with Søren Gath Hansen , Executive Vice President, Dong E&P
DONG Energy is involved in a long-term transformation from a predominantly Danish utility into a Northern European energy group. As part of the transformation the E&P division turned into a thriving and driving business with key assets in Norway, Denmark, and the UK. What has been the key to the success of DONG E&P?
Perhaps I should start with a bit of history. DONG was established in 1984 as the state-participant in all licenses given out in Denmark. Maersk and its DUC partners had held the sole concession on the continental shelf since first oil was found in 1966, but now a political agreement with Maersk made the company give up new areas.
That marked the moment that Denmark opened up for international oil companies, and it was also when the state decided that they needed to participate with 20 percent in new licenses.
The first years, DONG was not very successful. Maersk had, based on the great talent in the company, developed the technology needed to find and extract oil from the Danish Continental Shelf. DONG did not possess this knowledge.
The development of 3D seismic made it possible to understand the subsoil better and this led to new finds, but we have to fast-forward to the mid-1990s to see significant milestones in the history of DONG E&P. At the end of the 1990s, DONG found and developed a couple of fields. At the same time, we realized that a future as a company focused completely on the Danish Continental Shelf might not be self-sustainable.
DONG set up cooperation with different IOCs entering Denmark. This was a very positive experience for DONG; it allowed us to really develop our competences.
Around 2000 we decided to, while maintaining a focus on Denmark and developing the DCS, look outside Denmark and create the critical mass to actually be able to fully exploit the potential of the DCS. Norway was the first step of this internationalization, where we bought a small company to build up our position. Later we entered the UK, west of Shetland.
The strategy has been to develop a basis for a company that could sustain activities with a focus in Denmark. Although one of our largest developments is in Denmark, almost 70 percent of our production actually comes from Norway today, while we are also investing heavily west of Shetland. DONG is the biggest holder of acreage in that area.
One of the key reasons for our success are that we had been focusing on a quite limited footprint area. By choosing to focus west of Shetland we took a challenge. When we moved in, very few people believed in that area. This also meant that the entry barrier was not that high, which enabled us to take over the ConocoPhillips portfolio.
DONG believed in this area early on, and we have built up a strong position accordingly. By focusing ourselves on this area we have turned ourselves in basin masters with a deep understanding of that area. We are not being defocused by trying to build up a position in the southern gas basins. In the latest UK bidding round we expanded a little bit to the North Sea with new licenses, but the primary focus remains on the west Shetlands.
In Norway, we used the assets we acquired through the acquisition of Pelican. They had a small position with a production of some 5000 bopd. We built our Norwegian position from this modest start. The largest step came of course with the acquisition of Ormen Lange.
A second success factor is that we tend to be opportunistic. The West of Shetland focus was opportunistic in that we entered when everybody was asking whether it could develop into anything.
The Ormen Lange stake we bought at a high price. The acquisition was controversial at the time, with people wondering whether we did not overpay. It turned out to be a great investment that provides backbone not just for DONG E&P but for DONG Energy as a whole.
How did DONG succeed in purchasing such a major field at a time when it was still a very modestly sized player?
The Ormen Lange story is remarkable. We actually were not on BP’s shortlist as buyers because they did not believe that we would be able to act fast enough. Making this sales process they wanted completion certainty. DONG at that time was in the middle of a merger, and there were also discussions on an IPO while we were still state-owned. These factors made BP doubt whether we would be a ‘safe’ party.
We managed however, through a small Norwegian investment bank with good ties in BP, to actually be allowed into the bidding process. We were a couple of months behind the other bidders though and had a little over two weeks to make our bid. The name that we gave to this project and bid was actually ‘Dark Horse,’ and BP called us ‘Late Arriver.’ But the dark horse won. It tells something about our DNA and our ability to act fast. Our money is where our mouth is.
What is the significance of Ormen Lange in the development of DONG E&P?
At the outset, and certainly working in Denmark with the situation as it is today, DONG focused on small field development, or ‘vacuum cleaning’ as we like to call our activities on the DCS. Our Siri field is a success story as we have actually been able to keep the area alive by vacuum cleaning. That is one kind of strategy and it takes a particular kind of company, but we realized that we were not able to develop the company and the portfolio on the long term only focusing on late life fields and only vacuum cleaning; it has its own merits and disadvantages.
By the acquisition of Ormen Lange we entered into a completely new game. It also introduced a couple of new challenges for us, such as long-term reserve replacement.
Producing 5000-10000 bpd requires replacement as well, but suddenly moving up from that number to 80000 in a short time span presents us with a completely different reserve replacement challenge which cannot be solved by marginal field developments.
That decision made us realize that we need to put much more focus on new areas, growth areas, and exploration. That is the current development phase DONG finds itself in.
we are very focused and have a very diversified portfolio: with the Danish southern North Sea area we have a mature area with a fast turnaround of money: you drill a well and it is paid back within a year, but we are talking of course about limited volumes. With the mid-Norwegian area we have a fresh, young production area which is working fantastically well, with very stable production. Then we have the growth area West of Shetland where we really need to supplement our production. And for the long term we have the Barents Sea and Greenland: frontier with high risk and high reward.
Fifty percent of our growth is organic – a result of fields that we have found ourselves; and fifty percent is a result of M&A. That has been a very important instrument building up our company as fast as we have done.
DONG E&P started from scratch not too long ago. We started with Siri and South Arne in Denmark. South Arne made us a one-asset company. We then bought Ormen Lange because I wanted to diversify. But because of the size of Ormen Lange, we basically still were a one-asset company, but now based on Ormen Lange!
Soon however the Hejre field in Denmark and our developments West of Shetland will balance the portfolio and will put us in a situation with more or less equal contributions from Denmark, Norway, and the UK.
How much of a challenge is it to develop these very different assets and acquire the specific technology needed for that?
We are not operating everything ourselves. West of Shetland we are partners with among others Total. We believe that we have the knowledge and expertise to be operator for exploration in the whole area.
We are trying to develop our strong point as a proven and competent explorer, whereas in the development part we have a proven track record that we can develop in shallow water up to 70 meters.
We leave the deep water and harsh environments to other companies for now. We are focusing on exploration and reservoir understanding; those should be our strong points. We still have a limited portfolio. Seen from my point of view – we have people in Denmark, the UK, and Norway, and the Norwegian guys ask me where the next Norwegian development project will come, but we cannot in every country have a continuous development portfolio. The larger companies have enough critical mass to have development projects on a string, but our size puts natural limits to that possibility.
We truly believe in being an active partner. It is crucial that our partners can trust in us and that they know that, when we promise something, we will deliver. They will also know that we will challenge them but in a reasonable way.
Our markets are characterized by good relationships with the authorities, because they are the ones that hand out the licenses, but also because of the market position you can establish by getting access to partnerships. Naturally we cannot do everything on our own, and realizing access to larger companies through partnerships is certainly an important part of our market access. Being a preferred partner is very important to us.
One of Maersk Oil’s key achievements in recent years has been to successfully decrease its unit finding cost, thus establishing a healthier balance between production, return of investment, and reserves. How challenging is it to keep that balance in the coming years against the backdrop of DONG E&P’s rapid growth?
I heard a colleague say once, ‘the challenge of the E&P business is that we go a little bit out of business every day.’ We find the resources but as soon as we start to produce them, they disappear and will not come back.
We are very wary to fall into the trap of not stepping up exploration in time. One of DONG’s key ambitions is, as mentioned, to double production. That should go together with increasing our rate of return on invested capital, and, equally important, securing the sustainability of production.
We have three numbers: daily production, rate of return, and reserves to production. These rates have an internal tension, because it is easier to have a high rate of return if we stop investing and just produce, using our assets as cash cows, delivering a high rate of return, but that would be a short lived dream with a rapid decline in earnings just a few years down the line.
Increasing production without jeopardizing the rate of return numbers is a question of making sure that we sustain our reserve base. This costs money and creates downward pressure on the ROCE. Making this triangle balance is our major challenge and key focus. We believe we can.
On top of doubling production, we will double exploration as well, and indeed one of the challenges is to keep the unit finding cost low, especially working in a mature area.
DONG is an interesting but perhaps also slightly confusing story: a government- owned former NOC that is turning into a major player in Northern Europe. How do you want to be perceived by the international oil & gas community?
Our first headline should be that we act on a commercial basis, not that we are here to carry out some of the state’s responsibilities. That is not the way we are set up and are expected to act. The state is shareholder, and as a shareholder they have asked us to create value. We are not being tasked with performing specific tasks.
But of course, any company will have to think about not only about their shareholder as a stakeholder, but also of other kinds of stakeholders. Our ownership makes us put topics such as the environment and safety high on the agenda. The whole CSR package counts. When developing our strategy we think thoroughly about how we can support Danish security of supply. Especially in calm times when markets are liquid this might not seem that relevant, but in the final hour, it is not that bad that the Danish state has access to a company that can supply resources.