with Mike Wagstaff, CEo, Venture Production PLC
As the head of a company very much focused on the North Sea, how would you evaluate the current environment for companies like Venture in the region?
In terms of the operating environment, as a location to do business for an oil company, the UKCS is a pretty good place. In fact, for a company of Venture’s size and business model, it’s hard to think of anywhere else that would be better. Most people consider the North Sea mature, in terminal decline, expensive, highly regulated and bureaucratic, with high competition for opportunities – and if you do make any money, the taxman’s going to take it anyway. That’s the negative prejudice. On the other hand, while the opportunities may be smaller than in other less-mature basins, it’s just a fact of life, and the UKCS does have a number of things going for it. This includes strong infrastructure or platforms, pipelines and terminals, which means that discoveries or development are generally reasonably close to infrastructure with capacity, and if the oil and gas is brought to shore, there is a ready market that is linked to international benchmark prices. On a global scale, the tax regime, at 50% excluding PRT for new developments, is pretty benign compared to Norway at 78% or some of the new PSCs in OPEC countries like Libya or Algeria, where the marginal tax rate at higher oil prices can be as high as 90%. Moreover, there is a pool of access to rigs, equipment, services, and people, as opposed to a frontier base in West Africa where it can cost $100 million to get a rig down there to drill a well. Certain technologies, like subsea construction where UKCS is the world leader, mean there is access to world-class expertise on our doorstep. Also, the UK offers a commercial framework which enables Venture to construct any manner of commercial and financial arrangements desired, that can’t be achieved operating under a PSC contracting to an NOC.
Aberdeen as a centre of manufacturing for the oil industry, so if for example a valve is needed in a hurry it’s not necessary to wait three months for overland shipping. This responsiveness compensates for the fact that the average opportunity size is substantially smaller than elsewhere.
Venture faces the same challenges as others anywhere else in a mature basin in the world today: rising costs and inevitably shrinking opportunities, which means the unit cost per barrel is increasing, and there has been very rapid cost inflation over the last three to four years. With costs tending to follow commodity prices with some lag, and clearly with significant adjustment seen of late in oil prices, I expect equipment and services prices to come down, although how soon and fast remains to be seen. Reducing costs in particular is always part of Venture’s business, because in the case of billion barrel fields, things can go very wrong early on and you still end up making a lot of money, but when drilling only one or two wells into a field, there is not that same margin of error; Venture has to be much more careful and manage its risk better. This means taking calculated risks, and being careful on each individual project. Venture must do enough projects to make the statistics work for us, and spend time being very good at what we do: the subsurface, drilling, project execution, and production operations. The company has built a very strong and competitive business by being very good at what we do, which is actually very simple: acquire, develop, and produce. Then, take the cash and plough virtually all of it straight back into the ground again – it really is as simple as that. Venture is a business that happens to produce oil and gas, not a bunch of oilies that happen to produce money once in a while. With that philosophy, Venture finds ‘stranded’ reserves where there is room to invest, usually by drilling more wells to increase reserves, production, extend life, and therefore create value. Venture is not exploration-driven, and we are therefore not drilling wildcat wells in exotic and dangerous places trying to find giant oilfields, and equally we are not in the business of buying barrels and simply producing them out. There have to be areas to add value through our expertise. There are a number of reasons why old discoveries in the North Sea became ‘stranded’: they are either not material, too remote, commercially complicated i.e. broken up into too many partners, too difficult due to infrastructure or can be unlocked by evolving technology. For example, many of Venture’s assets represent discoveries made 10-20 or more years ago. In late September, Venture brought onstream the Chestnut oil field discovered 27 years ago, and the Chiswick field brought onstream in 2007 was discovered in 1984. On Chiswick between that time and now, 10 field partners had come and gone, and none could make the field work, but Venture succeeded. In this particular case, success was a combination of perseverance, focus, and taking a technology that had been successfully applied elsewhere, in this instance multiple fracturing of horizontal wells that had been used in the chalk oilfields in Denmark, and applying it to gas fields in the Carboniferous reservoir, which had never been done before. Venture has a willingness to do things differently and not accept norms, and while we don’t have any particular silver bullet, through a combination of different strategies and technologies, the company is able to unlock value.
Taking over such a large number of ‘stranded’ reserves, what are your concerns around the topic of decommissioning liability?
Decommissioning, like death, is a fact of life. Eventually, as a finite resource oilfields run out, and as a responsible business we are obliged to clean up after ourselves. Naturally, in the later life of fields, due to depletion and aging of infrastructure, decommissioning becomes more and more of an issue. It’s less of one for Venture, because our attitude towards it has been to invest, extend field life, and put it off, so that it actually becomes less relevant. For example, Venture took over the Kittiwake field platform from Shell in 2003. At that point, Shell had no plans to spend any money on it, and it was in a graceful decline with expected shutdown and abandonment in 2005. Venture took it over, started to invest, boosted production, and brought three new satellite fields onstream with another expected in November 2008, and a pipeline to connect to the main trunkline system to replace the environmentally unsustainable and precarious tanker loading system to improve efficiency. The net result is a facility that will now last until close to 2020. Venture is also looking at developing two gas/condensate opportunities over the same infrastructure, which could add another five to seven years on top of that, and I’m absolutely certain as time goes on other opportunities will arise to further extend life. Decommissioning has thus gone from being a 2005 issue to a 2025 issue and probably later. That’s the best way of dealing with decommissioning.
From another perspective, decommissioning is a tricky issue because of the Petroleum Revenue Tax, although this is not of a particular concern to Venture because none of our fields pay the tax, and is generally one for the big companies. Overall, there are questions as to where the burdens lie, and it’s a complicated issue for which nobody has a clear answer today. I don’t believe there’s a big business opportunity taking platforms apart; it’s much more productive to extend their life and get more oil out, rather than focusing on the scrap business. As every single one of Venture’s assets has seen decommissioning pushed back, the practical answer seems to be: don’t do it, extend field life instead.
Despite the doom and gloom, enough entrants have deemed the UKCS attractive, to the extent that some people feel there is an unsustainable level of independents. What’s your opinion on reaching an equilibrium?
The North Sea has seen many new independents come in, which is great and signals an attractive and open business environment, and the government regulators actively encouraging new companies to come in. The barriers to entry are relatively low, and it’s a pro-business environment. However, the reality is that, because of rising costs over the last five years, the industry has become very much, a “big boys” game, because investments run to £10s or £100s of millions – which are hard to raise as a small company.
Since becoming Chief Executive in 2004, you’ve presided over most of that time of changing costs. How has Venture’s strategy changed to accommodate this new reality?
In my previous existence I lived through a similar period of cost
inflation during the mid-1990s, where the majors had previously spent large sums upgrading refineries in the downstream for environmental compliance, which stopped in the mid-1990s when they decided money was best spent in the upstream. Consequently, this coincided with an increase in oil prices from $18 to $25 per barrel, which seems ridiculous by today’s levels but at that time was a rather large move. There was a similar period of cost inflation where there was excessive drilling, need for rigs, and construction equipment, and small operators in the North Sea ended up paying premium prices and getting poor performance. That is not sustainable.
What Venture did was lock in prices early where we could: rigs, steel, tubulars, etc. Venture made its first long-term commitment on a semi-submersible rig in late 2004, and at the time a day rate of $90,000 per day was a huge commitment, but rapidly become the bargain of the century. Venture also did something cleverer than just a successful bet on day rates, which was to realize how in tighter markets we could make ourselves a better customer for service companies. We weren’t going to do it on volume. Therefore, Venture concentrated business on a relatively small number of contractors where we built ongoing relationships rather than bidding on a job-by-job basis, and set out to create a different, more collaborative way of working with key partners. In doing so, our partners then knew they wouldn’t have to bid for work, so the resources otherwise tied up in bidding for contracts could be freed to solve problems and get projects done, with an open book. Because a given contractor already knew they were going to get all the work, the question became: how could they juggle the program to fit in with capacity to get more and better results? This has been a fantastic success for all parties involved. All Venture’s drilling has been with Noble, and our other big partnership is on the subsea construction side, with Subsea 7, where in early 2005 Venture made what was at the time was a radical solution to form a partnership to put all our business with them and work collaboratively. Venture has kept a running total of what that relationship has added in value over and above the norm, and it amounts to several hundred million dollars, due partially by creating the ability to complete projects when there is no theoretical capacity in the market. As an example, in 2007 the Kittiwake pipeline was laid to Forties. Initially there was no capacity to lay a 35km trunkline in the North Sea. But because of the relationship with Venture, Subsea 7 juggled their schedule, and moved a pipelay vessel back from Brazil earlier than otherwise, to get the job done. If that hadn’t been the case, the wait would’ve extended to 2009 for spare capacity.
The industry has historically suffered from a ‘Tom and Jerry’ relationship between oil companies and contractors. The reality is that in a mature basin, it’s not a zero-sum game, but rather about working together and getting things done effectively, or they simply don’t get done – especially today, in the current cost environment. Since this model started, others have tried to copy it, but it’s a lot of hard work, and goes against 50 years of ingrained behaviour on both sides. The drive for partnership has to come right from the top, and if both companies are prepared to work there are great results to be had. For a company of our size I think we do work harder at it than most. Venture wants to take this partnering concept to the next level, and is already thinking of new ways to do this in terms of partnership and collaboration. In quantifiable cost terms, the net result is that Venture has beaten the market, an even if costs have more than doubled over the last four years.
Going deeper into this idea about partnerships, what does the degree to which you take it say about the Venture management philosophy?
The historic attitude in management philosophy has been “us vs. them”. The change I refer to is not magic; it’s the same in many other industries. Looking at automotive manufacturing, suppliers are so integrated into the ultimate manufacturers that it is barely distinguishable where one ends and the other starts. Aerospace or computer manufacturers have had to adopt similar strategies because margins in their business are so much thinner. The oil and gas industry can and must go further, and although it takes time, two elements will accelerate it. The first is a generational change, which I suspect will occur with the upcoming retiring of a generation that came of age in the “good old days” of the 1970s and 1980s, and a different attitude replaces conventional wisdom. The second would be a sustained period of low commodity prices – although I wouldn’t wish that on the industry as a way of encouraging an approach that should be done anyway.
What is it about the oil and gas industry that has made it a laggard compared to other industries in adopting this otherwise prevailing strategy?
They’ve had to do it, and we haven’t. Factors underlying this include the structure of conservatism in the industry, and that it’s incredibly politically important as a source of revenues and control in many areas, and as such subject to a different kind of scrutiny and control that doesn’t allow the same kind of freedoms of other manufacturing business.
You mention the ethos coming from the top, but in terms of it trickling down, how would you characterize Venture’s corporate culture?
It’s got to come from the top, because you’ve got to talk the talk and walk the walk. If the people at the top don’t believe it, then nobody else is going to either. Often, the perception is that the worst time to do things differently is when you’re running flat out, and the tendency is to lapse back into old ways of doing things.
It’s almost harder in good times to change behaviour, but in the end, it’s not magic, it’s just common sense and hard work.
Going forward, what are the biggest issues on your agenda?
Clearly for everybody it’s global economic conditions, the drastic change in global commodity prices, and the underlying economic environment, in a short period of time. What that means for supply and demand, I don’t think anyone has the faintest idea.
The financial situation in terms of cost and availability of capital is critical, because the industry is incredibly capital-intensive, and most independent E&P companies are reliant on reasonable and regular access to external capital in one shape or form. How do
we manage an environment where the range of possible outcomes is more extreme than ever seen before? We’ve seen oil below $60, and it could go below $50 if there’s a massive global recession and demand dries up. I don’t think it will stay there forever, and the longer it does the faster it will increase when a recovery does occur, because the inevitable decline will eventually kick in. But there’s a big difference between running a business at $50, $70, or $90 per barrel, and gas prices are almost as volatile. How do you plan, keep flexibility and optionality, and manage in an environment where the downside is not bad, but utterly terrible? If something happens and the oil price stays at $50 per barrel and it becomes difficult to raise capital for three years, the cost of raising capital in an emergency situation is, for smaller companies, almost certainly terminal. It’s like walking a tightrope with no safety net.
What does this scenario mean for Venture?
Venture is incredibly well-financed, having raised $1.5 billion before the credit crunch set in, and is thus sitting on a large pile of cash, with a very strong and growing production base which is two thirds gas, that is growing and generating free cash flow even at lowered commodity prices. Venture has an interesting array of opportunities that are sufficiently robust to continue investment in a $50 barrel world. The question at $50 is: how fast do you push ahead with those projects? Because if commodity prices do weaken, companies can’t just go back to the bank with and ask to increase the overdraft. The question is how to manage uncertainty in the long term, with five, 10, or 15 year investment horizons driven by short-term production prices, and it’s come home to roost in the last few months moreso than previously.
Others issues include safety, and environmental responsibility, access to good people and opportunities, and getting everyone to perform. But over these challenges is a huge black cloud of uncertainty, which sounds bad, but is in a sense good because it creates opportunities, and putting this downturn in the context of historical cycles, it’s not nearly as bad as in 1998, 1986, and many times in between.
Despite all this uncertainty you mention, how do you see Venture capitalizing on its opportunities over this time?
In the five year horizon, Venture has a spread of portfolio across the North Sea containing interest in 50 discoveries, of which only 19 are on-stream today, which means there are over 30 opportunities with a range of oil and gas characteristics, some more technically challenging, some more commercially challenging, some easier to do than others, but it’s a great spread. As the base of its business, Venture will continue to acquire, develop, and produce. Equally, the company is looking at opportunities to add to portfolio. Bigger players will have to cut budgets and sell assets, and there’s less competition from smaller players without access to capital being forced to sell what they’ve got. Overall, it’s bizarre, but there’s always a silver lining in every cloud, and Venture is working in a good place right now.
What is your final message to OGFJ readers?
The North Sea is a mature area, from which it will be harder to get a marginal barrel going forward; that’s just a statistical fact. Success will require innovative use of technology and commercial arrangements, more collaborative approaches, and an open mind to do things differently. The behaviours that got the big projects developed 20 years ago will no longer work in the current environment. Ultimately, in a world or country that is desperately short of energy, maximizing indigenous resources, particularly in gas where the UK is a big net importer, will be particularly critical. From any perspective, but particularly the buyer or retail customer, getting more of your gas out of the North Sea where it’s close to market and bypasses the political consequences of dealing with most of the holders of large volumes of oil and gas, must be good in terms of energy security. We have all the tools we need, and I think that what we will see is a change in the North Sea, and people will start to be led by a new generation of regionally-focused companies rather than the big global players. These global players need to shift their focus to access big resources, and West of Shetland, alongside HPHT gas condensate, are the only places in the UKCS where the majors see a global resource. From Venture’s point of view, these resources are too big, expensive, and time-consuming. There are plenty of smaller opportunities that are big enough to be important to a company like Venture; there’s room for everybody in the food chain.