Total strikes

Pubished on Energy Post, (7-9-2017)

After a period of cautious investments and a focus on bringing down costs Total surprised the markets last month with its takeover of Danish Maersk Oil and Gas (MOG) for a sum of $ 7.5 billion. The deal will give Total additional production of approximately 160,000 boe per day.

MOG’s reserves are pre-dominantly located in the North Sea and are predominantly oil. Total thus choose not to invest in shale (where many US companies are directing a lot of their investments) and not in gas (touted by many companies as the transition fuel towards a low carbon world).

Whereas BP and Shell are selling North Sea assets, Total is increasing its focus on the North Sea. After the Maersk transaction is completed it will pass Shell to become the second largest North Sea producer (after Norway’s Statoil).

What kind of company was Maersk Oil and Gas (MOG)? Why did the Maersk group decide to sell after more than 50 years of profitable activity in oil and gas? And why did Total buy?

MOG: high profits from fracking chalk

The heartland of MOG is the Danish offshore chalk play that includes the giant Dan and Halfdan fields (together these 2 fields have produced over 1 billion barrels). These fields are characterised by a relatively tight, low permeability, reservoir. MOG’s great achievement and core technical competency was to develop these fields (and get relatively high recovery factors) by drilling horizontal wells and fracking them (long before this technique took off in earnest in US shale).

Maersk being such a dominant company in Denmark and the good relationship between Maersk and the Danish state have helped MOG. In 1962 the entire prospective part of the Danish offshore was granted to Maersk in a single license for 50 years. In 2002 (10 years before the license expired) the license for the core area was extended to 2042. The 2002 agreement turned out very well for Maersk as the Danish state signed a new contract that gave them relatively little exposure to a post-2002 rise in oil prices. Earlier this year tax adjustments enabled MOG to go ahead with the overhaul of the Tyra platform (now so rapidly subsiding that operations would need to be stopped around 2020 which would effectively mean the end of Danish gas production).

MOG’s other pillar was the Al Shaheen field, Qatar’s biggest oil field. Its geology is similar to Maersk’s Danish assets. MOG managed to secure the Al Shaheen contract in 1992 on relatively good conditions (other companies shying away from its challenging geology). Over the next 15 years it managed to crank up production to approximately 240,000 barrels/day. This was a real achievement, helped by MOG’s technical knowledge gained in the Denmark chalk fields.

For a long time, MOG was a very profitable oil company. Around 2010 its return on capital was about 30%; about three times as high as the average for its peer group. A significant part of the expansion of the parent shipping company was paid for by the profits from oil and gas. It was believed that oil and shipping were part of different (out of phase) cycles, thus stabilising profits of the Maersk group.

2005-2015: MOG unable to grow outside of chalk

From 2005 onwards clouds started to gather on the horizon, however. The production of the Danish assets peaked in 2006 and it was clear that the scope for new finds in the chalk play was very limited. For Al Shaheen there was scope for increasing production but the end of the Qatar license in 2017 had become in sight.

MOG’s production and high profitability were based on two assets and a single play only. Hence, from 2005 onwards, the company attempted to transform itself from a niche player into a medium size global company that would be active in many different areas and plays. An attempt that was eventually to fail.

The 2005-2015 period saw a number of relatively unsuccessful attempts to develop assets that in the long term could take over from Denmark and Qatar. A number of ventures, scattered around the world, were set up in the Gulf of Mexico, Angola, Algeria, Brazil, Kazakhstan, Kurdistan and the UK.

Despite an extensive appraisal campaign, the Chissonga discovery in Angola was never developed due to challenging economics. Maersk non-operated assets in the Gulf of Mexico were bought in 2010 at a relatively high price and new discoveries have not been developed due to poor economics. Brazil production disappointed and in 2011 Maersk made a significant $ 1.7 billion write off. Production in other areas remained relatively small. The most material project, the gas condensate Culzean field, is now being developed but profitability may be limited due to the high costs in a HPHT (high pressure, high temperature) North Sea environment and the current low oil and gas prices.

These projects often suffered from a lack of economies of scale (related to a lack of focus), trouble operating outside of MOG’s chalk comfort zone and the difficulty of growing profitably in a high oil price world with corresponding high costs and inflated asset prices. Too much good money was thrown after bad money.

The only highlight of this period was that MOG in 2009 picked up a small part of a Norwegian block that was operated by Swedish explorer Lundin. Lundin subsequently here made the spectacular discovery of what is now known as the 2-3 billion barrel Johan Sverdrup field and MOG owns 8,44 % of it. Based on Lundins market cap (predominantly determined by Johan Sverdrup) this relatively small share is now worth close to $ 2 bn.

2015/2016: Maerk oil and gas at a crossroad: grow or sell?

By 2015 a number of developments coincided creating serious issues for Maersk Oil and Gas:

  • The major drop in oil prices.
  • An accelerating decline of Danish production.
  • Unsuccessfull negotiations with Qatar on the extension of the Al Shaheen contract. Although such contracts are usually extended (it makes sense to let an established operator continue its work) this one turned out to be difficult. Over 2015 it became clear that Qatar had decided to invite offers from other companies.
  • The failure sofar in it attempts to profitably grow outside Denmark and Qatar.

By now a sale of MOG had become a serious option. Nevertheless it was decided to make a last attempt to grow and re-invent the company. It was thought that the 2014 oil price fall provided more attractive opportunities to grow; this time by acquisitions rather than organic growth. Reduced asset prices and the financial strength of the Maersk parent group should make this possible.

Late 2015 MOG acquired Energy Africa’s Kenyan assets (Tullow operated) for up to $ 800 million. Maersk at this time considered taking over a sizeable part (at a potential cost of $ 2 billion) of Shell’s UK North Sea assets (aiming to become a more dominant North Sea player).

2016: Why did Maersk decide to sell?

Over 2015 and 2016 a number of developments took place that eventually forced the Maersk group to change strategy (only a year after deciding to make a last ditch attempt to stay in the oil and gas business).

In June 2016 it was announced that Total had been selected to operate the Al Shaheen field after July 2017. Total had accepted a relatively small minority 30% share in a newly formed company running Al Shaheen. At the time this was a rather puzzling development: Total was new to the field and not known as a fracking and chalk specialist. It may be that Total at this time was already preparing a Maersk takeover (especially in case its Al Shaheen bid would be successfull). Total may have reckoned that MOG without Al Shaheen would likely be put up for sale.

In the past low oil prices had resulted in a stimulation of the economy and shipping (resulting in higher freight rates as well as low fuel prices). Over 2015 and 2016 the shipping vs oil hedge broke down and a period of simultaneous low oil prices and record low freight rates created a “perfect storm” for the Maersk group. This made MOG’s strategy to grow in a period of low oil and asset prices much more difficult and risky.

Over 2015 and 2016 doubts increased over the attractiveness of the oil and gas business in the longer term. US shale oil has resulted in an additional component of oil supply that is there to stay, resulting in the current period of “lower for longer” prices. Growing concerns on climate change and the resulting support for renewables will limit oil demand growth in the longer term.

As a result of these developments the Maersk group decided in 2016 to change strategy and put MOG up for sale. It also started to prepare for an IPO of MOG should a sale at sufficiently attractive terms turn out not to be feasible.

The MOG of the past, a niche player with a competitive technical edge, with a substantial part of its assets in Denmark, operating in a relatively profitable oil and gas world was a valuable part of the Maersk group.

The picture of the MOG of the future was a different one: a global player without a competitive technical edge, operating in a systematically less profitable environment. Selling to an established larger operator that should be able to get more value out of its existing assets was a logical choice.

Why did Total buy?

If a company has the financial resources and believes in a long term future for oil and gas, this may well be a good time to buy. Eventually the current low investments in oil and gas are likely to re-balance the markets (be it that it will take a lot longer than initially expected).

Total’s decision to buy a company focused on oil and focused on the North Sea rather than a takeover in gas or in US shale may turn out to be an astute one. With a stream of new LNG projects coming online up until 2020 the gas oversupply may last longer than the oil oversupply. For gas the worst is still to come. US shale has sofar failed to deliver profits. None of the majors has been successful with acquisitions here and apparently Total decided it could not do any better.

Statoil’s cost reductions on Johan Sverdrup have brought costs down to approx 25 dollars per barrel. With these low costs it will be a very profitable project in a politically secure area.

For many areas MOG assets are situated close to Total’s assets which will help synergies. Total estimates cost savings due to synergies at $ 400 million per year. The key region here is the Central North Sea where MOG’s Culzean is located in the immediate vicinity of Total’s HPHT Franklin and Elgin developments. Other areas with significant synergies are Angola, East Africa and the Gulf of Mexico. Total’s experience as an operator in Angola implies it is in a better position to get a Chissonga development off the ground. MOG’s Kenyan assets fit in well with Total’s neighbouring Uganda assets. East Africa now has the potential to become a major growth area for Total.

Finally, MOG’s knowledge and excellent technical track record on Qatar should be a real help for Total in increasing Al Shaheen production.

The changing world of oil and gas invokes different reactions. Companies like DONG and Maersk have decided to leave the oil and gas business altogether and other smaller players may follow. None of the majors are anywhere near such a point but they are focusing their new investments on very different areas. Total and BP are focusing on low cost oil (conventional onshore and shallow offshore). ExxonMobil and Chevron are focusing on deepwater and US shale. Shell is betting on gas and deepwater Brazil. The future will tell which of these upstream strategies will turn out to be the most successful one.



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