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 / Autumn 2010 / Issue 60(originally published by Booz & Company)


Big Oil and the Natural Gas Bonanza

The oil majors hope to make major money in natural gas, but can they learn to operate two distinct types of businesses under one roof?

Just a few years ago, natural gas, like oil, was plentiful only in a few countries (some of which, such as Russia and Nigeria, were seen as less than stable), while reserves were dwindling in the West. Since then, however, that point of view has been turned on its head. Today, natural gas is abundant virtually throughout the world, thanks to new so-called unconventional reservoirs (sometimes called unconventional reserves) discovered in the U.S., China, and Europe. At the same time, increasing concerns about carbon emissions have made natural gas, which generates only half the carbon emissions of oil, a relatively clean option for some of the world’s largest energy users. For some countries, gas has become a placeholder for running trucks, buses, and power plants until renewable energy sources such as solar and wind power and advanced battery technologies become cost-efficient.

But as the green-energy geopolitics surrounding natural gas continue to be well documented, another equally intriguing phenomenon is playing out: The unexpected revival of natural gas is quietly precipitating a fundamental shift in the oil and gas industry — a shift that few companies were prepared for but that may determine the industry’s overall future makeup. It pits the major oil companies against the independents, which have plied the unconventional reservoirs doggedly over the last seven to 10 years. And it raises questions about whether the oil giants can become big players in this new unconventional gas business. To do so, they will have to develop dual operating models under one roof — one, a traditional high-risk, corporate-led exploration model, and the other, a nimble, efficient, and decentralized operation. In other industries (notably airlines), such two-headed strategies have generally failed.

Unconventional gas, which is extracted from source-rock formations, usually shale, has changed the energy equation entirely. New shale plays — discovered in the past two decades, but only accessible more recently with improved recovery techniques — created a surfeit of natural gas just as consumers around the world began to pull back precipitously in response to the global recession. As a result, natural gas prices collapsed, falling from a recent high of US$13 per million British thermal units (MMBtu) to below $5 per MMBtu a year later.

This didn’t affect big oil very much. Companies such as Exxon, BP, Statoil, and Total had significant natural gas investments, but these reserves were mostly conventional onshore or offshore sites — vast pockets of free-flowing gas usually close to oil fields that the large, integrated oil companies alone had the resources, capital market strength, healthy balance sheets, and technical and project management skills to pursue. Moreover, the energy majors held diversified portfolios with substantial oil assets — whose prices had rebounded strongly, cushioning the effect of plunging gas prices.

In contrast, smaller natural gas independents were vulnerable to falling gas prices. This was particularly true because of the billions of dollars they had spent on leases, as well as on labor and equipment to apply hydraulic fracturing and horizontal drilling, the advances in technology that made unconventional gas more economical. Not only were the independents less diversified than the oil majors, but their capital structures were far less liquid. These were clear disadvantages, since unconventional reservoirs are exploited best by pouring large amounts of cash into drilling a large number of wells and employing a continuous improvement process to gain scale and efficiency. As a result, the most successful independents in recent years were those that were able to take advantage of the best unconventional drilling opportunities quickly and cheaply. They enjoyed the lowest-cost business models possible, and dispersed, decentralized decision-making structures, allowing frontline managers to make operational choices at the wellhead without having to go back to headquarters for approval. The independents that hung on through this rocky period may be vindicated.

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