Ryan M. Lance discusses the global energy landscape, as well as the future of energy security and sustainability.
The CEO Speaker Series is one way that CFR seeks to integrate perspectives from the business community into ongoing dialogues on pressing policy issues.
SENDER: It is my pleasure to introduce Ryan Lance to you today as part of the CFR's CEO series. He flew in from a blizzard in Montana this morning. And because this is such an interesting time in the market I will not spend time introducing him, other than to note that he has been CEO since 2012. And there are two reasons why—well, there are many reasons why it's an interesting time in the energy markets, but one of the reasons why this is a particularly timely appearance is because it now looks like the ban on export of crude will be dropped. And many people in the markets have once again revised down their estimates of the price of oil.
So while I was getting ready for this wonderful session I was going through material on the website of ConocoPhillips. And this is my favorite page. And you can't see it, but it doesn't really matter, because it just shows all the possible price paths of oil, which made me believe that I would not want to change jobs with you, even though I am working in a dying industry, which is to stay journalism. (Laughter.) So I thought we would start out by talking about the price of oil. And I thought we would start out by asking, a year and a half ago, no one thought we would be even discussing the possibility of oil at $35. Why did everyone get it so wrong? What did we all miss?
LANCE: Yeah, that's a really good question, Henny. And we spend a lot of time thinking about that as well. As I reflect on the last year, year and a half, I guess I would bucket it into three different areas that kind of have to do a couple with supply and maybe one on the demand side.
On the supply side, I will start by saying that some interesting things happened globally that were geopolitically connected. You had Libya, who recovered remarkably well after Colonel Gadhafi was overthrown. And production came back pretty quickly, but then the whole country disintegrated and we lost probably a million and a half barrels a day of supply. At the same time things were going on in Syria, there was uncertainty in Iraq, how quickly would they ramp back up.
We had the nuclear agreement with Iran—(coughs)—excuse me. And at that time, you know, we thought the supply would probably start to come down, but clearly Saudi had different intentions and they ramped up their production from a little bit under 10 million a day to 12 million barrels a day. So they consumed all of that capacity that was going off the market. And then come about November, September, October of last year, made the decision as OPEC to not curtail production to try to keep the price propped up.
So there's a whole dimension around those geopolitical supply-side things that were pretty hard for anybody's crystal ball to try to figure out how that was going to sort itself out. And then on the demand side, clearly, we've been all watching, and coming out of the recession we saw Europe go pretty flat, we saw efficiency standards and CAFE standards here in the U.S. start to reduce the amount of product the U.S. consumer was consuming on an annual basis. And then we saw China start to turn around a little bit. So I would say there was a bunch of demand things going on that were tough to predict and tough to kind of see.
And then thirdly is the U.S. unconventional revolution that's occurring here in North America. So we were adding about a million barrels a day of incremental supply to the marketplace. But over the last four to five years, that summed up to be 4 million barrels a day. And there were a lot of people that didn't think that that supply could continue to grow, that the declining rates associated with the wells that were producing were so rapid, so fast, that we wouldn't see the industry being able to keep up with that kind of growth.
So I think there was a confluence of those three events that happened that then, on the back of the OPEC announcement late last year that said we're not going to balance the market, it went into free fall. I don't think anybody predicted how far, how fast it would fall day. And I tell people—I tell investors this as well. You know, how many companies have to react to a 60 to 70 percent drop in your revenue in six months' time? And that's what our industry has had to respond to. So that's the—that's the magnitude and the size of what's hit our industry in terms of reductions and revenues and what we have to do on the capital and the cost side to react to that kind of a marketplace.
So I think the answer is no one saw it. And I think no one saw it because there were a lot of issues that are in play, and a thinly oversupplied market that whenever you have one or two of those go the wrong way you get a dramatic drop in the commodity price.
SENDER: Well, let's drill down a little bit. Is there any reason to think the Saudi will reexamine its decision to retain its market share?
LANCE: Well, certainly some thought maybe December they had made their point, and certainly a lot of the OPEC countries are suffering right now with the lower commodity prices because it takes a much higher price to balance their national budgets. I just think there are so many still supply demand, and their response to being—capture the market share to make sure they don't lose the market share, combined with some of the political issues that are there—you know, they've got to get Iran into the market, Iraq wants to still produce more volume. So the Saudis and others, the big four in OPEC, are sitting there saying, first, to accommodate all this extra supply we got to cut back our volume of production. We're not going to be the only ones to do that. If there's a way that all of OPEC could agree and get some of the non-OPEC members to agree to take supply off the market, it might consider it. I don't see that happening anytime soon.
SENDER: So then let's move on to one or two questions on the demand side. You know, most people look at China and say, you know, China is a huge factor in, and it means that the economy is slowing drastically. You know, when I go to China, I hear a lot about the gains in energy efficiency. You know, from your point of view, what is the conclusion you draw on China and the lack of demand there? Is it because of efficiency gains? Is it because they're changing their template of economic growth? Or is it simply that this is a huge slowdown?
LANCE: Yeah, I think it's, as everything, kind of a bit of multipronged answer to that. I think there is some efficiency gains that they're making because they have some very cheap, low-cost efficiency gains that they can make. And they're going after that. They're also changing, certainly, their energy system, trying to clean up the environment, moving more to natural gas, trying to move a little bit off less dependence of coal and trying to get into that—into that marketplace.
I also think there's a bit of—you know, the provincial governments, the states, the majors, the cities, you know, when you look back over the last 10 years, their performance was judged on one thing, and that was growth, and growth at all costs. Now they're being asked by the current administration in the current 10-year plan to say it's not about growth. It's about value. It's about the environment. It's got other prongs to that. But I totally think that, combined with the anti-corruption push by President Xi Jinping is creating a lot of uncertainty out in the hinterlands of China, if you will, because they don't know what good looks like. They don't know how to judge what projects should look like, what they should bring forward.
So I actually believe that once they figure that out, once they get their governance and their control systems in place that represent the next 10 years and the vision that Xi Jinping has to take the country, that the demand will start to stabilize a little bit, and pick up. Now, will it go—I don't know if it'll go back to 10 or 11 percent sort of GDP growth. We're probably in a world that's 6 to 7 percent, but spread over a much larger base in China, that still represents a pretty big growth in terms of the business—the demand for the products that we have as a business.
SENDER: You know, I mean, we can't foresee geopolitics. And it's hard to set it aside. But the only way to sort of deal with planning, you know, for the next, say, one to three years is to set it aside. You know, what are your assumptions about where the price of oil will be, not in the next 30 or 20 years, but in the next few years?
LANCE: Yeah. So Henny showed a plot—so we do a lot of center planning in the company. And the short answer is—and I think Enzo (sp) talked about it—Lee Raymond had a famous saying: Anybody who predicts oil is going to be fired in my company over the next year, or something. And it is. It's really difficult to predict. I don't know the pathway that it's going to go over the next two to three years. We have a belief in the company though that we're going back to lower, mid-cycle prices—mid-cycle being what is sort of a long-term equilibrium or average.
It may have been over the last three to four years somewhere around $90 a barrel. We don't think we're going back to that kind of a level. So we're going back to a lower mid-cycle price over the long term. I think the important thing is we believe it's going to be pretty volatile. We may see due to geopolitical events $90 or $100 oil coming back. My fear is that if you see that, you're going to see 50 (dollar) on the other end of that quickly again. So we got to be in a world of volatility.
So I don't necessarily know where prices are going to go over the next two to three years, but I know the kind of portfolio you want as a company to deal with that uncertainty in that portfolio. So you want to be investing in things that have a low cost to supply, cost to supply being defined as what Brent price or WTI, what oil price do I need to generate a 10 percent after tax return? And you want to bring that down as low as you can as a company. You want low cost of supply options for investment. You want a low cost structure in your company. You want a strong balance sheet, because you got to manage through these cycles.
So while I don't necessarily know where the price is going, I know the kind of assets and portfolio that you want as a company to try to manage through a period of uncertainty going back to a lower mid-cycle price. And that's what we're trying to do as a company. We're trying to position ourselves to have that kind of portfolio to survive in a very volatile price environment.
SENDER: So let's talk a little bit more on the micro level about ConocoPhillips. I mean, you know, you've engaged in cost cutting, you're cutting your investment, cutting capex. How do you think about where you will make those cuts? I noticed in your material a lot of those cuts are deepwater. And of course, deepwater takes a long time to come on stream. So am I right to say—does that mean you think that we will have lost cost for a long time now, if I just look at the areas of investment where you're pruning back?
LANCE: Yeah, so we've had to react to a 60 percent drop in our revenues. And the way you have to go through that process, you have to cut your capital, try to cut your costs. While the oil price doubled coming out of the recession from $50 to $100 a barrel, our costs in our business went up four-fold. So we had a hyperinflationary period coming out of the recession in our business, largely due to the unconventional revolution in North America and other things. So we've had to react to that and cut our costs, cut our capital program.
But what we've done is tried to cut where we've got the flexibility to make the adjustments about without hurting the medium- and the longer-term implications to the company. When we looked at our portfolio and we said, what are the things that can compete for investment in a lower mid-cycle prices in a very volatile world, we said we want to shorten the cycle time. So from when you first discover something to when it first comes on production, you need to shorten that cycle time because you don't want a large percentage of your capital going to projects that take eight, nine, 10 years to develop.
And in our portfolio, we've got a number of those options in the unconventional space of North America. So the technology, the innovation that's come in the company, what we've captured in the company, has given us an opportunity to invest in things that are much more shorter cycle time and that can react to the volatility we see in the marketplace. When you think about something like deepwater, its cost to supply we believe is somewhere north of $75 a barrel. So when we compare those opportunities to captured opportunities in the portfolio, it doesn't compete in our portfolio.
But I will say the world's going to need deepwater supplies. The technology and the innovation that have come in the deepwater province are incredible in our business as well. And that, as a growth engine and a supply source in our business, is going to be needed over the next 20 years. It's just a case, in our portfolio, we see more competitive investments with our unconventional position in North America that out-compete what we might see as the opportunity in the deepwater. So it's more a function of our company, our portfolio, not an indictment on that as a source of supply over the course of the next decade.
SENDER: So will your company look very different in five years' time than it does today, where, you know, you personify the traditional fossil fuel E&P company?
LANCE: Well, we will. But we do believe that being global and being diverse is really important in this business. So you don't want to be captured in one particular market, one particular geology, one particular resource type. So we do believe having a global, diverse portfolio is important. So we have a large position in Asia, a position in the Middle East. We have a position in the North Sea, both on the Norwegian and the U.K. side. But predominately, we're a company that's about 70 percent North America between our position in the U.S., Canada, and Alaska. And that's what—we're driving more to that, because we just have seen what the technology and the innovation can do on the unconventionals, that we're pretty convinced that we're in the very early innings of that game still. There's a lot of opportunity left to go do that.
You know, people don't give us—our industry a lot of credit on the technology side. We're actually very highly technologically oriented companies and industry. You know, our company alone has a computer that's one of the 30th largest computers in the world today. It does 3 trillion calculations a second. I mean, it's—this is very high-tech in terms of what we're doing. We could start a well in Queens, we could drill a mile down into the ground, we could come over, and we could pop up right at your feet, Henny, with a—with a drill bit. I mean, that's the technology that we're created in this business. And when we apply that innovation and technology, we see a lot of running room in the unconventional space. So in our company we're focusing more on that opportunity. And that's largely here in North America, which is why the repeal of the export ban has been so important to our company and the industry.
You know, 90 percent of the wells drilled in the U.S. are drilled by independents. They're not drilled by the integrated major ones. They're drilled by independent companies like mine. And that's where most of the activity is, and why it's been important to the independents to repeal the export ban because we have to have an outlet for our crude. If we continue back on a growth trajectory with reasonable prices, we're going to be faced as an industry with three things. We either got to shut in production, export the crude, or expand the refineries. And that's the decision we face. And that's why we wanted to put so much effort and momentum into this export.
SENDER: We will go in a deeper way on the export ban.
SENDER: And why, and all the sort of distortions that that has introduced in a few minutes. But let's stay on this topic for a moment because, you know, until I talked to Ryan earlier, I didn't realize that the oil industry, you know, is like cars which—you know, cars are now sort of moving computers. You know, when did this heavy investment in tech and computers start? Talk us through that, and all the ways you use the 30th most powerful computer on the planet.
LANCE: (Chuckles.) Well, you know, it started in our industry back, you know, probably 10, 15, 20 years ago in a bigger way because the data—obviously, the data coming in, the sensors that we can put on our equipment, and now we have to manage a lot of big data and we have to analyze big data, and we have to cycle through the 3-D seismic, 4-D seismic, how we're imaging the Earth, you know, two miles down into the ground by sensors at the surface, and how you manage that data. That's what's been leading the technology revolution in our companies. And then learning how to drill wells faster, safer, and cheaper, with less people at the surface, with more pinpoint accuracy. All that's been—you know, we've had—like most of the world today, over the last 20 to 25 years we've seen just, you know, asymptotic increases in the technology, the pickup and the usage of it to be relevant. You have to, to stay one step ahead of the competition.
LANCE: It's fun. It's a great area. You know, we—you know, you think of pictures in the oil and gas industry as people on a rig, dirty, throwing a chain around a pipe, drilling it, and all that. You know, that's not what happens today. It's all automated. Its' very few workers on a rig now to run and drill wells. And it's the safest our industry has ever been. And we have to continue to get there. And technology plays a big role in that.
Plus, we got to recover more out of the ground. Typically, as an industry—you know, in the unconventionals today we're only recovering 10 to maybe 15 percent of the hydrocarbons captured in the rock today. It's a huge upside for our industry to figure out how to apply the technologies in order to increase the recovery rate, just from the wells that we're drilling today that we don't really have a clear pathway of how to do that, but we'll figure that out over the next four to five years as we continue to innovate in the industry.
SENDER: You know, you've done a dramatically good job in cutting your costs, but as you think about where to deploy your investment dollars, I assume this kind of thing will continue to get that. But what about the energy landscape? You know, there's so many distressed companies out there today, you know, all along the energy food chain. Is this a good time to go out and make acquisitions? On the other hand, a lot of the majors, you know, are considering is this a good time for us to be more bold? Are you going to be predator? Are you going to be prey? Talk about that landscape.
LANCE: I have a few investors in here. I got to be careful. (Laughter.) No, yeah, it's an interesting market. I would tell you, you know, six to eight months ago when people thought the mergers and acquisitions or transaction market would really start to pick up. You know, what we're seeing in terms of as we look at it, because we follow it, obviously, very closely, most people were figuring that the oil price was going to recover up to some mid-cycle price. So most of the stocks in the market today are not priced on $35 oil. Those stocks are trading with the presumption that we're going back to some higher commodity price and that's how they're trading today.
What I would tell you is—as this downturn persists lower for longer, to your point, Henny, there's going to be a lot more distressed people in the marketplace. So as this persists, I think you'll see—we're starting to see more Chapter 11s, we're starting to see lienholders taking up the bond market trading, trading in high-risk bonds are moving up as well. So you do see some of that distress starting to play through the market, and we're watching it pretty closely. For the people that have good rocks, good names, good investments, good portfolio, you don't see a lot of really good deals out there yet today.
And what I tell our folks is it's got to be substituted in the portfolio. So we've reduced our capital because our cash flows are down, the commodity price is down. Anything that we were to buy has to be substituted in the portfolio. It makes no sense for me to get something that's additive to the bottom of the portfolio because it's not going to get funded. And that's a pretty—in our company, that's a pretty high hurdle today.
SENDER: You know, many people think that from a whole wave of Chapter 11s we will see a whole wave of Chapter 7s, which is to say liquidations. Do you share that fear?
LANCE: Well, certainly—yeah, it depends on your definition of a wave of this. As oil prices—if $35, $40 oil persists through 2016, we're going to see a lot more of that goes on. I think, you know, we would hope, or certainly in the industry we talk a lot about seeing the seeds—we're sowing the seeds of the recovery today because we're all throttling back our capital, we're all reducing our investment. The business on the global declines at about 4 to 5 percent per year.
So the $90 million a barrel supply, you take 4 to 5 percent of that, you're looking 4 to 5 million barrels every year, but at the same time demand is growing by a million barrels a day. So we're deferring investment as an industry, were sowing the seeds of the next recovery. The question is when does that come up? When do inventories start to work off? When does—and that would lead to commodity prices starting to improve. Most people see that happening maybe the end of next year. But if it doesn't, and it persists for a lot longer certainly that the wave or more Chapter 11, Chapter 7s are going to be a part of our business.
SENDER: You know, everyone is focused on the Fed today. Fed is obsessed with inflation. How much deflation do you see in your industry? And are you a beneficiary of that, or a victim of that?
LANCE: Yeah, so again, I go back to a 70 percent drop in your revenue over the course of six to seven months, you're pretty worried about costs, right? You kind of—(chuckles). And so it is interesting, as the macro conversation with the Fed today is all about when do increase rates? Is it, you know, 25 basis points or 50 basis points? You know our industry, when we're talking about our country, I review every week what our deflation capture numbers are. How much deflation are we capturing in the business? How much are our service costs coming down? How much of our business services that support our business coming down? And we're actively—we've seen 30 to 40 percent deflation of the course of the last year in our business, trying to become more efficient and trying to capture that inflation.
And it's interesting, in our business one of the—I was talking to Henny earlier—one of the lenses that we're looking for is when do labor costs start coming down in our business because that's one of the last kind of indicators that maybe we're starting to bottom out because people are attacking their variable costs, when they attack their fixed costs associated with our business as well? So it is a really interesting juxtaposition where a lot of the conversation is around when do industry and when does interest rates start to rise, whereas our business that's a concept that is completely out of the radar screen right now. We're all about trying to figure out how to attack that entire supply chain and reduce the cost structure so we can restore our margins at a much, much lower oil price.
SENDER: One final question before we turn to the possible end of the ban on exports. And that is, recently I was at a conference with the Central Bank governor of Mexico. And he was talking about their very ambitious hedging program. A lot of investors here today have big stakes in energy companies, many of them have protected those investments through hedging. Can you talk a little bit about those dynamics for us?
LANCE: Yeah, it has—so it's perpetuated the—probably extended the downturn a bit, because certainly the smaller, independent E&P companies who really need to protect their budgets against the volatility will lock in prices for next year, or even out two years in time. And that's a pretty active market. You can get out there. The forward curve is pretty transparent. And you lock in some of those prices to protect the budget. Certainly with Mexico I think they're the largest—probably the largest single hedger in the world on the commodity price side. But clearly they need to—they're trying to protect their federal budget by locking in the oil prices that Pemex can deliver. And I think they just released how much money they made on their hedges, looking—what they locked in for—
SENDER: It was 9 billion (dollars) or something like that.
LANCE: Yeah, what they locked in for a price was just today's price. That spread was over $8 ½ billion—$9 billion today. What we are seeing in the business, though, is the forward curve has—the whole curve has come down. So there's not a lot of ability—you can lock in the price for next year, but you might only lock in $40 a barrel. So we're starting to see a lot of these hedges start to roll off because companies are saying I can't—that's not a budget that I want. And so I've got to bank on some upside, which is also going to cause some of the distress in the business, because they can't lock in higher prices for the next couple of years and their current hedges are starting to roll off. Some companies are hedged about maybe a third to half their production in 2016. But I would say the far majority have a very low percentage of 2016 production hedged today.
SENDER: Yeah. Onto the export ban.
LANCE: Oh, good.
SENDER: And the end of that, most likely, now. You know, many people, I've discovered, who aren't in the industry don't even realize there is an export ban. You know, didn't that go away when we did away with price controls? You know, what is the history of that export ban? And I assume the backdrop was entirely different situation than there is today.
LANCE: Yeah, so it dates back—it dates back to the Arab oil embargo of the late '60s, early '70s. And you know, since then that let's not export any of our product if we're having to be so reliant on Middle Eastern supplies and all the imports. So it was something put in back, you know, 30, 40 years ago that was representative of the condition then, even though that condition in terms of net exports and imports wasn't a lot different than it is today, but then viewed as an issue or a problem because America was resource poor. We were going down, starting to decline in production coming out of the U.S.
And so you fast forward now over the last five years, with this unconventional revolution, the horizontal well-drilling combined with hydrolytic fracturing, and that technology—the convergence of those technologies have now enabled us to start producing hydrocarbons out of rock that's as hard as this table by basically cracking it open and letting the hydrocarbons flow out of the rock into the wellbore and get produced. And that's caused us to increase production dramatically over the last five years to the tune of 4 million a day. And so that's decreased the amount the imports that we have to rely on as a country by having that extra production in the U.S.
But an interesting thing happened. All of our refineries over the last 15 years have been remodeled to handle heavy oil—heavily oil being very thick, viscous oil from Venezuela, Mexico, and Canada.
SENDER: And there's no ban on exports of refined. It's just crude.
LANCE: Right, it's just crude. So that's an interesting dynamic here, because we were getting to the place that the kind of crude that we were producing out of these unconventional was a very light, sweet, crude, a very different chemical formula. And our refineries are ill-suited to refine it into products. You know, refineries can export and import product freely in the open market. So today we export 4 million barrels a day of diesel and gasoline. We import 2 million barrels a day of diesel and gasoline. And so the refineries are free to trade that in the open market, which is why your gasoline price is tied to global crude prices, because that product is freely traded around the globe.
U.S. prices for crude oil trade below global prices because it's trapped, and because the refineries haven't been able to consume all that oil, so what do have to do? We have to put it into storage. We have to put it into inventory. So inventory levels are rising to historic highs because our refineries are ill-suited to economically convert that oil into diesel and gasoline. So that's why I got back to the first point. If we continue the growth and continue the development of our unconventional resource in the United States we over the next few years will be faced with three choices, shut in production, expand refineries, or export the crude.
The problem with expanding refineries is they exist in communities today. And we haven't built a refinery in the U.S. in 35 years. And in fact, the globe is oversupplied by refining capacity. So you don't need any more refineries in the globe, in the world today. Plus, I don't think you could permit one in today's regulatory environment today. So we have concerns that the refineries can expand quick enough to consume all this different kind of oil that's coming out then due to the unconventional.
Now, we're incentivized to make sure that they can take all that they can process because it costs us money to ship it someplace else, to export it. So I tell my refining friends, and they know that, don't worry, there's plenty of oil to be refined locally as well. In fact, we're incentivized to go do that because it cost us $2 a barrel to ship it to South America or to Europe. We're going to make sure we can refine as much as we can here in the U.S. We just need the capacity to export it should we need it down the road. So it's a great policy for the country. It's jobs. It's economic growth. It, you know, doesn't add to the emissions. The oil is going to be needed somewhere.
SENDER: It gives you an incentive to do more at home than abroad.
LANCE: And it gives us the economic incentive to invest more here in North America, which is what will happen with the repeal of the ban.
SENDER: And does the discount for WTI as opposed to Brent narrow? Does it go away? You know, what are the sort of distorts that we will see disappear as a result of this?
LANCE: So I think—yeah, it'll be really interesting to see. Historically, the quality of the U.S. crude was above that of global crude, being a Brent marker. So we used to sell American crude for a premium to international crude. Today, it's flipped the other way. And it's flipped the other way because of these artificial market constraints that are on with exports. So today, U.S. crude trades below world crude by maybe a couple of dollars a barrel. Now, some say that it'll stay that way because that's how much the transportation differential is to get American crude into the global market.
I think the issue that we see is when refineries go into turn around, in other words they do maintenance, they shut down their refinery for 30, for 60 days to day maintenance, we've seen that differential go out as much as $20 a barrel. And that's when we have a problem. And so what we're saying is that over time we think that there probably is—they ought to trade at a close to parity, maybe a little bit below based on transportation, differential. Where it is today, which has been the argument of the people that don't want to appeal it say, well, that's where we're at today. The problem is, that's not where we're going to be three, four, five years down the road, which is why we need to fix the issue today.
SENDER: I think I will now abdicate to our members. If you have a question, please raise your hand, identify yourself, and limit yourself to one question. And there is a lot of hands in the center of the room. Thanks.
Q: David Fenton.
I'm just back from the Paris climate talks, and I want to note, it's pretty remarkable you've just gone 30 minutes without any mention of climate change, which is certainly going to affect your business, and all the rest of us. Now, by the physics of the situation, we can't burn most of the existing reserves of fossil fuels. We have to use a small amount of them to transition. So the notion that you're going to go to the deepest ocean and ends of the Earth I think is increasingly going to be at odds with physical, and political, and economic reality. Could you comment, please?
LANCE: Well, yeah, I think it's all about balance in the system. So how do you—how do you make sure we get affordable energy to all corners of the Earth? There's 4 million today that are dying because they don't burn—have access to cheap, affordable energies. They're burning wood and cow dung in their homes for heat and electricity. So it is about balance. But I go to Beijing and I walk around there, and we clearly have to do something about that. So I think it's all a matter of balance.
Even if you subscribe to the 2 degree Celsius change, by 2050, 60 to 70 percent of the world's energy demand is still going to be filled by fossil fuels. So you know, to be—to be in a position to even have cheap, affordable energy around the world, we've got to figure out how to do that sustainably. You can't—there is no pathway that I've seen by anybody that would suggest that renewables gets us there by 2040. It takes a century to turn over an energy system in the globe today.
So coal is still a part of the energy mix by 2040, 2050. We have to figure out how to do it cleanly. We have to figure out how to do it sustainably. And we have to figure out how to add more solar. We have to figure out how to add more wind. We have to figure out biofuels. It is truly all of the above because the world is growing, the energy needs are growing, and the developed world is growing. And they need access to affordable, cheap energy.
SENDER: So how do you stay relevant in a world where everyone is talking about solar, and wind, and alternatives?
LANCE: Well, I think, you know, as a company we came out over a decade ago and said that recognized that the burning of fossil fuels is adding CO2 to the—or, greenhouse gases to the atmosphere and we need to do something about that. We were pretty open about that. And I think we believe that there are market mechanisms that will work, and work today. And we have operations today around the world that have a price on carbon. We exist that way. We operate that way today.
As a company, we've cut over 6 million tons out of our inventory just over the last four years. While we've grown the company, we've kept our emissions flat to declining. So we recognize that we have to do that sustainably in order to meet sort of the demands that the public and the consumer's going to have on the business. We also know that we've got to keep the—we've got to keep the energy affordable. It's got to get to people in a reliable, and a safe, and an inexpensive way, to make sure they've got the opportunity to grow and develop, just like we have as a country. And that's the balance we're trying to strike.
SENDER: Yeah. In the back there.
Q: Thank you. Just to follow up on carbon pricing—
SENDER: Can you identify yourself?
Q: Oh, I'm sorry. Excuse me. Paula DiPerna, the NTR Foundation. Thank you.
Just to follow up on carbon pricing, would you support a national cap-and-trade effort to build upon the California system and the RGGI system and link it all in so that we can eventually somewhat implement the Paris agreement?
LANCE: So we were a part of the cap program back in 2005/2006. So we helped with the Waxman-Markey bills that went through Congress, you know, a decade ago. I think what we—we have some principles that we think are important. It's hard to say that one size fits all for everywhere. What Alberta maybe different than what we need to do, different than what Australia needs to do, different than what Europe needs to do. We believe in market-based mechanisms. So we would tell the government, don't pick winners and losers in this process. Make it industry-wide and try to accomplish it that way. So we've been out and supported that in the past, as long as it's got market mechanisms, it's industry-neutral, and it deals with everybody fairly.
SENDER: Yeah, up front. Thank you.
Q: Thanks. James Bambino from Platts.
We've reported in the past, recently, that a couple of Japanese refiners have been testing WTI, LLS, in you know, in light of a possible easing of restrictions, considering that's sort of right around the corner potentially. Where do you see a lot of your production? Where do you see the best market for a lot of your crude, considering it's no longer perhaps best suited for the Gulf Coast and it may indeed get better return in Asia—or Europe, for that matter?
LANCE: Yeah, I think for the kind of crude that we're producing with this unconventional production that's coming in North America, the growth that we've had, you know, it's best-suited for what we call simple refineries, in our business, which are primarily in South America and Europe, but I don't doubt some of it can go to Asia potentially. The obvious issue with that is just the incremental transportation cost. So I think early it's going to go to where the—where the refineries are that can consume it that have the lowest transportation costs. Initially I think that's Europe and South America, and maybe some spots in Africa as well.
Then ultimately it might go to Asia. We've actually exported some crude from our Alaskan operations to Korean refineries that want to try to run it as well, which is an area that hasn't been—was exempted from the export ban because Alaska grew so dramatically in the '70s and '80s, it overwhelmed the West Coast market. So President Clinton lifted the export ban on Alaskan crude. And we have taken some of that crude to Asia in the past.
SENDER: Thank you.
Q: Will Hiltz from Evercore.
I'd got two questions. First of which is, outside of the Permian Basin, what basins in North America today do you think provide the kind of full-cycle economics you need for at $40 oil and $2 gas? And then secondly, well, we've talked a lot about crude oil pricing, but I'd be interested in your comments on U.S. natural gas prices.
LANCE: So what basins are—work at $40 crude? I'll tell you, the core and the heart of the unconventional basins work at $40 to $45 crude. So that's the Eagle Ford, the Bakken, and the heart of the Permian, Niobrara in Colorado, and some of those other areas like that in the unconventional space. So it's not like there isn't any investment that would go into this space at $40 crude. You can get decent rates of return. I think the issue everybody has, it's the amount of the investment that we're willing to put in is a function of the cash flow we have as companies, and reinvesting that back into our business. So it's more—it's slowing down because our cash flows are down due to the drop in the commodity price.
On the natural gas side, I mean, that's an advent of the unconventional revolution as well. We've got a very flat supply curve. We've got a century of gas sitting in the U.S. And it's—you know, if it does sort of recover slowly, rigs can come back pretty quickly and drop the price back down very quickly, because the access and the ease to get into the rigs and bring more rigs to work is very quick. So we've got a blessing of a large amount of natural gas. Another bridge fuel, another certainly lower carbon intensity—I remind people, we're one of the few countries that didn't agree to the Kyoto Protocols. We're about the only country that met the Kyoto Protocols. (Laughter.) And we did that through natural gas production. We did that—we've lowered our emission rates to 1992 levels. And we've done that on the back of natural gas. Not by regulation. Not by anything that Washington, D.C., did. But by investments that this industry has made.
SENDER: Yeah, here.
Q: Jason Bordoff from Columbia University.
You mentioned you expected more volatility in the oil price moving forward. And I was just wondering if you could say another word about why that is, and in particular the role of shale. So some people have talked about it as being able to swing much more quickly and ramp up and down. It took about a year before we actually saw it start to decline. Can you tell us how long you think once the price—if the price were to spike back up, how long it would take for U.S. production to start growing again, and at roughly what price? or the U.S. as a whole, not for any one company or one basin, what price range do we need to see to see U.S. production start to turn and rise again?
LANCE: Yeah, so you have a number of questions in there, Jason. (Laughter.) Let me hit a couple of them. I think—you know, you look at history and our business—the cycle time in our business, so from discovery of a resource, or an opportunity, or a well, all the way to first production of that field or that opportunity set's been somewhere eight to 10 years. I would call it the cycle time.
But with the unconventionals now, that cycle time has been reduced dramatically down to maybe something on the order of one to three years. So the cycles in our business, because of this huge resource opportunity, it's going to drive that cycle time down from something a lot longer to something shorter. And that's why people talk about it as potentially being more of a swing producer. If OPEC doesn't choose to cut in production, the market will drive it because we can turn on—we can ramp up the rigs, we can ramp down the rigs reasonably quickly.
But that still, to your point, takes probably eight to 12 months. I mean, it's not going to happen instantaneously, like OPEC can do. So the resource in North America is driving that cycle time down to a—to a shorter level. So that's why I worry that if a geopolitical event were to drive $90 or $100 oil prices again, rigs would come back quickly again, we would be back on a trajectory or growth, and we would quickly drive prices back down because we would create an oversupplied world again, depending on how demand is increasing.
So your final one, you know, what does it take to drive that, I think the work that we've done, and the work the EIA and others have done, it's probably reasonable that, you know, in that $60 to $70 a barrel range is the price for American crude that's going to take to get us back on a half-million to a million barrel a day growth trajectory in the U.S. But we that'll come. We think, you know, that's probably a reasonable mid-cycle price to be thinking about as the oversupply works its way through the system in this recent downturn.
Q: Ed Cox, Patterson Balknap, and a director of Noble Energy.
You commented on domestic gas price, how it will be flat for a period of time. There's a big differential between that a deliberate LNG prices, yet I understand there's a glut of LNG. Could you comment on those markets and how they might go in the future?
LANCE: Yeah, so the LNG market today, with the exports going from the U.S. now, I think what we'll see going out in the future is the NBP, or the European gas price, will start to calibrate to U.S. prices, minus transportation differentials and liquefaction and cost. So our view is you probably see a $6 to $7 differential between Europe and U.S. prices to cover the cost of liquefaction and transportation. So they ought to move in that kind of a bandwidth, given the flat supply nature that we see in North America.
So I think it's going to be challenging for some of all these exports projects to get built, because not all of them can rely on long-term contracts to Asia. They'll have to underpin their economics and their decision to build that facility based on that difference between U.S. and European gas prices. And then you're really relying—you're really asking the question, what does Russia do? What does Gazprom do to gas prices delivered into Europe? And I think that's a big question. You know, what is their breakeven? You know, what cost would they drive market down to, to preserve their market share in Europe? And what impact then would that have back here in the U.S.? So I think the market will self-limit how much gas exports we have from the U.S. in terms of LNG. But the net effect at the end of the day is a pretty flat price deck in the U.S., I believe.
SENDER: Ryan, let me ask a follow-up question on Russia. You know, it's hard to talk about geopolitical risk, but with oil at these levels, do we start to worry about stability in Russia?
LANCE: Oh, certainly. I think what's kept their investment going is the—you know, they're spending their investment in rubles and they're selling their product in U.S. dollars. So they've been able to keep the investment going in Russia based on that currency spread. But clearly—you know, I don't know what the number is—over 70 percent of the Russian economy is based on the commodities of oil and gas. So clearly, if it stays lower for longer they have a difficult time. Some of the breakeven oil prices for the economies around the world are pretty disturbing. When you think of Venezuela, you think of Angola, you think of some of the other countries that require a much, much higher price to balance their budgets, what are they going to do longer-term if the commodity price stays lower for a longer period?
Q: Thank you very much. Mahaj Khotaja (ph).
My question is about—regarding corporate strategy. When you face the kind of decline in prices that you have faced, which is quite dramatic—you have—as you pointed out, very few industries have that—how does the executive suite think about that? And how does it differentiate itself—
SENDER: Sadly. (Laughs.)
Q: —from other such companies, which are facing the industry—which are facing the same problem? And then who are the—what will distinguish those who win and those who don't? And will there be a tremendous amount of consolidation in the industry if this persists?
LANCE: So we—yeah, I touched on that a little bit earlier. It is hard to predict where it's going, the pathway, and the volatility, and all that. But so I can't really on picking a commodity price to set my budgets and set my plans. I have to be pretty conservative when I go do that, and balance the cash-flow needs of the company in the short term. But what I can do, is I know what wins in that kind of environment, in a lower for longer, volatile environment, I know the kind of portfolio that any company would want to have. And I think that's the race, to try to make sure you have that kind of portfolio, which is—which is investments that are low cost to supply.
So you have captured investments in your portfolio that have a low cost to supply. And you have choices and options about how you allocate capital around the world based on low cost to supply options for investments. I think that's key. I think you need a low cost structure. Obviously, it's commodity price. Those that have the lowest cost structure have the highest margin. So you need to keep a low cost structure. You need to have a strong balance sheet.
So bigger companies are going to have a better chance of surviving this than smaller companies because you got to have the balance sheet capacity to take the debt on during the downside, and as the prices recover you got to pay off the balance sheet, repair the balance sheet, get ready for the next cycle. So you have to have a strong credit rating, access to the markets, access to the debt markets to go do that. And then I think you have to be light on your feet. You have to make decisions really quick. You have to have internal structure, governance, and controls that allow you react pretty quickly to the price that—the situation, the environment, and the commodity price that you find yourself living in.
So while I don't know where the price is going to be four months from now, I do know the characteristic of the portfolio that you want to have a competitive advantage and win in this kind of environment.
LANCE: Well, consolidation is—you know, people consolidate because they can lower their price structure. But we're capturing deflation pretty quickly right now. So really, you know, consolidating to lower the cost structure is really not kind of in the game, because we're all capturing deflation. Are there synergies on the corporate side? There will always be a few synergies that you can go capture. You don't have access to a growing resource growth engine, you have a hole in your portfolio, that's going to drive—you know.
So there's three or four sort of characteristics that are going to drive M&A. And we largely—two or three of those are kind of off—really aren't in play today. But what is in play today is just a good value because you have distressed companies out there. And the lower this commodity price longs—to Henny's point, as people declare, go insolvent, Chapter 11, Chapter 7—you know, those are going to be the kinds of opportunities people are looking for. Not so much it fits one of those other—ticks one of those other boxes, it's just there's a good deal out there, because the other side is so distressed.
You have a lady in the back there, she's been persistent.
Q: Thank you. Tracy Austin, Mitsubishi Corporation, Americas.
My question is, to what extent are you factoring in changes to energy policy as a result of climate change in your long-term projection of demand?
LANCE: Yeah, so it's a really good question. So I talked a little bit about scenario planning that we do as a company. It kind of underpins a lot of what we do as we go and talk to our board, and talked about what we do. We present sort of a base case on supply/demand. But we look at a lot of different scenarios. And in fact, just this October I was with the board. And we looked at sort of a—what you might call a hyper-regulation scenario with the company that addresses some of the issues, you know, what happens in a 2 degree Celsius world? What sort of regulation do you see coming? What impacts does it have on the company? So we look at that in real time, and we try to make that address.
I'll go back to even 2012, when we spun the company. We had a scenario in our company called tidal wave. Tidal wave was a scenario with unconventional production ramping up dramatically with a global demand falling off. Now, we only gave that scenario, in 2012, about a 30 to 40 percent chance of materializing, and we're in it today. So I think the important thing is while we don't know where prices are going, we—it's really important to test your—test your portfolio, your decisions, your strategy against these scenarios to understand—to know the signposts that you want to see as to which scenario you might be going into. So we have a rigorous system around monitoring that.
And then secondly, as we think about it, it's what decisions would you make as a company that are different in each one of the scenarios? And more importantly, what are the no regrets decisions that you would make as a company across all scenarios? So we do—we have a very rigorous process in our company to try to address that. And one of those is very much focused on climate regulation and what that means to our portfolio and our company.
SENDER: Yeah, back there. Thanks.
Q: Stephen Schwebel.
Early in the 1970s, Venezuela expropriated its oil companies—
SENDER: Sir, can you speak to the mic?
Q: Early in the 1970s, Venezuela expropriated the oil companies. And nevertheless, a few decades later, Conoco went into Venezuela and brought its technology to exploit the heavy oil which was unexploited. Nevertheless, Conoco was—
Q: —expropriated a few decades after that. Could you comment on that history, please?
LANCE: Yeah. I mean, you have the history very well-documented there. (Laughter.) So as a company we were—you know, a decade ago in the mid-2000s, we had found some technology we thought was working quite well in the heavy oil environment. So, more thick, viscous oil, how to recover it, how to do that cheaply, how to do that and make a positive return. And some of the big deposits of that heavy oil are in Alaska, Canada, and Venezuela. And when we looked at it, we thought those could all be competitive with that new technology that we're development. A lot of it came from U.S., heavy oil in California—Midway-Sunset, Kern River—a lot of the old fields that we've been working on as an industry for over 100 years.
And we did. We went back into Venezuela. We demonstrated the technology. It worked. We had a big position in the Orinoco Belt of Venezuela. And in 2008, we got—you know, they took the assets away from the company. So they demanded a much different commercial arrangement, one that didn't really incentivize any future investment. President Chavez, at the time, was ringing the nationalistic bell quite a bit. And we chose to leave and not try to negotiate something that we felt was unattainable and didn't really incentivize us to keep bringing our technology and our investment into the country. So today we're in arbitration with the Venezuelans around the expropriation of those assets. And that's been a long journey, but we're making progress.
Q: Hi. I'm Cassia Janusek (sp). I'm with McKinsey and Company's energy practice.
And my question is around your strategy. You talked a bit about how you're thinking about shoring up your portfolio in the short term. And I'm just wondering what your views are on the long-term aspirations for ConocoPhillips. You're unique in that you're the largest super-independent in North America. Yet, you still fall far below the majors in terms of production. So do you have an aspiration to have the production capacity and growth as a major, or are you thinking about doubling down in unconventionals and being a leader there? How do you see this, particularly amidst your decision to go out of deepwater, which has definitely changed your portfolio mix?
LANCE: Yeah, so we're not a company that's focused on the bottom line growth. So you know, if you ask us, are your aspiration to be twice as big as you are today? I mean, if it works out that way, fine. We're more focused on value. And we're more focused on making sure that our investments are the most competitive they are in the business today. So the lowest cost to supply. And if that leads to production growth that's modest, you know, that's kind of our plan as we think about the medium and the longer term.
So our offering to our investors is one of a compelling dividend, modest growth, and a real focus on returns and value. So we're not trying to grow at growth's sake, because we could put a lot more capital into the business and we could grow a lot more, but that would be at the expense of the balance sheet because we'd have to borrow money, commodity prices don't support it. So what we've really done is exercise the flexibility that we've created in our portfolio over the last three to four years. And that's been purposeful. We've (cored-up the portfolio ?). We've gotten out of areas we don't think compete for investment, you know, in our portfolio, which is the deepwater decision for us.
What that does inform us is that we have a lot of running room and opportunity in our unconventional portfolio of North America. So it just is a statement about the competitive hurdle with our portfolio. And we think those are better investments. They're going to be better investments for our company—shorter cycle time, they can react to the volatility, they're higher returns, and we can control that. And we've got a lot more control, rather than being in long-dated projects where if prices swing low you've got to power through them, you don't really have a choice. So that's the direction we're trying to move our company, that I think is a bit differential, maybe, to some of our competitors. But it's not about trying to grow to be the size of one of the integrated majors.
Q: Thank you. Tom Wallin with Energy Intelligence.
I have a question again about exports. And the U.S. is exporting, you know, almost a half million barrels a day of crude right now, mostly to Canada. With the lifting of the ban, assuming that goes through, what kind of volume would you expect, say this coming year in this oversupplied global market. And what would you expect longer-term in a more balanced market environment?
LANCE: Yeah, I suspect with the way the market—and the oversupply in the market is today, you're probably going to see little impact, you know, in the near term, if your time horizons is in the next, say, 12 months. Now, if you start to reach out in the next two or three years, medium and the longer term maybe five years, you know, I think we can see somewhere between a half a million to 2 million barrels a day being exported from the U.S. to markets. So we're not talking about a huge number.
I think what we're doing is talking about leveling out some of the volatility we see because the market has access to U.S. barrels that they don't typically have access today. But I don't think that's growing to a huge number, but it's going to be a material number. And it's going to help us during these period to maintain investment, to maintain the employment, and maintain the activity level. It's going to help us when we get these artificial blowouts because our refining system goes into turnaround or has a bad couple of months, or something like that. It's going to allow us the ability to react to that and damped out that volatility, so we avoid those big blowouts. And that's why it makes so much sense as an energy policy for our country.
SENDER: Yeah, here.
Q: Nick Brant with Lazard.
Thanks to technological progress, we've noticed an extraordinary decline in the costs of exploiting unconventional oil and gas. As you look out over the next few years, what further potential is there for reducing those costs?
LANCE: Well, I certainly think we're not done yet. I think it is probably slowing down a little bit. The industry's probably captured 30 to 35 percent efficiencies over the last year, year and a half, as the commodity prices have fallen. What I tell people is that we're still early in the maybe second inning of this unconventional game. We still don't really understand the physics about how fluid flows through rock, you know, that's as hard as this table. So that's where the technology is going, is to make sure we can understand it. When we stimulate a well, when we hydrologically stimulate a well down, how much of that gross rock volume are we actually impacting? I think we're finding out it's a lot less than what we think. So that's what's leading to the low recovery factor.
So I think there is another whole wave at these kinds of lowers prices that technology can continue to lower the cost to supply in the unconventional. It's why I tell my OPEC friends, don't—we're not—you're not going to kill this industry. This industry's already reacted but cutting the supply chain, getting our costs in order, becoming competitive on a cost to supply basis. Sure, it's a higher cost than some of the low-cost Middle East production. But it's not going to be the last that goes off the supply market. And it's going to do that because that innovation is still early in its phases. We're going to learn how to get more of it out of the rock. We're still going to learn how to be more efficient. And we're still going to learn how to be—apply the technology in a much more—stronger fashion.
Now, as prices start to rise, we're going to be—we'll have some inflationary pressures on goods and services as the price starts to come back. But I think we've captured enough of the efficiency through the technology that it won't be one-for-one. We won't see that go up just a dollar for dollar.
SENDER: Does anyone have one quick question, because it's almost 2:00? If not, I will ask one final quick question.
SENDER: And that is, you know, looking forward, will we see other sources of supply that we're not thinking about today? So for example, China potentially has huge shale, but the technology is a challenge because you require water and China is water-scarce. And it's much harder to get at. You know, what are the potential sources of supply that you should be thinking of?
LANCE: Well, I think, you know, technology and innovation doesn't stand still. So it's going to continue and create new sources of supply. I think North America's not the only place blessed with the geology of unconventional rock. You mentioned Sichuan Basin in China, other places in South America, or Argentina in the Vaca Muerta, the other places in South America. That's going to happen. The challenge is exactly what you talked about, Henny. If it's a water-scare area or it's got other sort of issues. We're blessed in the United States with an incredible infrastructure system and an incredibly supply industry that is very quick to react to that, and a regulatory system that is open, transparent, and clear that we can understand the regulatory system when we're making our investments. That doesn't necessarily happen around the world.
So I think those supply sources are there. They will come. But they're going to require a higher commodity price, because they're higher cost to supply because of those issues. They don't have the infrastructure. They may have water issues. They may have a regulatory system that is less than transparent, like Venezuela. And you know, at the end of the day, that drives more cost into the system and it just requires a higher commodity price to get there. And that's your function of where you think long-term supply and demand is going, whether that price is going to be sufficient to incentivize the development of that supply.
SENDER: Thank you so much. We are at the end. I'd like to thank all of the members for being such a great audience and such great questions. Thank you. (Applause.)
LANCE: Thank you. Thank you so much.
SENDER: You are fabulous. You couldn't have been better.