Ed Crooks Shell’s outlook for oil production and prices: why $70 per barrel matters

Malcolm Brinded, one of the top executives at Royal Dutch Shell who is hanging on to his job in the shake-up ordered by new chief executive Peter Voser, gave an interesting presentation last week setting out the company’s view of the outlook for the coming decade.

His message: Shell can grow its production out to 2020, but the oil price will need to stay above about $70 to make all of its investments profitable.

His speech, to a Credit Suisse conference in London, was a corrective to some of the gloomier stories about the production outlook that came out following the company’s annual strategy update in March.

Shell is building new production capacity to deliver 1m barrels of oil equivalent and about 4m tonnes per year of LNG.

Mr Brinded put up a map showing some of the areas where Shell sees the most exciting opportunities for the future:

In the company’s version:

He highlighted Shell’s large portfolio of new projects with attractive project economics. LNG growth is continuing with a successful start-up of Sakhalin that, contrary to other start-ups in recent years, had no unplanned downtime in the first month of LNG start-up and is showing very good ramp-up performance. Two new Deepwater projects are nearing completion with BC-10 in Brazil starting up this year and Perdido at the Gulf of Mexico starting up early 2010.

Mr. Brinded then went on to highlight various parts of Shell’s future options that can support upstream growth to 2020, without further exploration success or acquisitions. Shell’s positions in North American Tight Gas and Australian LNG were presented in more detail.

However, his presentation also made clear the need for the oil price over the long term to average at least its present level of about $70 for all of those opportunities to pay off, particularly the Canadian oil sands.

Shell expects oil industry costs to come down, it says:

Mr. Brinded pointed out that he saw some inflationary costs pressures easing in the beginning of 2009 and that Shell is taking the opportunity to get better pricing from service providers and better levels of service. He also referred to the new organisation announced by Shell with a simpler organisation structure with more focussed accountability, creating a better platform for strategic delivery and lower costs

But even so, much of Shell’s production requires an oil price of $50+ for investments to have a positive net present value, and a significant proportion requires an oil price in the region of $70+.

This is the slide Mr Brinded showed that illustrates that point:

The chart is purposefully imprecise, but it looks as though the average oil price needed is about $45-$47 per barrel. However, almost 10 per cent of Shell’s new production seems to need $67+ oil, and a few percentage points of that need more than $72 or so. That top end of the cost curve seems to be the Canadian oil sands, where investment is still very expensive. Costs in Alberta roughly tripled during the 2000s, and although they have fallen, it is only by 10 per cent or so. There is still a long way to go before we are even back at the cost levels of the middle years of the decade, when the projects now under construction were given the green light.

The implication of Mr Brinded’s chart is that if oil seems set to stay below $70 or so for long, some possible future production will not happen. It reinforces Tony Hayward of BP’s point: the equilibrium price of oil is about $75, give or take $15 on either side.