Petroleum economics: investment analysis and corporate behaviour

A. Cost performance on the Norwegian continental shelf An unprecedented boom for more than ten years has resulted in a sharp cost increase in the oil industry, in Norway and in other extraction countries. Combined with a drastic drop in oil prices, the oil industry and the extraction countries have faced major economic challenges. This has given more attention to the cost side. It will not take much effort to find examples of projects with extensive cost overruns. What are the factors behind cost overruns? Based on media coverage, one might get the impression that the oil and gas sector in Norway suffers from inability and competence to plan and carry out projects according to budgeted costs. Is this reputation well deserved? Does the Norwegian oil industry perform worse than other extraction countries or other industries? We have conducted an empirical analysis of Norwegian development projects. The average cost overrun in the aggregated data set (1970-2013) is 36%. The overruns have fallen in recent years. They are 25% in the last ten years of the data set, which is a good performance considering the strong business cycle. As of today, in a downturn, we see some projects under budget. Comparing with cost overruns in other extraction countries, Norwegian development projects have good cost control. The overruns on the Norwegian continental shelf also do not differ from global surveys overruns in transport and electricity infrastructure projects. The analysis indicates that cost overruns tend to be reduced as experience accumulates. This means that we see the largest overruns in operating companies that are new in Norway and for projects in new areas. This improves as experience accumulates. Our research indicate that cost will increase now when activity picks up again. Cost growth will be dampened by idle capacity in several parts of the supplier market and by long term supply contracts entered at low rates. B. Capital rationing in oil companies and tax competition We have analysed capital rationing in the petroleum sector, i.e., the fact that oil companies limit or cut their investment budgets. The definition is that a company rations capital when profitable projects, measured at the company's cost of capital, are not sanctioned. An equivalent formulation is that the oil company sets a required break-even price (BEP) that is lower than its expected oil price. Oil companies are required to report their future price assumptions in their annual account. Combined with their statements on BEP requirements, we get an indication of capital rationing at the company level. BP indicates in their annual report a long-term oil price level of USD 75/bbl, and has communicated a BEP requirement of USD 35-40/bbl. AkerBP announced in 2016 that new projects must satisfy a BEP of USD 35 per barrel (/bbl). In Statoil's annual report we learn that it expects a long-term oil price in the range USD 75-80 per barrel. By 2016 the company had cut its investment by 50%. On its Capital Market Day in June 2015, Statoil made particular mention of the need for projects to have a positive NPV at USD 50 per barrel, and reported this year that it has lowered the break-even price for five projects starting up in the next five years to an average of USD 27/bbl. ENI reports a USD 7 billion divestment target in the period 2016 to 2019 and has cut the breakeven oil price to USD 27. Chevron has cut investments by USD 5 billion since 2014 and is planning to make even deeper cuts. The priority is to cover its dividend payments from free cash flow and to keep down the debt rate. We examine capital allocation in multinational oil companies by applying model fields in the USA, the UK and Norway, and analyse how capital rationing by international oil companies is affected by the various tax systems. When capital is scarce resource countries compete to attract investments. We have seen dramatic tax reductions in the UK and at the same time a tax increase in Norway. On the basis of our analysis, one might question the competitiveness of the Norwegian fiscal regime that has an effective tax rate almost twice as high as in the UK. Norwegian fields that are profitable to society do not receive investments fund from oil companies in our portfolio analysis. This is in accordance with reality. We see that large oil companies leave or divest at the Norwegian continental shelf and increase their investment in the UK. Norwegian Ministry of Finance need to revise their tax models that do not account for tax competition.

Gjort grundige undersøkelser om kostnadsstruktur og investeringsvalg i norsk petroleumssektor. Etablert årsaker til overskridelser. Kartlagt kriterier og indikatorer for oljeselskapenes investeringsvalg og diskutert hvordan Norge kommer ut. Hatt tett kontakt med næring og forvaltning under hele forskningsprosessen samt vært aktive på å formidle resultatene.

The project will address current issues in the petroleum industry, drawing on theories and empirical methods of economics, finance, and management. We will provide input to topical strategic issues in the petroleum industry and resource administration, bu t also to detailed decisions pertaining to regulation, taxation, and investment decisions. Close contact and co-authorships with employees in the petroleum sector and in government, secure that the research addresses real issues facing the industry and th at the data is of high quality. Much emphasis will be put on publications in high ranked journals, seminars and bringing research results out in media. The main topics of the project are as follows. In the first part of the project we estimate fluctuati ons in overall investments on the Norwegian continental shelf. A common cause of cost overruns is underestimation of cost increases directly related to the business cycle. Improvement estimation of aggregate investment would improve planning and investm ent decisions in the companies and in Government. Our research will provide essential input to macro models. At the same time, analyses of cost overruns may highlight crucial factors for cost control. Corporate behaviour, taxation, investment decisions a nd risk management are the topics of the second part of our project. Corporate behaviour may differ between different types of companies. Increased diversity of companies raises new issues. We will undertake comparative analyses between Norway and the UK of taxes and corresponding investment behaviour.