A consistent theme of recent earnings calls has been exploration cost cutting. One company after another has touted its reductions. ConocoPhillips even announced that it was exiting deepwater exploration altogether. In parallel with these reductions is an emerging rig glut. Offshore rig utilization has fallen from more than 90% to ~79% in one year’s time, with upwards of 100 new rigs scheduled to join the market in the near term.

This combination has left energy ministers wondering what they should do. The classic approach to international energy development is the production sharing agreement. Governments enter into contracts with international oil companies, pursuant to which the IOCs pay all of the exploration costs, thereby assuming all of the risk. If there is a discovery, the IOC and government then share the resulting production. Such blocks are often allocated to IOCs via auctions. But what is the point of holding a bid round if IOCs have no available funds for new blocks—however prospective they may be?

The last time IOCs cut exploration spending, I visited with the energy ministers of several countries regarding an alternative “do-it-yourself” plan. It caught their attention, but soon fell by the wayside when oil prices recovered and IOCs started drilling again. The essence of my proposal was that developing nations should stop waiting for IOCs and instead, seek to control their own destinies. For example, a country could take advantage of the oversupply of drilling rigs and enter into a multi-well contract for an otherwise inactive rig. Several exploration prospects then might be drilled in rapid succession.

How can a developing nation afford such a program? I discussed multiple options with the oil ministries, including:

  • Equity raise. Just as the larger national oil companies (e.g., those of Brazil and China) have raised capital by selling stock, smaller national oil companies could consolidate their assets and launch IPOs, with the proceeds dedicated to a series of exploration wells.
  • Debt raise. In cases where governments have petroleum revenues from earlier discoveries, some of these revenues could be leveraged to support a bond offering or other credit facility. If enough wells can be drilled, the risk of total loss can be reduced through portfolio economics.
  • Service company participation. When service companies are faced with inactive rigs, it makes them more likely to assume exploration risk. Service companies may be willing to contribute their rigs in exchange for an equity stake in the wells, or alternatively, may self-finance all or part of their costs, hoping to recover from at least one successful well.
  • Delayed invoicing. In the United States, service companies have been drilling some wells pursuant to “delayed invoicing” contracts, with payment not being due for six months or more. Such an approach enables several wells to be drilled in succession before the first invoices are due to be paid. Assuming at least one well is a discovery, the government could use the discovery to raise capital and pay the delayed invoices.

For nations with exploration prospect inventory, now is the optimal time to aggressively drill. Rig costs are declining, and the development of any resulting discoveries also will be less expensive. Since it takes a few years to achieve first production, oil prices may be higher by then. Nations with emerging projects may be able to sell reserves to IOCs eager to rebuild their inventories after years of retrenchment. What better outcome than to benefit from both today’s low cost environment and tomorrow’s (likely) higher revenues.

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About the Gaille Energy Blog. The Gaille Energy Blog discusses innovative proposals in the field of energy law, with a new issue being posted each Friday at http://www.gaillelaw.com. Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).