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When Should Big Oil Say No?

By Tyler Crowe and Taylor Muckerman - Mar 8, 2016 at 2:17PM

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Royal Dutch Shell and ExxonMobil are contractually obligated to start work that will cost them.

Last week, big oil moved to Brazil for offshore drilling -- not because anything has changed for the horribly depressed sector, but because their lease holds on the land are running out.

In this clip, Sean O'Reilly, Taylor Muckerman, and Tyler Crowe debate the options these companies have, and talk about what it means for ExxonMobil (XOM 2.23%) and Royal Dutch Shell (RDS.A) (RDS.B) to essentially be forced to drill into projects that will lose them money.

A transcript follows the video.

This podcast was recorded on March 3, 2016. 

Sean O'Reilly: At what point does an oil company say no? As noted in a recent Bloomberg piece, Big Oil moves to drill in Brazil not because things have improved, but Royal Dutch Shell by its likely BG Group acquisition and ExxonMobil are being forced to drill offshore of Brazil, where they risk losing leases that they have already bought. Guys, is this fair? Could this be good in the long term because these projects take such a long time to get going and produce and everything?

Tyler Crowe: This is one of those weird situations where, like you said, when does a company say no? It's almost kind of like the gambler's dilemma. It's like, when you're down, can you recover, when do you walk away, because of the concept of a sunk cost. Basically, when all these companies went into the Brazilian black oil rush that happened, what, 10, 12 years ago when the pre-salt fields were found and Petrobras (PBR 0.69%) everyone was really excited about what's going on down there, and they spent a ton of money on lease holds, basically saying, "We're going to go drill these, and we want to own the rights to them." Nowadays, they're 10 years up, we're in the middle of a major oil price crash, and the due date to start these projects is starting to happen. It kind of gets to the point, it's like, they could do it. Certainly, they have the resources if they really wanted to, but they don't want to spend the kind of money. When do those lease holds basically become a sunk cost and they have to walk away?

That's one of the things that I'm not certain as to whether it's the right idea, because as we've seen with shale and some of the other faster-development-cycle things, perhaps it's going to take a long, long time for deepwater projects to get the economics that they're looking for.

Taylor Muckerman: Yeah. Some of the fees that these companies will have to pay equal the amount that it'd cost to drill a well anyway, so that kind of helps the decision-making process. It is unfortunate for these energy exploration and production companies because their hands are kind of tied. You saw a lot of it happen in the U.S. during the shale boom early days, when leases were starting to come up for renewal or expiration, and 2012 when shale gas prices were less than $2 per million BTU or right around that $2 mark after being north of $10. Companies were forced to drill, otherwise they would lose these leases. Similar situation here. Unfortunately, prices are still low so they're being forced into it, but I think the big beneficiary here could be, if they do decide to drill, would be offshore oil rig companies, because they've seen a lot of contracts be shortened or completely written off by Petrobras and other companies down in the Brazilian waters.

I know a personal holding of mine, Ensco, has lost a rig or rig time to Petrobras. They have four rigs down there right now.

O'Reilly: I feel like every rig company has lost something to Petrobras one way or the other.

Muckerman: Maybe Petrobras doesn't pick them back up, but maybe BP does, maybe Total does, maybe Shell or Exxon, these companies that could be forced to make that decision. Maybe they needed an extra rig to pick up, and companies with experience down there, rigs that were originally built for the Brazilian pre-salt fields, would have a unique advantage to getting back in there earlier than maybe they had expected.

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Stocks Mentioned

Royal Dutch Shell plc Stock Quote
Royal Dutch Shell plc
RDS.A
Exxon Mobil Corporation Stock Quote
Exxon Mobil Corporation
XOM
$87.55 (2.23%) $1.91
Petroleo Brasileiro S.A. - Petrobras Stock Quote
Petroleo Brasileiro S.A. - Petrobras
PBR
$11.76 (0.69%) $0.08
Royal Dutch Shell plc Stock Quote
Royal Dutch Shell plc
RDS.B

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