As oil firms slash billions of dollars of investment to survive the market crash, France’s Total (TOTF.PA) and Italy’s Eni (ENI.MI) are making some of the smallest cuts, gambling in the hope of big-ticket discoveries that will reward them when prices recover.
Both approaches carry risks. Intensive exploration programs mean higher costs and lower profits in the short term, with no guarantee of finding new fields. But firms that scale back too far may damage future growth prospects, forcing them to splash out on acquisitions.
Wood Mackenzie analysts expect this year’s exploration spending to fall to just half of a peak of $95 billion reached in 2014. Against that background, Total’s 21 percent cut is among the smallest.
The French company, which pursued a “high risk-high reward” strategy under late chief executive Christophe de Margerie, will still spend $1.5 billion on exploration this year, including off Myanmar, Argentina and Nigeria.
“Our new exploration manager will be able to explore most of the prospects he wanted to,” Total Chief Financial Officer, Patrick de la Chevardiere, told journalists last month.
“We’re giving him a certain budget which leaves him sufficient flexibility to explore what he wants to explore.”
Eni has not published separate exploration budget numbers for 2016 but said it will keep seeking new resources in mature areas where it can use existing infrastructure and know-how to lower costs.
The Italian group became the first big oil firm last year to cut its dividend in order to navigate the market downturn.
Its bet on finding new resources was boosted last year when it made the bumper Zohr gas discovery offshore Egypt, the biggest ever in the Mediterranean and its fifth large oil and gas find in just three years, giving it the best track record in reserve replacement among majors.
With oil prices down around 70 percent since mid-2014, the temptation to cuts exploration costs is strong. But the nature of the energy business means companies must constantly add new resources as producing assets gradually run out of oil and gas.
“In a downturn, exploration is about securing access to opportunities and high quality acreage at very low cost,” said Stephane Foucaud, managing director of institutional research at advisory firm First Energy.
Those with tighter pockets will have to rely on adding new resources through acquisitions further down the line, a more expensive option.
“Many (oil majors) consider that buying smaller companies would now be an investment with a higher return than if the majors were doing the frontier exploration themselves,” said Eric Oudenot, a partner specializing in oil and gas at The Boston Consulting Group.
Europe’s biggest oil major, Shell (RDSa.L), has led the way through its $53 billion acquisition of BG Group, a gas producer with exposure to attractive deepwater licenses offshore Brazil that will help increase Shell’s proven reserves by 25 percent.
Its own investment cuts have already made an impact on the business. Its reserve replacement ratio (RRR), a metric used to reflect new reserves added relative to the amount produced, was negative in 2015 for the first time in around 12 years. By comparison, Eni’s RRR was 148 percent in 2015, not including the impact of the Zohr discovery.
“While we’re not entirely comfortable with a negative number, it’s not the most important thing today,” Shell Chief Financial Officer Simon Henry told reporters last month.
British oil major BP (BP.L) saw its RRR fall to 61 percent last year, from 63 percent in 2014 and 129 percent in 2013. It said the weaker ratio was a direct result of the low number of final investment decisions and reduced activity in the United States.
BP is one of the companies which has severely slashed its exploration spend. Its budget has shrunk to around $1 billion from $2.4 billion spent in 2015, a fall of nearly 60 percent.
The oil major was badly burnt last year by around $3 billion in upstream write-offs, many due to unsuccessful exploration campaigns.
“(Exploration is) the one thing I think that we can phase, and we’ll just be very cautious and careful around that,” said BP Chief Executive Bob Dudley on the company’s full-year earnings call in early February.
Norwegian oil major Statoil (STL.OL), which has slashed exploration spending by around 31 percent to $2 billion this year, said it was already on the lookout for acquisitions to build its exploration portfolio.
“We are quite active now in building a new global exploration portfolio and there is no doubt now is a good time to do it,” Chief Executive Eldar Saetre told Reuters last month.
Wood Mackenzie analysts say low exploration levels will feed through to lower production in 10 to 15 years’ time.
“Exploration is the easiest cost to reduce for a management team,” said BCG’s Oudenot. “It only bites you back a few years later.”