Chevron Project Offers Glimpse of Oil's Future

RIO DE JANEIRO (WALL STREET JOURNAL via Dow Jones Newswires), October 30, 2008

Chevron Corp. executive Ali Moshiri spent the past seven years scouring the globe for hard-to-get equipment, schmoozing foreign officials and taking billion-dollar risks to fast-track a new oil prospect off the coast of Brazil.

Despite the full-out effort, Mr. Moshiri concedes Chevron's $3 billion Frade (pronounced Frah-jay) project is a mediocre prospect compared with the huge pools of easy-to-get oil the company has tapped in the past. Even if it fulfills its greatest promise, the deep-water oil field will contribute only a trickle to the global river of petroleum. And Frade, whose first well is now being drilled, could still fail to deliver enough oil to make all the effort worthwhile.

But Mr. Moshiri remained dedicated to the project for a simple reason: It's about as good as it gets these days. For oil companies seeking to reverse years of falling production, the consuming and expensive birthing of Frade have become the norm.

Big Western oil companies such as Chevron once had the run of the world's biggest oil fields, known in the industry as elephants. Not anymore. Today, they are locked out of the best prospects by uncooperative governments. "If you're only going after elephants, you'll never hunt," says Mr. Moshiri, sitting in his wood-paneled office in a downtown Houston skyscraper.

What does all the effort buy? Chevron believes it can extract about 270 million barrels out of Frade over the next 18 years. The world guzzles that much every three days.

The global economic slowdown is shrinking demand for crude oil and has caused oil prices to plummet since this summer. Pressure on the global oil industry to find new sources of crude is receding, but the daily struggle of replacing production declines in aging fields is a problem that isn't going away. And cuts to capital budgets to cope with the downturn in prices could hobble the industry's ability to ramp up supply when demand returns. The result could be "a serious supply crunch" in as little as two years, says Paul Horsnell, commodities research head for Barclays Capital.

Companies in oil-rich exporting nations, of course, don't face as bad a squeeze, because they usually get first shot at fields on their home turf. Brazil, for instance, has announced a series of vast offshore discoveries this year, which the government may open to home-grown giant Petroleo Brasileiro SA or a new national oil operator. But in general, even oil superpowers such as Saudi Arabia have fewer giant fields to tap than in the past, making large increases in output costlier and tougher to achieve.

Next month, the Paris-based International Energy Agency is expected to release its first-ever assessment of the condition of the world's 400 largest oil fields. It is expected to conclude that future crude supplies will be far tighter than previously believed.

The five largest Western oil companies produced 3.2% less oil and natural gas last year than they did five years earlier, despite spending billions of dollars a year on the effort. UBS AG, the Swiss financial giant, expects these companies to eke out a 2% annual increase in production through 2011, as years of investment bear fruit. For this, the industry can credit the work of executives such as the 56-year-old Mr. Moshiri. The Iranian-born engineer heads Chevron's exploration effort in Africa and Latin America. His job is to take marginal projects and make them profitable in order to keep production growing.

Publicly traded energy companies are being criticized for not increasing production fast enough. Mr. Moshiri doubts the industry can shift to a higher gear. "Can we do more than what we are doing today? I don't think so. I really don't," he says.

Frade's long road from idea to oil production shows the daunting obstacles oil executives face. Projects are more complex and costly, but oil prices -- a huge factor in returns -- are harder than ever to predict. Oil prices this year have been volatile, rising from $86.99 a barrel in January to $145.29 in July before falling as low as $62.73 on Tuesday. Oil closed at $67.50 on Wednesday.

In this environment, Mr. Moshiri believes his approach for making Frade work could become a template for the future. He vetoed conventional approaches, pushed for solutions to drill fewer wells and recycled nearly derelict equipment in order to save time and money. Still, Frade's budget more than doubled over the past four years.

Mr. Moshiri became involved with developing Frade in October 2001, when he was promoted to lead the Latin American exploration and production unit of the newly merged Chevron and Texaco. He concluded the oil reservoir was still too poorly understood to calculate the risks or the costs. In one of his first moves as Latin America chief, he sent the Frade team back to the drawing board.

Texaco's plan to build a large floating platform was scrapped. It was too expensive, he decided. The economics of Frade were fragile, in part because the oil was heavy -- or viscous -- which produces less gasoline and diesel fuel, and therefore sells for less than light oil found in Louisiana. "This was a project that was challenged from day one," says Mr. Moshiri.

As Chevron struggled with designing a lower-cost development plan, it caught a break. Well data suggested the oil wasn't trapped in a honeycomb of compartments, a situation that could have made it prohibitively expensive to develop.

The Frade team wanted to drill more wells to better understand the oil chamber. Mr. Moshiri put his foot down. The plan was too expensive and time-consuming. He backed a plan to drill fewer, simpler and less-expensive wells.

Many of the project engineers had spent decades in the business and were accustomed to attacking bigger and easier-to-develop fields. An engineer assigned to Frade, who had spent 16 years in Saudi Arabia working with the world's largest oil deposits, wrote that Frade was a "marginally economic asset," in a 2007 Society of Professional Engineers paper.

Mr. Moshiri had to remind the team that the days of cherry picking fields with huge reserves are over. "If we do that, we will create huge problems for our industry and the supply picture," he said.

But coming up with an economic plan to develop Frade was tough. In August 2004, a top official at the Brazilian agency that oversees offshore oil production criticized the company. "There has not been enough done to get it ready," Newton Reis Monteiro, the official, told an industry publication.

To counter that impression, Mr. Moshiri and a team of Chevron engineers and geophysicists flew to Rio de Janeiro for a series of meetings with officials. They presented technical data to impress on them that Chevron was seriously studying Frade, not idling. It worked, and pressure from the Brazilian government abated, according to Mr. Moshiri. Efforts to reach Mr. Monteiro were unsuccessful. A government spokesperson declined to comment.

Chevron's original plan was to drill about half of the planned 19 wells, begin producing oil, then study production data for 18 months before drilling the remaining wells. It was a conservative approach. If the first wells didn't look good, the company could forgo drilling more and cut its losses.

But as Chevron geologists counseled moving slowly, Mr. Moshiri decided in the middle of 2005 to place a big bet on Frade. They would drill all the wells, one after another without a break. It was the oil industry equivalent of going all in with a poker hand. "That is our job, to take risks and push the envelope," he says.

All indications were that costs were about to rise, amid growing demand for oil-field equipment. Mr. Moshiri realized Frade's window of opportunity was closing. Wait too long, and the project economics would fizzle out.

This set off a rush to line up a rig capable of drilling in deep water. The daily rates for rigs -- giant floating machinery that are part ship and part island -- were rising swiftly.

Mike Mileo, the project manager, couldn't find an available rig. So, in November 2005, he cut a deal to create one. The Sedco 706 was a 30-year-old rig designed for an earlier generation of shallower exploration. But it was battle tested. In 1982, it was drilling off Canada's Newfoundland coast in bad weather when a nearby rig was felled in a winter storm, killing all 84 people on board. The Sedco 706 was unscathed.

But it wasn't suited for modern deep-water drilling. It wasn't even being used to drill anymore. It was moored in the North Sea, attached to another rig by a walkway. It was a floating sleeping quarters for oil workers, a marine motel of sorts.

A year earlier, Chevron would have had its choice of rigs sitting idle around the world, but those had been snapped up amid rising prices. Chevron proposed a three-year contract at $315,000 a day if owner Transocean Inc. upgraded Sedco to operate in deeper water. Transocean agreed.

But Mr. Moshiri had a problem. Transocean needed a $345 million commitment within a week. If not, there were other suitors. Mr. Moshiri called his boss in California. "How sure are you about this project?" asked executive vice president George Kirkland. Mr. Moshiri wasn't sure about Frade and dodged his boss's question. "What I am sure about is that we'll keep this rig busy throughout the contract," he recalls saying, if not drilling Frade, then some other Chevron well.

If rig prices dropped and Mr. Moshiri had needlessly locked Chevron into a contract for an expensive piece of equipment, it would be a career black mark. But it was a necessary gamble, he thought. Three days after asking, Chevron's executive committee voted by email and gave Mr. Moshiri the go ahead. After finishing its North Sea contract, the rig was towed to a Singapore shipyard to be readied for Frade, before heading to Brazil.

To get the other critical piece of hardware, Chevron had to recycle another aging piece of equipment. The development plan requires the oil to be carried up to an enormous ship that is moored in place above the wells. But global shipyards were full, and building such a ship would push back oil production by 18 months.

A contractor found two oil tankers that could be reconditioned to do the job. But Exxon Mobil Corp. snatched them up before Chevron could sign a contract.

The contractor located another tanker: the 30-year-old Lu San, which had begun life as the Aristotle S. Onassis, part of the Greek shipping magnate's famed fleet. The ship had seen better days. It didn't even have a working engine. In 2006, it was towed from Singapore to Dubai where a small army of Indian and Pakistani pipe fitters and sand blasters installed an engine, a new steel underbelly and stripped away asbestos.

Mr. Moshiri tapped a supply chain that spanned five continents. The order for "umbilicals" -- pipes to send chemicals and electronic signals to the wells -- was so large the supplier couldn't move the finished 200-ton spool from its factory, even with its heavy equipment. It took three days for the pipe to be guided foot by foot across to the dock where it was wound onto a new spool.

The most likely outcome is that 85,000 barrels a day will flow from Frade at its peak -- less than half of 1% of current U.S. consumption. Chevron must split this with its partners, Petroleo Brasileiro and a Japanese consortium. Its share, 44,000 barrels, isn't even 2% of the company's current production.

In June, two years after Chevron approved the project, the installation of the subsea pumps and valves on the seafloor began. Doing this before drilling wells was not ideal, say Chevron officials, but necessary in this case. Chevron had a brief nine-month contract to use a specialized boat called the Polar Queen for the installation. There are only a handful of vessels capable of this work, and they are booked years in advance.

The Polar Queen arrived from Angola in June and started lowering hundreds of millions of dollars of equipment to the seafloor beneath several thousand feet of Atlantic Ocean water.

Even as work on Frade continues today, questions remain. Despite years of computer modeling, Chevron doesn't know how much oil the rocks contain or the exact location of the reservoir. The first wells drilled will either confirm, or confound, expectations.  

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