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(originally published by Booz & Company)


Big Oil’s Big Shift

As a result of the Gulf accident, the oil industry faces profound changes — not just in the management of environmental risks, but in every aspect of its business.

Now that the oil spill in the Gulf of Mexico has been mostly capped, there will be many efforts to catalog its impact: the damage to local (and perhaps global) ecologies, the lost income for tourism and fishing businesses, the increased litigation, and the political fallout. But in the clamor surrounding the crisis, the effect of the accident on the energy industry itself is often overlooked. The oil sector, not just in the U.S. but also around the world, will almost certainly undergo a profound evolution as part of the aftermath. The types of companies that thrive and the types that fail, and the way they do business, will permanently change in the years to come.

To understand why, we have to look past the emotions of the moment and focus on the specific aspects of the oil business that the spill will affect most. Risk has always been inherent in the extraordinarily complex projects that extract oil from the ground or sea. During the past few years, industry trends have added to this risk. The most accessible and productive oil fields, including those in the Middle East and Russia, are now owned and operated solely by national oil companies (NOCs). Leading international oil companies (IOCs) such as BP, ExxonMobil, and Shell — also known as the oil majors — therefore find their access to “easy” reserves rapidly shrinking.

Indeed, it is the need for better equity positions in oil exploration and production that has driven the oil majors to look farther afield to higher-risk, more remote, more difficult-to-reach places, such as the deep sea, central Africa, and the Arctic. And as the availability of “bookable” reserves continues to diminish, the pace of growth and the earnings of the major oil companies will likely suffer even more.

Put simply, the IOCs will have to get used to placing more expensive bets and relying on ever more challenging technologies to tap reserves. Drilling at 5,000 feet below sea level, or in the Arctic, requires levels of investment and technical skill equivalent to those needed for space travel. That’s why the repair of the Gulf leak was so difficult; it was like fixing a space shuttle in orbit.

Before the recent crisis, the major oil companies managed the risks of these challenging drilling environments in two ways. On the one hand, they implemented a series of checks and balances to minimize unsafe practices. People and plant safety is the number one overall priority at all the oil companies we know. At the same time, in their day-to-day practice over the years, many of the same companies have adopted a “mitigation”-style behavior. Assuming that some level of risk would always exist, they have managed it within their cost constraints and time pressures, mainly by allowing frontline contractors or managers to make the necessary trade-offs within each situation as it arose.

This latter approach will no longer fly. The oil spill has accelerated concerns about safety and environmental quality that had already been growing. Henceforth, access to global reserves — for all oil companies, the oil majors and the NOCs alike — will be constrained by heightened regulatory requirements. In deep water, oil companies will increasingly have to guarantee enhanced safety and environmental safeguards or forfeit their license to operate.

In the West, the regulatory penalties for missteps have already become harsher and will be more rigorously enforced. After the Piper Alpha offshore rig explosion in the North Sea in 1988 that killed 167 people, the United Kingdom introduced one of the strongest oil and gas safety regimes in the world. Recently, the U.K. announced that it will double the number of inspections of offshore platforms. The restructuring of the U.S. Minerals Management Service to strengthen oversight of the oil and gas industry is likely to be replicated in many other countries. Even in Asia, Africa, and the Middle East, where regulations have been relatively lax, the emerging middle classes are pressing politicians to be more stringent. When a pipeline in the Xingang harbor in Dalian, China, exploded on July 16, triggering a large oil spill, the government responded rapidly with stricter environmental standards for port operations throughout China.

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