Vol. 58 No. 9

September 2006

Clarence P. Cazalot Jr., President and CEO, Marathon Oil Corp.

As Chairperson of the 2006 SPE Annual Technical Conference and Exhibition, can you give us some highlights of this year’s event?

One of the areas of focus that has become very important to the industry is unconventional hydrocarbons. That is becoming a dominant theme in the business today and is rejuvenating North America, whether it is Canadian oil sands, which have gone from being considered marginal just a couple of years ago to a very significant opportunity, or all the tight gas and fractured shales. Our company is moving more and more in that direction as well.

Another important topic that certainly will generate a lot of discussion at the conference concerns the issues about people and the technical skills critically needed by this industry, both now and in the long term. There also will be a panel on reserves classification, which has been a high-profile issue as well. And, of course, the focus on technology—what new technologies are needed and the advances that are being made today.

The conference’s opening general session and panel sessions do focus on those critical issues: heavy oil’s part in meeting future demand, reserves classification, and the role of young professionals. Do you think the challenges facing the industry now are greater than they have been in the past?

I believe they are. Some may disagree with me and say that the industry has always faced challenges and that this is not an easy business. But I do believe that today’s challenges are potentially game-changers in terms of how and where we conduct our business. For me, it begins with the high commodity prices we are seeing. High prices certainly spur increased activity and provide economic incentives that are creating both current and future problems. The current problems you can see in the competition for people resources and for new opportunities and assets. They are driving up the very cost of doing business—from wages and salaries to seismic costs to drilling costs to land costs. For the long term, the big question is, “To what extent and how will demand for crude oil, natural gas, and refined products all be impacted by these high prices that have risen so dramatically in such a short period of time?” High prices also have attracted a lot of new competitors into the business, not just publicly traded companies but private equity, and caused the emergence of national oil companies much more rapidly than we otherwise would have seen.

In summary, I believe these challenges—access to resources, people, and rising costs—would have arisen anyway, but they have been exacerbated by the high-price environment. I think these are pretty fundamental challenges for the business that are bigger, and perhaps could have a greater impact, than the challenges that we have faced in the past.

Do you think that there is any short-term solution to the people problem?

There is no silver bullet. We have to work hard as an industry to retain our experienced employees for a longer period of time than has historically been the case. We have built-in benefit systems that really encourage people somewhere between the ages of 50 and 60 to retire. But people of that age are really at the peak of their productive careers, and there is no reason why we cannot and should not retain them or encourage them to stay, keep them challenged, keep them productive, and keep them fully compensated. It may mean changing the way we do work. It may mean someone not working in an office building all day, or having different types of work environments and incentive systems that allow us to retain the current work force longer.

If successful in this, we have really just bought a little more time to fix the real problem. We have to use that time very wisely to expand the pool of technical personnel, primarily engineers and geoscientists, and attract and keep people in the industry. That has to begin in grade school and high school, and that effort has to be global. The idea that the bulk of our technical work force will be from the U.S. and U.K., which is largely what the business is today, has to change. We have to source talent globally. We have to do a better job, particularly in the areas where we operate, of tapping into the local talent pool and building not just local employees but global employees for our corporations for the long term, and also tapping into groups that historically have been under-represented: women and minorities.

National oil companies have become more internationally competitive and governments seem to be limiting private-company access to reserves, especially in places such as South America. Are these real threats to large operating companies such as Marathon?

They are, and it goes back to one of the key challenges the international oil industry is facing—access to resource. You see varying numbers, but anywhere from 80 to 90% of the world’s current proved oil and gas reserves are held by national oil companies and host governments and not necessarily available to us. And if these resources are available, the kinds of economic terms offered are more challenging than in the past. In many cases, national oil companies are competing directly with us and can take advantage of government-to-government relationships. You can see, for example, what is going on today between Russia and China, or India and China. We see it in west Africa, where the Chinese have entered in a very strong way, leveraging their government contacts and relationships. In many cases, there is a national champion; but in the U.S., there is no one national champion. So it is a much more competitive environment than it has been in the past. The service companies can look out a few years and see that their customer base is evolving more toward the national oil companies.

But you have to believe that there is some way we can cooperate. On the one hand, we look for security of supply; the resource holders, on the other hand, are looking for certainty or security of demand. Given those needs, there is a compelling rationale to work together, and that is what we are trying to do. We are having discussions with national oil companies about the fact that they have resources to develop, and we have refineries and retail outlets in key markets, and there ought to be a way for us to work together profitably.

Do you think this is a temporary situation or a permanent change in how national governments and national oil companies operate?

It was an evolving change before prices went up. I think it is just a natural evolution in the development of these countries. They want a national champion, and they want someone on a par with the international oil companies. But high prices have accelerated it. It is not going away; it is a fact of life. The real issue is whether the operators can work together with the national oil companies.

What is your outlook for oil prices?

I can paint different scenarios for you. I have enough gray hair to know that this has been a cyclical business. I do believe that prices will come back down to a more reasonable level—U.S. $40–$50/bbl. That is my expectation. I do not think that $75/bbl crude is sustainable.

Having said that, I can go back to what I said earlier, that as an industry we are having a difficult time accessing new opportunities and the reserves are controlled by national oil companies. Even if we had them, our ability to do all of the drilling and major project development is constrained. So on that basis, if world demand grows to 95, 100, or 105 million BOPD in the next 15 years, I can easily see that the industry is going to have a difficult time increasing supply to those levels that fast. And if supply cannot keep up with demand, what results is high prices.

So I can paint you either scenario. And that makes it difficult to plan. Much of the investment that we are making and that most of the major oil companies are making, is on projects that do not really begin to produce revenue for 4 to 6 years. We find ourselves today in a very high-cost environment, so we are building high costs into these projects without really knowing whether we are going to be producing in a $30/bbl price environment, a $50/bbl price environment, or a $70/bbl price environment. And I can say the same thing about natural gas. If you invested a dollar today and it came on stream tomorrow, that would be different. But we simply do not have that luxury given the long term, complex, and global nature of our industry.

As someone who has held numerous top positions in your career involving geophysics, geology, and production, how would you assess the amount of upstream R&D that is going on today in the industry? Is it adequate to address the industry’s future upstream needs?

It is clearly insufficient, and it has been for some time. The shame of it is that we went from one extreme to the other. In the days when all the major companies had major R&D facilities, there was good work done. But everyone went back and looked at how much was invested, what real breakthroughs came out of it, and what real value was created for our business. Most of the companies came to the conclusion that there really was not a sufficient payout in terms of a sustainable competitive advantage and that much of the real technological breakthroughs were made in the service industry.

Consequently, as we hit the lower-price times, operators moved away from major research facilities and began relying more and more on contractors to do the work. The problem is that the contractors are strained, and when they look at the competitive window and the competitive edge that they get, it is pretty short to pay out all of the sunk investment, not just on the technologies that work, but on the ones that do not. So I believe we have swung too far and that the right answer is somewhere in between.

My philosophy is that we should not be competing on technology and that we should not have every company with its own R&D laboratory doing its own thing. What we need to do is cooperate on developing technology in partnerships that involve the international oil companies, the national oil companies, academia, and governments, and that we should pool our resources, develop the technology, and standardize around it. That would lower costs and shorten lead times. Then we would compete in terms of how effectively and how well we deploy the technology. That said, we are a very competitive industry. There are some groups out there today promoting cooperation on technology, but when everyone sits down, no one really wants to lay their cards on the table because they are afraid that they will have shown their hand. So what ends up emerging as the few areas of consensus are things that are a bit longer-term or far-reaching and less certain.

Our company is focusing on gas commercialization technologies and doing it in partnership with academia and some other private laboratories—gas to liquids and gas to fuels and how we can develop some of the stranded gas around the world and take it directly into a transportation fuel. Some of the other work we are doing is on the drilling and completion side—we have some very talented people doing good work that is value added. But we also need to be able to do some things that we can not do today, and that is where a broader industry partnership would help.

One of the best examples of technology development that I can point to is Deep Star. That was a great example of the industry coming together, including producers and the service companies, and everyone pooling their knowledge. In those days, it was not easy for the industry players to share their riser or some other deepwater technology. But everyone contributed, the vendors standardized around it, and I think that has been a successful model. As I said, once you have developed the technology, then you compete on how well you deploy it.

How optimistic are you that all of these groups can get together and work cooperatively?

I am not optimistic in a broad sense. I think in isolated areas it is happening and will happen. We just looked at the amount of money that all of the key players in this industry are spending on research, and this industry is dwarfed compared with others if you look at R&D spending as a percentage of sales or profits or capital employed. We are not very aggressive, but we need to be.

My view is that all of the parties should come together and decide on the technology areas that would provide the greatest impact, whether it is better seismic imaging in complex overthrust or subsalt areas; whether it is being able to get that additional 3% recovery out of existing fields; whether it is better drilling technology so that we can cut the costs of deep subsalt wells. Absent this kind of cooperative effort, the technology is not going to happen because no one is really out there devoting the resources to making it happen. So are we not better off having it happen and then having it available to us and having the opportunity to apply it?

One area in which Marathon has made significant technological contributions is in drilling and completions. What are the most “game-changing” technologies that Marathon has developed? What upstream advances is Marathon working on now?

I think our casing-conveyed perforator technology that was developed in collaboration with Expro, BJ Services, and Core Laboratories is a good example. A consortium put it together, and it is now deploying it. Another example is the MaraSplit multilevel technology, allowing multiple-well drilling from one location, that we developed jointly with Baker Oil Tools. Those are the kinds of things that we have been focused on that are value-added technologies.

What is the greatest technological need or challenge in drilling today?

There are many, but one that comes to mind immediately is that we could do a better job of pore-pressure detection before drilling. That would certainly help lower the cost of wells. Also, better bit technology and better reliability of downhole tools for high-pressure/high-temperature environments are needed, as well as just having more-automated rigs, which would help in the area of safety.

What significant production does Marathon have coming on line in the next year or two?

Our primary growth in the next 3–4 years is going to be in three areas: Equatorial Guinea, Norway, and Libya.
If you go 5–7 years out, you can add deepwater Angola to that list.