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A certain future: The fundamentals of oil and gas

Thank you, Herman, for that kind introduction and welcome everyone to the BHP Luncheon. I’m Steve Pastor, President of Petroleum for BHP, and it’s an honour to have the opportunity to share BHP’s perspectives on oil and gas markets and our industry.

The theme of this conference is ‘Adapting to Uncertainty’, and what an appropriate theme for the reality we face.

From geopolitical uncertainty, including climate change and free trade, to disruptive technologies like Electric Vehicles, uncertainty in oil demand, particularly in the long-run, threatens our ability to plan and invest wisely, to effectively meet the demands of a growing world.

Despite these uncertainties and other challenges, we know, that with increasing populations and standards of living, the world needs ever more low cost, reliable energy and we believe demand, not only for Natural Gas, but also for oil will continue to grow significantly for the foreseeable future.

So part of what I want to talk about today relates to how long demand will grow for oil, what that means for supply opportunities and how we at BHP are adapting to what we see as a bright, but uncertain future.

BHP overview

Before I talk about our outlook for markets I’d like to briefly update you on what’s been happening at BHP.

We’re among the world’s top producers of iron ore, metallurgical coal and copper and we have substantial interests in energy commodities including oil, gas, energy coal and uranium. Our strategy is to own and operate what we call Tier 1 Assets, assets that are large, long-life, low-cost, and expandable. And, we have a great portfolio of Tier-1, world-class assets across our commodities.

Including Petroleum where we’ve been in business almost 60 years. We safely produce around 600,000 boes per day from around the world and this year we expect to deliver that production at unit costs of ~ $10/boe generating margins around 66 percent, our Petroleum Business has delivered strong cash flow and attractive, competitive returns on investment through the cycle.

But, like all elements of our portfolio, we constantly review our assets to make sure they are a good fit with our strategy and they are worth more in our hands than they otherwise would be in someone else’s. And following a recent portfolio review, we re-classified our Onshore US shale assets as ‘non-core’ and we publically announced that we are pursuing options to exit our US onshore positions, for value.

For several years, we’ve recognized that our US gas market and price assumptions and outlook at the time of our acquisitions did not fully appreciate the enormous supply of low cost gas to be unlocked by Shale industry players, including ourselves.

And following a global unconventional hydrocarbon endowment study, we found opportunities to replicate what we consider Tier 1 shale oil outside the US don’t really exist elsewhere.

More recently, we’ve see the impact of pro-cyclical investing in the ultra-flexible US onshore where capital remains abundant and inexpensive and where barriers to entry are low and where hundreds of small players compete aggressively for thin margins.

And, although we have very high quality US Onshore acreage and in fact, some of our unconventional oil plays like our Black Hawk in the Eagle Ford and our Delaware Basin position in the Permian, have enviably low positions on the cost curve with breakevens below $50/bbl. We don’t see them as large or long life enough on a global scale to stay in the portfolio and that’s an important, and perhaps differentiating point for BHP.

Although we recognize the sweet spots of US tight oil are very cost effective and competitive today, we simply don’t see US shale oil as the marginal, price setting barrel in our global market beyond the early to mid-2020s.

So, we’ve decided to concentrate our focus on high quality conventional deepwater, where we’ve demonstrated core competencies and competitive advantages for decades. Where we believe we can create a much better return on capital employed. In regions we understand geologically to have Tier 1 potential and where fiscal terms allow us to make attractive, competitive returns on our investments.

A big driver of the decision we made to focus on high quality conventional relates to the counter-cyclical opportunity we see in the deepwater, where competition has thinned out over the last several years as many companies in our industry shifted some or all of their focus to low risk onshore unconventional plays.

Deepwater counter-cyclicality and higher barriers to entry, along with having the right high quality, economically advantaged opportunities to invest in, creates a much more attractive investment environment for us.

So, we will exit US Onshore and we will concentrate our efforts on delivering a world class Conventional Petroleum business with the best returns on investment of any company in our industry and the best returns of any commodity within BHP.

A certain future

Now that I’ve spoken about the current state of play for BHP, I’d like to turn to the future – for both BHP Petroleum and for our industry.

With a global position across multiple commodities, BHP has a detailed understanding of the forces driving global demand, and we know oil and gas will unquestionably continue to play a crucial role in the primary energy mix well into the future.

By 2035, there will be roughly 1.5 billion more people on the planet than there are today!

And along the way, all people, but particularly those in developing countries will continue to demand higher standards of living, similar to what we in developed countries, take for granted every day.

Simply put, more people and more energy per capita means Global energy needs will rise – and, fossil fuels will supply around 80 per cent of energy needs into the 2030s.

Now, we have a relatively green view of the rate of penetration of Electric Vehicles in the Light Duty vehicle space. And with that, we expect demand for oil will slow a bit compared to the last couple of years, but oil demand will continue to rise from today’s nearly 100 million barrels per day, by around 1%/year on average for the next decade. And to offset natural decline, by 2025, just 7 or 8 years from now, the world will need around 35 million barrels/day of new supply to come online. And, that requires enormous investment and effort, alongside the right price, to induce investment required to replace one-third of today’s supply.

As we move into the early to mid-2030s, we do expect absolute oil demand will likely peak somewhere around 105 to 115 million barrels per day. But again, we believe natural decline and a steep cost curve will create attractive investment opportunities in oil, well into the middle of this century.

Natural gas will unquestionably be the fastest growing fossil fuel for the next several decades, with estimated annual demand growth in the 2 to 2.5% per annum range, underpinned by strong demand Asia, North America and the Middle East.

Although we see a relative abundance of natural gas resource and a somewhat flat cost curve for the next 10 years or so, our industry clearly has a lot of work to do to deliver the enormous natural gas and LNG supply to meet demand growth... decades and decades into the future.

To efficiently support global growth while at the same time addressing concerns about a warming climate, we also need to drive the advancement and effective use of new technologies including Carbon Capture and Storage and we need to address policies in a practical way to incentivise lower carbon emissions.

These are some of the many factors contributing to uncertainty and volatility of oil and gas prices and we are prepared for the risk that prices remain low for longer.

Like many of you here today, we hold all new investments to an economic standard of providing competitive rates of return at oil prices of $50 per barrel.

To that end, we are working on multiple fronts to make sure we can turn exploration and appraisal success into profitable production.

For us that starts with a very focused exploration program that’s concentrated in areas where we have a deep understanding of the geology from tectonic plate to reservoir pore. But Tier 1 yet-to-find oil is increasingly scare and difficult, and effective use and advancement of technology will play a big part in determining how successful we are.

A key for us, for example, will be evolving seismic technologies to improve our ability to see beneath salt. Subsalt imaging improvement will significantly reduce risk, enabling us to increase the probability of success where are hunting for the next billion barrel oil fields.

And, post discovery, we drive hard to be efficient during appraisal, really attacking scope to optimize on the value of information and to ensure capital efficient development.

We believe use of fit-for-purpose facilities, with existing industry standard designs, which are simpler and require fewer people and contracting for equipment and services in a way that leverages competition, are some of the key ingredients to maximize potential value.

Earlier this year, our Board approved the Mad Dog Phase 2 project in the Gulf of Mexico. Mad Dog 2 is a good example of driving hard for a more capital efficient investment. Where costs were reduced by more than half, taking cost from close to $20 billion a few years ago, down to below $9 billion enabling one of the biggest discovered undeveloped oil fields in the Gulf of Mexico to be profitably developed, well below today’s prices.

So, investing counter-cyclically, leveraging de-escalated costs for offshore rigs and services, maximizing the use of existing infrastructure to minimise field development costs and applying phased development approaches when circumstances warrant it, like Tiebacks or Early Production Systems that accelerate time to first production and cash flow, while also providing dynamic appraisal data for subsequent development, these are all techniques that must be applied to enable the opportunities we have to be profitable at today’s prices.

Additionally, we are and must continue driving hard for productivity gains, applying Formula 1 racing techniques that consider how to eliminate waste and lean out every step of the work we do.

So, these basic building blocks:

  1. Responsible capital allocation;
  2. Improved productivity; and
  3. Making efficient use of innovative Technologies.

are not only what we must do to be profitable a today’s prices, but they are also key to adapting, surviving and thriving in the uncertain world ahead.