21 May 2007

Pollyanna Dunderdale, part I: offshore exploration license trends

Newfoundland and Labrador's energy minister Kathy Dunderdale claims that the offering of a mere five parcels of offshore real estate in the 2007 call for exploration bids a sign of renewed interest in the province's offshore oil and gas prospects.

Specifically, she focuses on the interest in Labrador:
"This year’s Call for Bids focuses on offshore Labrador, which, up to this point has been relatively unexplored compared to other areas of our offshore. Industry obviously has confidence in the prospectivity of these parcels and this puts us on a path of having additional discoveries in this region."
In an election year and in polling season (Corporate Research Associates is in the field right now) any government would have an interest in puffing up good news or trying to create good news where a more sober analysis might lead one to something other than a pollyanna-ish conclusion.

If we take a very simple look at the overall picture, this year's call for bids is nothing to crow about. There are only five parcels in the current bid. Last year, there were twice as many.

Even with the number of parcels offered last year, the experience in 2006 is an object lesson on why we should draw conclusions on the number of licenses issued and facts related to that rather than on the number of parcels offered.

Since 1988 when the first parcels were offered, the Canada-Newfoundland and Labrador Offshore Petroleum Board posts parcels for sale based on expressions of interest from likely explorers. There are rules and conditions attached to the holding of an exploration license. There are also costs associated with all of it. As we can see from the chart, the number of parcels offered is no indication of how many parcels will actually turn into licenses.
Last year, for example, NL 06-2 contained three parcels. Even though a company or companies had expressed interest in them, there were no bids received. NL 06-1 and NL 06-2 contained a total of eight parcels, with bids ultimately being received on six. In other words, only half the parcels offered actually attracted bids.

Check the years before that. There have been a whole bunch of years in which the number of parcels bid were a lot lower. If you look just at the past couple of years, you might even believe that things are getting better. The lines go up and up is good.

Well, maybe yes; maybe no. If we look at licenses (bids) as a percentage of parcels offered, we see some interesting numbers. These really clarify the relationships noted in the first chart. Out of the 16 years in which lands have been offered for sale since 1988, bids matched offers in only five cases or 31%. Another five cases fall above the 60% line. The remainder are below 60%.

If we extrapolate that data, we might reasonably project that at least three parcels will be bid at the end of this whole thing sometime in the fall. That would put this year's land sale at the bottom end of the chart. It's hardly encouraging at all. Even if the entire number of parcels in this sale were turned into licenses, we'd still be in the bottom portion of our license experience.Another way to look at offshore would be a look at the money bid. The next chart shows that over the past three years, that even though there is a minor upswing in the number of licenses issued, the dollar value has dropped.

Dollar values are a gauge of costs involved in exploration but they also reflect the level of interest and competition. In a period of high interest and high competition, bids will increase. When interest is waning or there is relatively little overall interest due to costs, bids decrease.

In the early 1990s for example, when oil prices were low and the western economies were in recession, the bids were low. There were even two years in which no lands were offered. No one was interested.

By contrast, if you look at the period after the basic royalty regime was announced, the dollar bids, the number of parcels offered and the number of licenses issued was high across the board. Even with high exploration costs - those things are pretty much fixed - and a relatively low price for oil with equally low forecasts, companies were interested in the local offshore.

That's not a coincidence. These three points are linked. A globally competitive royalty regime produced interest from the investment community. it's also important to note that in the same time frame, the operators on the last major oil field discovered to date also returned to the Newfoundland offshore and began examining how to get a very costly field into production.

When poorly informed commentators talk about fallow field legislation and mention Hebron, they fail to notice crucial facts. Hebron is heavy, sour crude in heavily fragmented structures. It will be expensive to develop - compared to the three other fields - and it will also get a lower price on the market. Oil prices are publicly quoted based on light sweet. Heavy sour sells at prices lower than than that. Heavy sour is also more costly to refine and produces relatively fewer end products for a given amount of crude at the start.

Add that together and you can see why Hebron was considered non-commercial for most of the 25 years since it was discovered. A combination of factors, not the least of which was a stable, competitive royalty regime and the investment returned.

Is the current land sale a sign of great things to come, as suggested by the provincial natural resources minister.

Not really.

It isn't a sign of good or bad times, necessarily.

In part II we'll take a look at the specific parcels offered in this sale.

-srbp-