Big oil is searching for the largest projects with the best economies of scale and the potential for impressive profit margins. This search has turned up some great projects, which have the potential to yield tens of billions of dollars in profit. But the problem is that these mega-projects are getting too big for even the world's largest integrated oil and gas players like ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX), and Royal Dutch Shell (NYSE:RDS-B).
These mega-projects and the way they are handled was a hot topic of discussion at the World Economic Forum last week in Davos. Chevron's Gorgon LNG joint venture with ExxonMobil and Royal Dutch Shell was one of the major projects under consideration.
Gorgon has seen costs spiral from an initial estimate of $37 billion, projected back in September 2009, to a current figure of $52 billion -- an extra $15 billion is no small change, even for Chevron. The reason for this multibillion dollar cost blowout? Rising labor costs, the strong Aussie dollar, and project delays are all to blame.
And it's not just Gorgon that is reporting ballooning costs; the world's largest, most complex, and most expensive oil project, the Kashagan oil field, operated by a consortium of companies including ExxonMobil, Royal Dutch Shell, and France's Total, has seen costs explode during the last decade. From an initial cost estimate of $57 billion for the life of the project, the Kashagan project is now expected to cost a staggering $136 billion over its lifetime -- that's 138% more than originally planned.
The project is suffering yet more delays as engineers try to battle to find out why a major pipeline began to leak (it is believed that a high level of acidity in the water is eating away at the pipeline). According to the last reported figures, the Kashagan field has cost $50 billion to get to where it is today, five times original estimates.
When commenting on the Kashagan project at Davos, one oil executive exclaimed: "Kashagan! I don't want to hear this word any more."
Meanwhile, ExxonMobil's partner in crime, Imperial Oil, recently upped its cost estimate for the Mackenzie Gas Project in Canada's far north by about 40%. This project has yet to even begin construction, and costs are already rapidly escalating. Actually, it's not entirely fair to blame the company for this one; project costs are rising due to the ballooning cost of labor within Canada and a shortage of construction materials.
The recurring trend throughout these cost escalations is a shortage of skilled labor and rising construction costs. Parts become more complex and oil reserves become harder and harder to extract. But oil executives are now coming under pressure due to rising capital spending, project delays, and having little to show of it. As a result, they have promised shareholders that capital spending has peaked and it's now the time for the sale of expensive assets.
Appeasing investor concerns
Shell is leading the charge here, recently announcing a review of its shale oil business in the United States, Nigerian assets, and cancelling plans to build a multi-billion dollar gas-to-liquids plant in Louisiana. The company plans to sell off a total of $15 billion worth of assets over the next two years, although this figure could double.
And it's not just Shell selling down assets. ExxonMobil sold its power operations in Hong Kong for $3.4 billion back in November. Meanwhile, according to a report by Bloomberg, Chevron is working with Jefferies Group to find buyers for at least four of the company's natural gas and crude oil pipeline operations within the United States, worth around $1 billion. Chevron also offloaded several billion dollars in oil-bearing assets within Nigeria last year.
The rising costs of these mega-projects in the oil and gas industry are of some concern. However, investors should not be worried, as Big Oil's skilled management teams are working hard to cut costs in other regions, divesting non-essential assets to boost returns. Actually, this could be really beneficial for investors over the long term, as international oil companies start to slim down and return more cash to investors, concentrating on only the most lucrative assets.