SPE DISTINGUISHED LECTURER SERIES is funded principally through

SPE DISTINGUISHED LECTURER SERIES is funded principally through a grant of the SPE FOUNDATION The Society gratefully acknowledges those companies that support the program by allowing their professionals to participate as Lecturers. And special thanks to The American Institute of Mining, Metallurgical, and Petroleum Engineers (AIME) for their contribution to the program.

E&P A Dynamic Growth Business Aidan Mc. Kay, SPE Shell Exploration & Production Company SPE Paper 84433 Originally presented at SPE – ATCE Denver, CO October 2003

History of Supply / Demand Growth Potential Investment Levels Required Six Competitive Forces Shaping the EP Industry Profits Conclusions SPE 84433 A Mc. Kay

Hydrocarbon (Oil & Gas ) Demand from Wellbores Daily Production (Million Boe/d) 240 200 Gas (? ) 160 128 mln boe/d Curr ent e st 120 imat ed d 80 eclin e rat e Oil (? ) 40 0 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 Aggregate global production decline is ~ 5+% per annum. Aggregate long term oil & gas growth is 1. 5% per annum average. SPE 84433 A Mc. Kay

Number of Cars & Light Trucks Globally (millions) Number of Vehicles Globally (History and Forecast) 1400 1200 USA ~ 200 mln vehicles (adding 15 mln pa) China ~ 5 mln (Growth undefined) 1000 800 Range of Forecasts 600 400 200 0 1940 1950 1960 1970 1980 1990 2000 2010 [Assumes an 8 Bln population by 2030] SPE 84433 A Mc. Kay 2020 2030

Number of Commercial Aircraft (thousands) Number of Commercial Aircraft 35 30 25 Range of Forecasts 20 15 10 5 0 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030 Time (Years) SPE 84433 A Mc. Kay [Assumes an 8 Bln population by 2030 AND economic progress ]

Hydrocarbon Reserves & Demand (Bln boe) World Proven Hydrocarbons (Bln Boe) 6000 5000 4000 3000 • • The planet may have 40 - 100 years supply 80% of hydrocarbons are in onshore areas; 20% offshore Much is low cost access…. . most owned by governments… New ones (mature) opening each day. Hydrocarbon Demand from Wellbores Growing at ~12% pa ? 1000 -3000 Bln boe Oil sands/Bitumen Heavy etc 2000 Oil 1100 Bln bbl 1000 (Expect+ Undiscov. = 2000 Bln) 2002 44 Bln boe 0 SPE 84433 A Mc. Kay 2030 88 Bln boe Gas 700 Bln boe 4000 Tcf

Capital Investment Capex ($ Bln) Private Oil Company Annual EP Capex Actuals & Forecasts Excludes OPEC Countries and Russia Spend] 300 250 200 150 ~ $1 Bln scale “giant” projects, start of offshore, DW etc Big 5 oil companies ’ 93 ~18 Bln pa, 2003 ~$34 Bln to increase oil by 15 % & Gas by 20 % in 10 years to 14. 8 mln Exxon, BP, Shell, Chev, TFE Big US Independents ~ $8 Bln pa, for 2 mln boe/d 100 50 0 1960 SPE 84433 A Mc. Kay 1970 1980 1990 2000 Time (Years) 2010 2020 2030

THE TRADITIONAL “S” CURVE FOR TECHNOLOGY Business Benefits Creaming of Candidates for Technology Widescale Implementation of Technology Initiation Of New Technology Obvious Candidates First Trials INNOVATION SPE 84433 A Mc. Kay GROWTH MATURITY Time

New Well Technology S Curve Evolution GAINS CONTINUE ? Business Benefits ? Intelligent Wells Underbalanced Drilling Offshore Coiled Tubing Multilateral Drilling Multi-fracced Wells Multilateral Wells Horizontal Wells Slim Hole Exploration Hydraulic Fracturing Horizontal Wells with Hydraulic Fracturing Vertical & Deviated Wells Time 1970 SPE 84433 A Mc. Kay 1980 1990 2000 2010

Capital Investment Capex ($ Bln) Private Oil Company Annual EP Capex Actuals & Forecasts 300 Assumed Reduced Impact of Technology (30% Reduction in Investment) 250 200 150 ~ $10 Bln scale projects ~ large scale devt of marginals ~ Major infrastructure ~ supplier cost increases 100 50 0 1960 SPE 84433 A Mc. Kay 1970 1980 1990 2000 Time (Years) 2010 2020 2030

80 70 60 50 40 30 20 10 0 es gl om er at e ar on In d us A tr er ia ls (C on Pe rs & il os O al G C as m le co Te & ce pa s ns e D m he C Se IT & ar e ftw So ef e ic al s ic e rv ct r El e & ni cs El ec tr o ar s al ic al s tic m ac eu In om ot A ut IT Ph H iv e ar dw du ar e st ry ) $3. 3 Bln in total EP ~ $2 Bln in total & Annual R&D Investment ($ Bln) Industry Sector Research and Development Spend 2001 D iv e rs ifi e d Industrial Sector NB : 1995 equivalent R&D spend was ~ $4 Bln SPE 84433 A Mc. Kay Source: UK Financial Times Monday 14 th October 2002 pages 10 -11

900 Source : Company Annual Reports 800 2001 2000 1999 700 600 500 400 300 200 100 IP ) A I( Te on vr C he EN to ur al lib G xa co n P B H D al oy el l/R Sh SPE 84433 ch ut ob n. M Ex xo To ta l, Fi na rg Sc hl um be il El f 0 er Annual R&D Spending ($ mln ) Oil & Gas Company Research and Development Spend • Pressures from Shareholders to cut R&D spending in 1990 s. • Service Industry starts to do material “ tech devt”, A Mc. Kay but significantly lower profits mean less R&D funding

Six Competitive Forces Shaping the E&P Industry • Cost Structure – Need for Continual Improvement • E&P Portfolio Restructuring • Shifting to Gas • The Quest for Growth • Need for improved financial management • Industrial consolidation SPE 84433 A Mc. Kay

Where to Exploit the Hydrocarbons in Longer Term BIG 5 MEO SAUDI, KUWAIT, “NEW” EP Business “OLD” EP Business IRAN, IRAQ, UAE BIG GAS USA, Canada, North Sea, Small ME Countries Selected others + Low Govt Take, stable terms - High UTCs - Mature Basins (limited growth) - Capital intensive, - high costs on supply curve + Long asset tenure + High upside at higher prices + gas markets are developed QATAR, Russia Brazil, Angola, Iran, CIS, Sakhalin, Kazakhstan, China Other OPEC Countries, S. America, Pakistan, Bangladesh - High Govt Take, less stable terms - Commercially risky - Limited upside @ higher prices - gas markets are emerging - ultra competitive (“loss leading”) - Low degree of control with govt - Lower degree of control with govt + Green/Brownfield (high growth) + Low UTCs resources + Low UTCs- MRH ; DW High UTCs Natural Shift with Declines Where EP Industry made most of the money in the past …. . But margin is small @ low prices and where capex treadmill potential exists SPE 84433 A Mc. Kay Where the EP industry must go in the future, but where EP margin may be thin. . . at all oil/gas prices like R&M or Chemicals

11. 5 11 10. 5 10 9. 5 9 8. 5 8 7. 5 7 6. 5 6 5. 5 5 4 3. 5 3 2. 5 2 1. 5 1 0. 5 OLD E&P (examples) $16/bbl oil & $3/mln scf gas $22/bbl oil & 3. 5/mln scf gas $30/bbl oil & $4. 75/mln scf gas NEW E&P (examples) BIG- GAS Qatar (likely rents) BIG 5 MEO (likely rents) SPE 84433 A Mc. Kay Th ai l N and Ve ige ne ria zu el a A ng o K B la az ra ak zil hs t C an hi R na us si a A bu D h K ab uw i a Sa it ud i U N Ca K et na he d r a D lan en d s G ma er rk m an Eg y y G pt ab on SA 0 U Net Income After Tax per Boe ($/boe) E&P UNIT MARGINS ($/bbl) FOR E&P ENVIRONMENTS Which is better: “bond-like” investments or investments with more risks but with price upside?

50 years of EP Consolidation Continues, Nationals Join, What Next? 1950 Standard Oil (NJ) Socony Vacuum Superior Oil Standard Oil (IN) Standard Oil (OH) Atlantic Richfield Sinclair British Petroleum 1960 Royal Dutch/Shell Oil The Texas Co. Tidewater Pacific Western Getty Skelly Gulf Standard Oil (CA) Standard Oil (KY) 1970 1980 1990 2000 Exxon /Mobil Amoco Britoil Arco Vastar + TNK BP Royal Dutch /Shell Texaco Chev/Tex Chevron Occidental Cities Service Phillips Aminoil General American Oil Continental Union Oil Pure Oil 2005+ State Oils & Former State Oils TFE, ENI, REPSOL, PETROBRAS, Conoco. Phillips Unocal Marathon

Will Consolidation Continue? In What Form? 2005 - 2010 2003 Exxon/Mobil Royal Dutch/Shell BP Chev/Tex Phillips/Conoco • Alignment around geography & cultures • Regulatory involvement is likely • National Oils rightly playing away from home • Does Aramco marry or eat the survivors • How will Gasprom play going forward ? TFE ENI YUKOS Sibneft (? ) Rosneft Statoil + Norske Hydro (? ) Petrobras + Repsol (? ) SPE 84433 A Mc. Kay Ga. Zprom (? )

An Growth Example of Similar Behaviour in Independents 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Devon Hondo Alta Worland Kerr Mc. Gee (N America) North Star Penz Energy Santa Fe Mitchell Ocean Energy United Meridian Seagull Anderson Home Ulster Numac USA Companies Canada Companies A 650, 000 boe/d company with a $2. 5 Bln pa capex requirement, All cash flows re-invested. SPE 84433 A Mc. Kay Source: Devon Annual Reports

Big Four Major Oils E&P Net Income (CCS) Annual Net Income after Tax ($ Bln) 40 35 30 25 20 15 10 5 0 US Vehicle Industry 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Time (Years) Large pressures to increase dividends and Share buybacks in a bear market SPE 84433 A Mc. Kay Source: Company Annual Reports

The Ten Largest US Market Capitalisations Versus Time 1928 Rank 1. 2. 3. 4. Company 1969 Mkt Cap (S Bln ) Company General Motors AT&T US Steel S. . O. N. J. (Exxon) 1999 Mkt Cap ($ Bln ) Company 2003 Mkt Cap ($ Bln ) Company Mkt Cap ($ Bln ) 22 18 9 9 IBM AT&T General Motors Eastman Kodak 159 102 76 51 GE Microsoft Citigroup Cisco 459 335 314 306 Microsoft GE Exxon. Mobil Wal-Mart 266 256 231 217 5. G. E. 6. Du. Pont 9 8 Exxon Sears Roebuck 51 40 Exxon. Mobil Pfizer 284 271 Pfizer Citigroup 178 173 7. F. W. Woolworth 8. S. H. Kress 9. S. Oil of California 7 7 6 Texaco Xerox GE 32 31 27 Intel Wal-Mart IBM 244 239 194 Johnson & J 163 IBM 137 AIG 128 10. NY Central Railroad 6 Gulf Oil 24 Nokia 187 Merck Oil Companies will continue to play huge global role SPE 84433 A Mc. Kay Source: Various 114

Conclusions Ø E&P is a dynamic, profitable, growth business Ø E&P business is capital intensive and requires high technology like space travel or the defence industry Ø We have interesting conflicts in meeting global hydrocarbon demand whilst meeting the needs of stakeholders Ø The scale of investment required will be challenging and is not recognised in society. Ø Sustaining the industry success will require R&D success levels at least equal to those of the past to keep future investment costs down. We need to avoid under-investing in the research we need. Ø We have met the energy needs of the planet in the past and will do so in future. This is a great place to work. SPE 84433 A Mc. Kay

Key Points to Reflect on: Ø Can we get OEDC individuals out of cars, into buses/trains ? Ø Quality E&P investments are very, rare (ie risk/reward balance) Ø Portfolio Management & Mergers add nothing to global supply ØSelling assets in production returning WACC+, is dubious. Ø Role of Exploration 2005 – 2030 is very uncertain, If so then where ØBI 5 MEO, BIGGAS, NEW EP, or Frontier exploration Ø Impact of Technology in Future in Cost Redn (Is it large or small) ØNot at all clear that material steps are being made Ø R&D Spend is low (vs industries & history), so what breakthroughs ØMajors & Service Industry may not be doing enough Ø Cash Today is Mantra, (Dividends & Buybacks) not investment Ø Having a large surplus of cash today, is not valued in market. SPE 84433 A Mc. Kay

Backup Slides Not likely to be Used SPE 84433 A Mc. Kay

Oil Price ($/bbl) Actual Possible Outlooks on Oil Prices? 38 36 34 32 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 Volatile Or Low Oil Price World again ? Low Oil Price World 1910 -1970 Volatile Oil Price World 1971 -2002 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030 SPE 84433 A Mc. Kay

We Tend To Get Overly Pessimistic in Downturns SPE 84433 A Mc. Kay March 1999

Then rapidly revert 12 -18 months later …. Yet the big supply demand did not change? September 2000 SPE 84433 A Mc. Kay

The Individual Optimum May not be Optimum for Society Happy with HUMMER II Happy with HYBRID It is a symbol of my success It costs me $3000/yr more in fuel It is “safe” , fashionable, and Has loads of utility It is my contribution to a problem, We need to leave it in better shape It is very efficient, and is the future It has all the functionality I need Long term fuel issues and Environment are not his problem Would he still buy it if it had a 0. 6 -1 ltr vs 3 ltr engine SPE 84433 A Mc. Kay

SPE 84433 A Mc. Kay H Number of Cars (Mlns) 10 9 8 7 6 5 4 3 2 1 0 ys ge le yu ot r nd /C itr ai oe A ut om n ot iv e N is sa n H on da R en au lt on ag rd hr lie r. C eu A /P PS am D lk sw Vo Fo s or ta yo To ot al M er en G Annual Car Sales By Top Ten Manufacturers (Does not include Trucks or buses etc)

Alternative Fuel Vehicle Penetration in USA Growing Strongly, but only 0. 6 mln out of 205 mln vehicles Number of Cars (Mlns) 0. 6 Electricity (incl Hybrids) 0. 5 0. 4 Ethanol (85%/Gasoline 15%) 0. 3 Compressed Natural Gas 0. 2 Liquified Petroleum Gas 0. 1 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 SPE 84433 A Mc. Kay Ref : USA Dept of Energy

EP Technology S Curve Evolution GAINS CONTINUE ? Business Benefits ? Intelligent Wells Underbalanced Drilling Offshore Coiled Tubing Multilateral Drilling Multi-fracced Wells Multilateral Wells Horizontal Wells Slim Hole Exploration Hydraulic Fracturing CREAMING OCCURS ? [Capital Intensity rises] Horizontal Wells with Hydraulic Fracturing Vertical & Deviated Wells Time SPE 84433 1970 1980 1990 2000 2010