Mike Weill '80: Managing Risk in the Oil Industry
Mike Weill grew up in an “Esso” home with a chemistry-major father who spent a career in the downstream (refining) end of the oil and gas industry. When he graduated from Cornell with a degree in chemical engineering and went to work for Shell in the upstream (exploration and production) sector, there were plenty of family discussions about how many “strikes” he had against him. The upstream presented a different, less conventional and unknown career path at the time.
Weill has had the opportunity to guest lecture on fossil fuels at the School for the last couple of years. On one visit, Andrew Hunter posed the question “Can you imagine what would happen if fossil fuels went away tomorrow?”
Weill thought about that for a minute. His response, “We take for granted that we can drive down to the local gas station and fill up, heat our homes with natural gas or heating oil, and when we flick the light switch, the lights come on. We love to complain about the price of gasoline, but the general public has very little understanding about where it all comes from.”
Since Weill graduated in 1980, there have been remarkable changes in the upstream industry. During his years as a student he experienced the Arab embargo of 1973 followed by the Iranian revolution in 1979. These events had a dramatic impact on oil prices and caused the first wave of alternative fuel thinking. Less known outside the industry was the impact of the mid-1970’s nationalization of private oil companies in Saudi Arabia, Iran, Iraq, and Venezuela. The impact of these events was to cut the life blood, oil reserves, of all the major oil companies at the time. There was still plenty of oil to refine, but the source of earnings for most large oil companies had been taken away overnight.
As Weill sees it, the upstream oil and gas business is fundamentally about managing risk. Broadly, these risks are reserve, technical, and political. Reserve risk is about whether there are hydrocarbons in the ground at all and, if so, can they be extracted commercially. Technical risk is about producing those hydrocarbons and the environment in which they are produced (for instance, the deepwater or arctic environments vs. onshore). Fiscal risk can range from countries changing their tax regime to the nationalization of oil companies. According to Weill, oil companies try to avoid managing all of these risks at the same time.
Weill uses deepwater exploration, which involves the merging of ideas and technology, to illustrate what he means by managing risks. In order to find oil in the ground you need to satisfy three basic assumptions: that hydrocarbons exist in that location at all, that the geology allows a mechanism to trap the oil (otherwise it leaks to the surface), and that the hydrocarbons are trapped where they can be produced (i.e., there is porosity and/or permeability). This is an idea game, he says. A geologist will generate an idea about why there should be hydrocarbons in a given location and will test the idea by drilling a well. If they find something, they will drill everything that resembles that idea until it no longer works and then they must come up with another idea. In deepwater exploration, the drilling rig used to test this idea will cost a million dollars a day and the well will cost north of $100 million. At best, Weill says, a well has a one in three chance of finding something and at worst a one in 10 chance.
Of course, all of this exploration is supported by technology, which in this case involves seismic imaging, bouncing sound waves into the earth to determine the shape of structures miles below the earth. In 1980, the industry used 2D seismic data that could reveal only relatively shallow intervals. Today, the standard is 3D data using 500’ vessels streaming multiple 10km cables to image complex structures to 30,000 feet or more below the surface.
Once oil is discovered, it must be produced. The figure below shows how quickly the industry moved from using fixed structures in less than 1000 feet of water to drilling in 10,000 feet and producing from almost that depth. According to Weill, a “moon shot” analogy is helpful when discussing what is required to extract oil from deepwater sources. Think for a moment, he says, about a platform at the surface that floats, must provide sufficient buoyancy to support a small refining facility, multiple wells, and oil and gas export pipelines to the sea floor more than a mile away. The pipelines must be designed to withstand external pressures of 4,000 psi and temperatures below 32 degrees in an environment that workers cannot reach. The platform also must be able to survive a 1000-year hurricane. And, Weill adds, there are inherent risks to such an operation as the whole world witnessed with the Macondo blowout.
According to Weill, offshore drilling involves reserve and technical risk. Move the facility to West Africa, he says, and suddenly political risk has been added to the equation.
The last 30 years have seen dramatic changes in the upstream sector of the industry. Fortunately, when the nationalizations of the 1970s occurred, a couple of events offset those losses, specifically the discovery of oil at Prudhoe Bay in Alaska and the discoveries in the North Sea.
The other major change was that natural gas became an economic commodity. Previously, natural gas, or “town” gas, had long been used to meet local energy requirements, but much of it was “stranded,” uneconomic to move to market. Outside the United States, says Weill, we saw the development of pipeline infrastructure to move the gas to market, and a new technology, liquified natural gas, where gas was cooled to a liquid and moved to market on a ship. These changes allowed the industry to diversify and move into different areas to survive.
In the mid-1980s Saudi Arabia, the largest (and swing) producer in OPEC, realized it was losing market share at a dramatic pace. It chose to flood the market and prices plunged precipitously. This caused a severe pull back in the industry, and many properties were sold. There were always “independent” oil companies, small producers with limited geographies, but the large wave of sales by the major oil companies caused a whole class of companies to emerge, such as Apache, Anadarko, Devon, and Chesapeake Energy. In the 1990s, the industry moved into deepwater. Basins in the Gulf of Mexico, West Africa, Brazil, and the Far East opened up. In the first decade of the new century, the onshore United States, long thought to be in decline, became the home of a new resource, unconventional gas, and then oil. With names like the Barnett, Haynesville, Eagle Ford, Marcellus, and Bakken, completely new sources of hydrocarbons have been commercialized, and the cycle begins anew. While most consumers have focused on the price of oil at the gas pump, says Weill, the industry has gone through several cycles of reinvention, always with technology at its core.