WoodMac: $70 Is the New $30

Wood Mackenzie says higher oil prices are offsetting the greater challenges faced by companies who explore for oil and gas - but only just. In analysis recently completed as part of Wood Mackenzie's Exploration Service, the average return on exploration for conventional hydrocarbons in the past three years was just under 15% - assuming that oil prices remain at US$70 per barrel in real terms.

A similar analysis completed by Wood Mackenzie in 2005 showed that this level of return could be achieved with an oil price assumption of US$30 per barrel in real terms.

Andrew Latham, Vice President of Exploration Service for Wood Mackenzie explains: "We have seen a fundamental shift in the economics of wildcat exploration in the last two years. There are a number of factors which are reducing full cycle returns from exploration - some have already had an effect on explorers, whilst the full impact of others has not yet shown up in economic returns."

Latham continues: "The most significant impact on returns in the last three years has been the increase in the expected cost of developing new discoveries - particularly in the offshore sector. Rising global demand has driven drilling, subsea and production facilities costs steeply upwards. A number of high profile re-forecasts of development costs in recent years have thrown this into sharp relief."

"The impact of government policy is a much bigger issue when looking at the exploration opportunities of the near future. The cost of new acreage in prospective basins has been pushed up by the increased use of public bidding rounds. These auctions reduce the exploration investors’ potential returns, for those willing to bid aggressively, and limits the ability to operate for the rest," Latham continues. "With many of the most petroleum rich parts of the world effectively off-limits to international oil companies, accepting moderate returns at high oil prices may be the only way for companies to continue to be active in conventional exploration for hydrocarbons."

Wood Mackenzie warns that the costs of exploration itself have also increased - the amount spent per well drilled has risen by 60% since 2004. Wood Mackenzie believes this trend is likely to continue in the next two years, further diluting returns, as the number of wells drilled by rigs on older and cheaper charters reduces.

As well as costs, the economic rent taken by host governments also has a major impact on the returns which can be expected by investors in exploration. Latham concludes: "Many of the well-publicized changes in contract terms and governmental attitude to the oil and gas industry have not significantly impacted explorers’ revenues - yet. The majority of recent exploration is based around licenses which were negotiated in the 1990s, with fiscal terms more favorable than could be negotiated today."