Do You Really Want To Live Forever?
If you enjoy roller-coasters, put your money on the oil price. A remark, an inventory report or an incident in any major oil producing country can have an instant, significant impact on prices, which affect the revenues of firms globally. Commodity price speculation aside, the oil industry is a great long term investment. The industry started in the aftermath of the 19th century Industrial Revolution. The invention of the internal combustion engine saw the rise of the first oil super-majors: Standard Oil Company, forerunner of ExxonMobil; Royal Dutch Shell; and the Anglo-Persian Oil Company, now BP (I had the fortune of being part of the first two). Its resilient yet cyclical nature provides windows for investment and exploitation.
Standard Oil first started consolidating the different parts along the value chain – the producers of crude (Upstream), the refineries (Mid-stream) and the petrol stations (Downstream). My role in Upstream involves asset valuation and opportunity identification. An oil firm has to constantly replenish its assets for continuation. Why is this?
I assume the readers of this article survive by eating some sort of food. Imagine you are having a sandwich for lunch. With each bite, your sandwich gets smaller. Similarly, an oil company's primary asset, finite reserves of oil and gas, must be continuously produced to generate revenue. With production over time, like bites out of a sandwich, the size of the company's reserves grow smaller.
When we run out of food, we have to look beyond our plate for our next meal. Perhaps there is something in the fridge? Or could we run to the supermarket and get ingredients for a home meal? Perhaps we could just go to a restaurant and have someone else make our meal for us?
Likewise, an oil company's reserves must be continuously replenished to maintain its existence. This may be pursued via Development in pre-existing fields (looking in the fridge), Exploration (supermarket) or the restaurant (investing in non-operated ventures, NOV). Occasionally, technological advancement can also transform production across the entire industry (see US production chart below). In my next article, we look at reserves are replenished as current production declines.
P.S. For the more discerning audience, here is an analogy for questions to ask while evaluating opportunities, in the form of a fable: