speech

Navigating the Investment Challenge

By Peter J. Robertson, Vice Chairman
Chevron Corporation

Keynote Address

London, England, Sept. 19, 2006

Thank you, Herman [Franssen]. And in response to your positive comments about Chevron's thought provoking ads, may I commend you all to visit willyoujoinus.com – we look forward to hearing your views.

And thank you to Minister Ghanem for that excellent presentation, which provided a good framework for the discussions that we'll have today.

It's a pleasure to be here this morning. Thanks to the organizers, the Oil and Money conference is an outstanding forum to compare notes and share thoughts on issues all of us are dealing with.

And, as we all know, there is no shortage of issues in our industry today. In fact, energy itself – finding it, producing it, transporting it and using it – is one of the most critical issues facing the global community.

That reality is reflected in the headlines we see every day. It's reflected in the volatility of prices. And it's reflected in the joint statement of the G8 this year on energy security, which emphasized diversification, efficiency and investment.

It is the last point – investment – that I would like to focus on this morning — the scale and scope of the investment challenge that we face, some suggestions on how to navigate the investment challenge, and how this relates to the question of so-called "cheap" oil.

The fundamental driver of the current investment cycle, clearly, is the growth in global demand for energy.

The Energy Information Administration (EIA) estimates that between 2003 and 2030, the world will increase its use of energy by 71 percent. Growth in energy demand will be particularly strong in the developing world – including several billion people whose rightful first step out of poverty is access to basic energy supplies.

The industry's response to this demand has been to increase investment in new supplies – which we are doing at record levels across the entire energy value chain. We've been through investment cycles before. We saw three major investment phases in the 20th century. But there are several factors that differentiate today's investment cycle from those of the past.

The first difference is the sheer scale of investment. The EIA estimates that through 2030, investments in oil and gas will require $6 trillion to meet demand projections. Oil investment is forecast at $3 trillion, with two-thirds going into non-OECD countries. Investment in gas production will also require about $3 trillion.

If you add investment across the entire energy spectrum, including power generation and distribution, the investment target is nearly $17 trillion by 2030. Clearly, we haven't dealt with investment on this scale before.

Another characteristic of the current investment phase that's different from the past is its complexity.

A significant portion of new investment is going toward large, complex projects such as extra-heavy oil and the deep water, which take years to bring onstream and involve multiple networks of partners, sometimes with different objectives. These projects have enormous fixed costs, long lead times and extended recovery periods for capital investment. They require sophisticated, disciplined and far-sighted management.

A topical example of this complexity is Chevron's recent announcement of test results at Jack, a project we're leading in the U.S. Gulf of Mexico with our partners, Devon Energy and Statoil. The Jack well test was the result of several years of active exploration. It required major investments in seismic imaging and drilling technologies to navigate the salt overlay and tight rock formations that characterize the lower tertiary formation in that region of the Gulf. The well test alone represents an investment of more than $100 million.

It will take about another year to fully assess potential flows from the well, and another 3 to 5 years after that to build it out and produce first oil. Estimates are that the lower tertiary may contain anywhere from 3 billion to 15 billion barrels of recoverable oil (equivalent).

This type of complexity is what we mean when we talk about the end of "easy" oil. But it's also ushering in a new and rewarding frontier for our most advanced technology and exploration methods.

Another point of distinction in the current investment cycle is the range of risk that we face – geologic risk, geopolitical risk, price risk and contract risk, just to name some. But the history of our industry is one of identifying, managing and overcoming risks. It is what we do. And despite all of the hurdles we face today, the global energy industry is stepping up to the investment challenge.

New investment by the five major international oil companies alone totaled approximately $70 billion in 2005, an increase of nearly 20 percent over the previous year. Double-digit increases in capital and exploratory spending in 2006 and 2007 seem likely if current trends hold.

Investment on a similar scale is also being made by some of the national oil companies – notably Saudi Aramco and Petrobras.

Even with this historic level of capital spending, it's probably fair to ask the question: Are we investing enough?

Many argue that investment should be more aggressive – projections of demand growth justify it and current cash flow in the industry certainly makes it possible. But we also have to take into account the realities of constraints in investment today, which are significant.

One is the rising cost of almost every investment input. Rig rates, for instance, have soared in the past 18 months, compounded by last year's hurricanes. Rates in the Gulf of Mexico have more than doubled since last year. Jack-ups in the North Sea are commanding fees of $300,000 a day. Rates for deepwater, high-end drillships are expected to edge up to $500,000 a day for 2008 and 2009 contracts.

The price of raw materials is also emerging as a bottleneck to investment. Spot prices for steel and iron have nearly quadrupled since 2003. Copper prices have increased about 500 percent since 2002. Nickel has nearly doubled in price over the last year.

While we don't buy these commodities on the spot market, these trends play out as increased costs for a broad range of fabricated steel structures, valves, compressors, pumps, OCGT and other items. Coupled with reduced numbers of contractors and high demand for shop space and engineering resources, the cost of these goods has increased as much as 200 percent over the last few years.

Another constraint – discussed a lot here and just as challenging – is the availability of skilled people. After reaching a peak of 11,000 in 1983, the number of petroleum engineering graduates in the United States hit a low of 1,300 in 1997 – rising slowly to 2,400 today. This is hardly surprising in the wake of 120,000 positions eliminated by the 25 largest private oil and gas companies worldwide since 1999.

Add to this fact that thousands of the industry's most experienced engineers are planning to retire over the next decade, and we are clearly facing a labor deficit that will be an investment bottleneck – just when we're reaching the most intensive phase of the investment cycle – for some time to come.

Lastly, investment decisions are clearly impacted by access – or lack of access – to new production opportunities. Successful development of energy thrives best in an environment where multiple players apply a broad range of financial, technical and management resources.

It's no coincidence that the U.S. Gulf of Mexico, one of the few offshore areas in the United States open to robust exploration and production, continues to be a prolific source of oil and gas. It is a function of hundreds of oil and gas companies from all over the world, working in a variety of partnerships – and competing with one another – to develop the region to its full potential.

I think it's clear that when we look at the energy landscape, our industry faces a paradox – we're generating strong revenues and cash flow tied to the price of crude, but we also face a variety of challenges to sustaining that performance.

So I'll conclude my remarks by offering a few ideas about how to navigate those challenges and take better advantage of the opportunities in front of us.

First – given the growing demand for energy from the global economy, our industry needs to take a portfolio approach to investment and look for sound investment opportunities across the entire energy spectrum. The fact is that we need to make investments for the near term, the medium term, and the long term. The challenge is to do them all, but to weight them and prioritize them in a way that will deliver predictable, economic returns – and reliable flows of energy.

At Chevron, for example, we continue to make significant investments in our base business. That ranges from maintenance of existing infrastructure, to exploration and production, and enhanced recovery techniques such as the steamflood technology we developed in California and are currently sharing with our Saudi partners.

We're also broadening our portfolio with growing investments in unconventional hydrocarbons such as extra-heavy oil in Venezuela, oil sands in Western Canada, and gas-to-liquids in Nigeria and Qatar.

And in a world that needs every molecule of energy we can develop, we also see a business model emerging for reasonable investments in alternative energy. Chevron has put a strategic emphasis on investing in second-generation biofuels based on cellulosic conversion technology.

For example, we're funding a portfolio of research partnerships aimed at developing indigenous feedstocks into fuel products. The Georgia Institute of Technology is focusing on conversion of local forest products in the Southern United States, and the University of California at Davis is exploring the use of high-end agricultural waste as a resource.

We're also investing in a large-scale facility in Texas that will produce biodiesel from soybeans when it comes onstream early next year.

It's clear that oil, gas and coal will continue to anchor the global energy portfolio for decades to come. But new energy sources – as well as focused technology leading to higher levels of energy efficiency – can make a material contribution to long-term supplies. In fact, Chevron has a wholly owned operating company dedicated to selling efficiency. This is a profitable business in itself.

Another requirement for sustained and successful investment is predictability, based on contract sanctity and increased transparency. This is an important and topical subject to itself, but I'll make just a couple of points.

In the current price environment there is a natural and rightful inclination on the part of governments and resource-holders to maximize the returns on production. But there is clearly a tipping point where those policies can be counterproductive.

The International Energy Agency (IEA) captured this issue in classic understatement: "Governments must strike a balance between short- and long-term objectives," it said in a recent report. "Once investment has occurred, the host government may be inclined to raise taxes and royalty rates to increase revenues quickly, but at the risk of discouraging further investment."

We believe this concept of balance is extremely important. Sudden shifts in contract terms should be carefully considered in the light of increased costs, more sophisticated technology and the inevitability of a cyclical downturn in prices at some point in the future. Stable, predictable and reasonable terms are needed to ensure that investments continue to flow.

Another way to increase predictability in the marketplace is through the support of multilateral organizations that create a robust environment for global trade.

As an industry, we need to demand political leadership that promotes inclusive commercial frameworks – and level playing fields – to stimulate trade and investment.

That includes expanding the WTO to welcome global players such as Russia. Enhancing the global network of trade and investment will be one of the most important drivers of stability in the marketplace.

The final point on how we can effectively navigate the investment challenge is probably obvious. It's people – how we employ them, how we serve them and where the benefits of energy flow.

We need smart, skilled people to deploy investments effectively. That means more investment in training and development. It means more partnerships with universities. It means building workforces that are truly global.

In some respects, it means nurturing a new kind of skill set in the industry, particularly people with hybrid skills – half earth scientist or engineer and half information technologist, for example. People who can function in the interface and see the future.

The people equation also means that all of us – the industry, governments, communities – must be committed to extending the economic benefits of energy production to all levels of society.

Energy is more than mobility, light and heat. It's a fundamental driver of economic growth and opportunity for the globe.

It can do so directly, through the creation of jobs in the industry – and indirectly, through the investment of energy revenues in education, economic development and other forms of social capital.

The more that our industry and all other stakeholders work together to create broader prosperity and stability in the communities where we operate, the more secure we will become as long-term, profitable enterprises – and the more secure the global energy supply will be.

We'll spend the rest of this morning talking about a subject tied directly to investment – the price of oil, and whether, in fact, we've seen the end of cheap oil. If cheap oil is defined as the low price plateau that dominated most of the 20th century, the answer, I think, is obvious.

But whether we've seen the end of cheap oil is probably not the right question to ask. The more relevant question might be – what is the fair price of oil?

What is the price of oil that will allow sustained investment over the longterm? What is the price of oil that won't create material demand destruction? What is the price of oil that will continue to generate global economic growth?

The marketplace will ultimately determine that price.

But every one of us here today must play a role in helping to ensure that the marketplace works efficiently, predictably and inclusively. That is the best framework for getting at the fair price of any commodity.

I look forward to a stimulating discussion this morning.

Thank you.

Updated: September 2006