parked trillions of dollars in ‘massive passive’ investment vehicles that simply track prices and bet only on an upward price movement.

Nikki also explained the role of OPEC and the unique position of Saudi Arabia as the world’s ‘swing producer’, apparently able to increase or cut supply to balance the market and calm prices as required. It was the Kingdom’s decision to give up this position in 2014 that has upset the market and exacerbated the price slump.

The issue of government subsidies was discussed and, as Nikki explained, it’s more complicated than many people assume. The IMF has calculated that the industry receives $5.3 trillion per year, mainly through the ‘externalising’ of costs associated with the environment and health. In layman’s terms, these costs fall on the public purse, even when they are clearly related to oil and gas production and consumption. Nikki gave several examples of tax cuts for the industry in the UK, plus some direct investment, with which the current government is attempting to support production in the North Sea.

Problems facing the oil and gas industry

The oil price drop is not the only issue facing the industry, though it is key to several other significant challenges. Oil companies need to remain investible and this is mainly dependent on their access to oil reserves and to finance. Companies generally aim to replace the oil they pump each year with new reserves, and to have access to many years of supply ahead. However, since the mid 2000s, no new major conventional oil resources have been discovered and Big Oil, the Western super-majors (ExxonMobil, Shell, BP, Chevron, ConocoPhillips & Total) have missed out on production contracts in Africa. Their size, and focus on high-cost, high-tech production in areas such as the Arctic has been blamed, plus the fact that they have long been excluded from the main areas of relatively easy production – the Middle East, Russia and Latin America.

The risk for the oil companies is that their access to shareholder capital, the bond markets and the banks will be closed. In fact, worryingly, banks in the US and Europe are generally considered ‘over exposed’ to energy, and their own stability has been questioned – they are likely to be wary of energy investments for some time to come. Over a hundred companies have already gone bankrupt in the US and this is believed to be putting a particular strain on many American banks.

The oil industry has always remained confident, however, because of its monopoly position in the world of transport. Despite some biofuels and some electrification of vehicles, we still need refined oil for our cars, planes and ships. However, as Nikki explained, over the last year there has been a growing discussion of ‘peak demand’, and as companies such as Apple and Tesla look set to begin serious production of electric vehicles, there is a very real question as to whether the oil industry is as safe as has been assumed.

Towards a sustainable future

An unforeseen threat to the industry is the divestment movement which has had a profound impact. Large investors such as the Rockefeller fund have not only divested  from fossil fuels but some have stated that they will invest positively in green tech. Divestment campaigns have sprung up everywhere and the Fossil Free Bristol Divestment Campaign, the student society Fossil Free – University of Bristol and Bristol Energy Network are organisations offering ways to act locally for sustainable energy if you would like to get involved.

An obvious answer to the industry’s multiple problems seems to be a transition to renewable energy, but at the moment this seems to be of limited interest. Some relatively small investments have been made but without greater pressure from the public and from powerful investors (such as pension funds and insurance companies) it seems likely that the industry will not respond. Despite a world-wide massive cutback in exploration and production budgets, the big oil companies are still spending billions on finding new reserves and still arguing that they should be able to return to areas such as the Arctic when/if the oil price rises.

For us it seems that the best way forward is to put pressure on the oil companies either as active shareholders or indirectly through our pension funds – and to cut our personal use of oil and gas. Europe’s drop in gas consumption is already having an impact on investments here and the world’s sluggish response to low oil prices (we’re not all driving high-consumption cars) is a worrying new factor for the industry to consider.

Climate change and new legislation following in its footsteps is becoming a very real risk for investors, and the threat of ‘stranded assets’ is making it easier to convince actors to divest. As a final tip to the audience, Nikki Jones mentioned ShareAction, a charity for responsible investments, which has set up FairPensions fund, amongst other projects. To look into where your own funds are placed and to ask your bank not to place your money in fossil fuel funds is a great way of taking action for sustainability.

ingridAbout the author

Hi all!

I’m a MSc student studying environmental policy and management at University of Bristol and I will be posting about activities in Bristol Energy Network, as a way to spread the word about community energy projects. I’m sure there are people out there who would be interested in getting involved in projects and I hope this blog will bring some inspiration to you.

Ingrid Wadman