Royal Dutch Shell plc (ADR) (RDS.A), Chevron Corporation (CVX), Exxon Mobil Corporation (XOM): Why Oil Majors Are Betting Billions on This Unattractive Market

Royal Dutch Shell plc (ADR) (NYSE:RDS.A)Peter Voser, the outgoing CEO of Europe’s leading energy major, Royal Dutch Shell plc (ADR) (NYSE:RDS.A), has announced his company’s plans to invest $30 billion in Australia over the next five years. Voser was speaking at the Australian Petroleum Production and Exploration Association conference. However, like other firms operating in the country, Royal Dutch Shell plc (ADR) (NYSE:RDS.A) is also concerned about rising inflation and increasing costs. In such an environment, the chief executive believes that the government must provide “the right regulatory and tax policies to drive innovation and investment.” Otherwise, Australia could lose about $100 billion in potential investment to other, more business-friendly regions.

Most of Shell’s investment is focused on liquefied natural gas (LNG) projects. Royal Dutch Shell plc (ADR) (NYSE:RDS.A) is currently partnering with Chevron Corporation (NYSE:CVX) and Woodside Petroleum in Australian LNG projects. Shell has a 25% stake in Chevron’s massive $53.8 billion Gorgon LNG project and a 24.3% stake in Woodside Petroleum’s North West Shelf floating LNG venture (FLNG). Besides these two projects, Shell’s other upstream Australian LNG ventures are the Prelude FLNG project, Wheatstone, Browse, Sunrise and Arrow Energy.

The massive Gorgon project is now 60% complete. Chevron Corporation (NYSE:CVX) will start engineering and designing works for the expansion by the end of current year. At full capacity, Gorgon will pump 15.6 million tonnes of LNG each year. With the expansion, its annual capacity will increase to 20.8 million tons.

The Prelude floating LNG project in Australia, which will convert natural gas to liquid to be exported to the energy-hungry nations of Asia, is expected to be the first international energy project to use liquefied gas technology. When the project was approved in 2011, Shell gave a cost estimate of between $10.8 billion and $12.6 billion. Its Prelude floating gas rig is currently under construction in a South Korean shipyard.

Meanwhile, Woodside and Royal Dutch Shell plc (ADR) (NYSE:RDS.A), after mulling abandoning the development of the controversial $45 billion onshore LNG plant at James Price Point, have signed an initial agreement to develop the Browse project, which will focus on floating LNG. The reason for the change is that the FLNG-Browse project is much more economical. Woodside has a 31% stake in Browse, while Shell has 27%. According to analysts’ estimates provided by Platts, the FLNG-focused Browse project would cost up to $36 billion, which makes it nearly three times bigger than Prelude.

While Royal Dutch Shell plc (ADR) (NYSE:RDS.A) has taken the lead in developing the world’s first FLNG venture, Exxon Mobil Corporation (NYSE:XOM) is gearing up to develop the world’s biggest FLNG project off Western Australia. According to Australian Environment Department, the company will make a final decision by 2014 or 2015 and the project could start operations between 2020 and 2021. Exxon Mobil Corporation (NYSE:XOM) plans to produce twice as much LNG annually from the venture as compared to Royal Dutch Shell plc (ADR) (NYSE:RDS.A)’s Prelude project. Exxon Mobil Corporation (NYSE:XOM) has not given any cost estimates, therefore, I believe it is safe to assume that the project would cost the company significantly more than $12.6 billion.

There are uncertainties regarding costs of projects, which could be one of the reasons why Exxon Mobil Corporation (NYSE:XOM) is not revealing the cost estimates.

Australia: Costs boom vs. LNG boom

Although Australia is on track to become one of the biggest producers of LNG in the world, currently, it is not an ideal place for oil and gas exploration.

Generally, the cost of developing an LNG projects are 20% to 30% higher in Australia as compared to other countries. According to the estimates of Bureau of Resource and Energy Economics, Chevron Corporation (NYSE:CVX)’s Wheatstone project’s capital costs are around $2.9 billion per million tonnes while a similar project in Southern Africa, the Angola LNG project, has capital costs of less than $1.7 billion per million tonnes.

In fact, the Financial Times has identified that it is the most expensive country when it comes to offshore exploration and production. According to the Business Council of Australia, in remote parts of the region, construction wages are between $120 and $200 per hour, significantly above the U.S. Gulf Coast’s average wage of $68 per hour.

The rising cost is the single biggest concern for energy firms operating in Australia. The region’s oil and gas workforce represents some of the industry’s highest paid workers in the world. A shortage of skilled labor and the strong Australian dollar are the main reasons behind cost blowouts of several LNG projects.

Chevron Corporation (NYSE:CVX)’s Gorgon budget inflated by 41% to $52 billion. Similarly, in Queensland, the BG Group and Santos have also faced cost blowouts in their LNG ventures while Shell is mulling abandoning its Arrow LNG project. Last year, Santos upped the budget for its Goldstone LNG project by 15% to $18.5 billion while BG’s gas export plant in Queensland has seen its cost estimates rise by 36% to $20.4 billion.

Why Invest in Australia?

The current business environment in Australia for offshore oil and gas development is far from attractive.The Australian government needs to take Voser’s suggestions seriously, particularly since they are coming from the head of a firm that is one of the biggest foreign investors in the country. Even locals, such as Woodside Petroleum, are reluctant to give green signal to their ventures. A friendlier regulatory and taxation environment can allay some of the fears of energy firms that are investing billions in Australia.

However, I believe that despite the financial challenges, oil majors such as Shell, Chevron Corporation (NYSE:CVX) and Exxon Mobil Corporation (NYSE:XOM) will continue to invest heavily in Australia because of the overwhelming need to constantly find new reserves to remain competitive for the long term.

These companies are even willing to invest billions of dollars in politically challenging regions. For instance, both Shell and ExxonMobil are some of the leading investors in Iraq, which I have highlighted in a previous article. ExxonMobil is even working closely with the volatile semi-autonomous Kurdistan region in Iraq. Similarly, Chevron is betting billions of dollars on Argentina and its oil producer YPF to gain access to world’s second-largest shale oil basin.

Therefore, Royal Dutch Shell plc (ADR) (NYSE:RDS.A), Chevron Corporation (NYSE:CVX) and Exxon Mobil Corporation (NYSE:XOM) are relatively riskier investments now than they were before as they are willing to take on political and financial challenges to bolster their reserve portfolios.

Benefits outweigh risks

There are also considerable potential rewards here as these riskier investments will improve their reserve-replacement ratios, which will ensure that the companies stay competitive for decades to come. Therefore, the benefits outweigh the risks, especially for Shell, which is one of the leading investors in Australia. The Australia region is considerably less challenging and has abundant natural gas reserves as compared to some developing countries. Moreover, there simply aren’t that many places left to explore and the oil companies have few options but to hunt for oil in politically or environmentally challenging regions of the world.

Royal Dutch Shell plc (ADR) (NYSE:RDS.A), Chevron Corporation (NYSE:CVX) and Exxon Mobil Corporation (NYSE:XOM) are going to move forward with their LNG development, particularly the more flexible FLNG projects. The companies may delay their final investment decisions or abandon some of the onshore projects but through more business friendly policies, the Australian government can offset the problems coming from higher operational costs.

The article Why Oil Majors Are Betting Billions on This Unattractive Market originally appeared on and is written by Sarfaraz Khan.

Sarfaraz Khan has no position in any stocks mentioned. The Motley Fool recommends Chevron. Sarfaraz is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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