1 Huge Challenge Facing Oil and Gas Companies

As the size and scope of global oil and gas megaprojects have increased, cost overruns and delays have become increasingly common.

Mar 16, 2014 at 12:00PM

With the world's accessible reserves of so-called "easy oil" largely depleted as a result of decades of intensive drilling, international energy companies' quest for hydrocarbons has led them to places as remote as Canada's oil sands, Russia's Siberian frontiers, and deepwater locations offshore Brazil and West Africa, where resource potential is high but so are costs and risks.

Many energy companies have embarked on megaprojects that take decades to complete and cost tens of billions of dollars. Unfortunately, delays and cost overruns have become an increasingly common feature of these uber-expensive projects, diminishing companies' potential returns and leaving them vulnerable to a decline in commodity prices. Is there any way to surmount these issues?

Kashagan Isola D

An aerial view of the Kashagan megaproject in the Caspian Sea. Photo Credit: Eni SpA.

More megaprojects, more delays
As the number of megaprojects and the level of spending on these projects has grown sharply over the past decade, so has the average length of delays. According to industry research cited by Luc Messier, ConocoPhillips' (NYSE:COP) senior vice president for project development, the average length of upstream project delays has grown from roughly six months in 2000 to a whopping 2.5 years in 2012.

To energy industry observers, this statistic shouldn't come as much of a surprise, given the increasing frequency of delays for megaprojects. Take Kashagan, for instance, a vast oil field in Kazakhstan that has failed to live up to expectations despite tens of billions of dollars of spending over the past decade.

The project, which is currently being developed by a consortium of companies including ExxonMobil (NYSE:XOM), Eni, and Royal Dutch Shell, has been hailed as the largest, most technically complex, and most expensive oil project ever. Despite initial optimism, its development has been beset by weather-related issues, challenging supply routes, and clashes with local government officials.

As a result of these issues and skyrocketing development costs over the past decade, Kashagan is now estimated to cost $136 billion over the life of the entire project, up from an initially expected $57 billion. The project was initially scheduled to go into service in 2005, but the date was pushed back to 2008, then 2010, 2012, and eventually to 2013. Kashagan finally achieved first oil in September.

Similarly, cost overruns and delays have become increasingly common for liquefied natural gas projects, especially in Australia, where labor shortages, a strong local currency, and the resultant surge in labor costs have led to especially severe cost blowouts. Chevron's (NYSE:CVX) Gorgon LNG project in Western Australia, for example, saw its cost estimates surge from $37 billion in 2009 to a whopping $54 billion currently. The expected date of first cargos from the project has also been pushed back from early 2015 to mid-2015.

Is there a solution?
While megaprojects will remain vulnerable to the vagaries of commodity prices, including not just oil and gas, but also steel and other raw materials used to construct equipment and rigs, there does appear to be one generally accepted solution to mitigate risk.

According to panelists at the recent IHS CERAWeek conference in Houston, phased construction may be the best approach. ConocoPhillips, for instance, is utilizing a phased approach to develop two major projects in Canada that will help the company better manage the available workers it needs to build the facilities. Similarly, Noble Energy (NYSE:NBL) is using a phased approach to develop the Leviathan and Tamar gas fields offshore Israel, two of the largest deepwater gas discoveries of the past decade.

In addition, investors may also want to consider companies' track records of delivering major projects on time and on budget. While virtually every oil major has some blemishes in its track record, Statoil (NYSE:STO) stands out as one of the more capable project managers out there, having delivered 100% of its projects on time last year.

One of the main reasons for the company's stellar project execution capabilities is because it serves as the operator of most of its projects in the Norwegian Continental Shelf, which gives it better control over costs. It also seeks to mitigate execution risk by extensive early-phase testing and planning, as part of a new project model it adopted after the 2007 merger with Hydro's oil and gas division.

While more megaprojects in the future will almost certainly mean more cost overruns and delays, investors can choose to invest in companies with exceptional project execution track records or in companies employing a phased approach to project development.

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As Statoil and its integrated oil peers continue to pursue even more challenging and technically complex megaprojects in the years ahead, one energy company should continue to profit from their need to improve project execution capabilities. Imagine a company that rents a very specific and valuable piece of machinery for $41,000 per hour. (That's almost as much as the average American makes in a year!) And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click here to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable landslide of profits!

Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool recommends Chevron and Statoil. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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