R&D UNDER THREAT

The companies that own the world's most powerful supercomputers for commercial use are not in the information technology industry, neither in biotech nor even finance. They are in the oil business: Eni of Italy, BP of the UK and Total of France, according to public disclosures.

The computers, which can process two or three thousand trillion calculations a second, are used for handling large volumes of geophysical data from seismic surveys, creating sophisticated 3D images of rocks thousands of feet underground.

Their power is a testament to the industry's technological progress. But as pressure to cut costs grows, because of falling returns on capital and weaker oil prices, spending on research and development to sustain that progress is under threat.

Some analysts and investors worry that oil companies will not spend enough either to sustain growth in their core businesses, or to open options in alternative energy sources for a world in which oil and gas consumption is constrained by climate policy or high prices.

The Rockefeller Brothers Fund, founded by the sons of the great oilman John D Rockefeller, said this week it planned to sell its holdings in fossil fuel companies, in part because the family believed renewable energy was the business of the future. The successors to his Standard Oil, the fund suggested, were failing to grasp the opportunities that he would have seized.

The reason oil companies need so much computing power is because their core business is becoming ever more challenging.

"It's difficult for oil majors to get access to conventional reserves that are controlled by [oil-rich countries'] national companies," says Jean-François Minster, scientific director at Total.

"So they have to focus on very high-tech resources – deep water, the oil sands, the Arctic – that need new solutions if they are to be developed."

Analysis of company reports shows differing responses to that challenge.

The largest spenders on R&D last year were European: Netherlands-based Royal Dutch Shell , with $1.32bn, and French group Total with €949m.

ExxonMobil of the US, the world's largest listed oil company by market capitalisation, was some way behind at $1.04bn.

As a proportion of sales, Eni, BP and Exxon spent the least, with R&D at about 0.2 per cent of their revenues, and Total spent the most at 0.55 per cent.

R&D spending gives a sense of where companies are placing their bets. Shell and Chevron cut their spending sharply during the downturn, and have since been reviving it. Total's spending has been growing steadily, while Exxon has kept it steady at just over $1bn since 2009.

Shell and Total are also the two big oil companies that have the greatest interests in renewable energy, including biofuels and solar power.

However, Gerald Schotman, Shell's executive vice-president of R&D, says its key research is in its "upstream" oil and gas production business.

As fruits of the group's research efforts, he cites innovations in imaging that will enable Shell to "see what others cannot see" when looking for oil, new production technologies such as floating liquefied natural gas plants, and chemicals to help extract resources that would otherwise remain trapped in rocks.

The increased spending appears to be showing results: Shell was granted 189 US patents last year, up from 127 in 2011, although it was still behind the 227 granted to Exxon's upstream and engineering subsidiaries. Shell's patents have more significance for the industry than its competitors', according to the Patent Board, a research firm.

Yet having risen strongly in recent years, R&D spending by Shell and other companies may now fall back, as it did the last time oil prices declined, in the second half of 2008.

Nick Butler, a former strategist at BP, worries that R&D will be cut "just when it matters", as the industry faces a potential long haul of weak prices, with faltering demand and strong production growth in the US.

As Terry Wood, BP's technology vice-president in strategy and planning, puts it, today's R&D is for "projects five or 10 years down the road". If companies cut research, they will have fewer attractive projects in the future.

In the longer term, cutting R&D in renewable energy could also be a mistake. Some companies have already been pulling back. Chevron this month sold some of its solar, biofuels and energy efficiency operations to Oaktree, a private equity firm. BP pulled out of solar power in 2011, and tried unsuccessfully to sell its US wind power business last year.

Mark Lewis, an analyst at Kepler Cheuvreux, argues that the companies are making a mistake. The falling costs of solar and wind power, he argues, mean that electric cars will become increasingly competitive with petrol-fuelled vehicles, especially if the price of oil rises as extraction becomes more difficult.

If China and India decide to shift their transport systems towards electric vehicles, it will wipe out a large proportion of the expected growth in demand for oil

"The oil companies have got time to take this on board, because electric vehicles are still a very small part of the market," he says. "But the price dynamics are only going to go in one direction."

Renewable energy businesses are different from fossil fuels, technically and commercially, and oil companies have generally not been good at managing them. If Mr Lewis is right about the future, though, developing some expertise in alternative energy could be the best investment they could make.

Rise of the oil service companies ratchet up pressure

One important factor shaping oil companies' research and development efforts is the perennial push and pull over control of technology with service companies such as Halliburton and Schlumberger .

Oil production companies including ExxonMobil or Royal Dutch Shell do not want to maintain and invest in proprietary technologies for everything they do, so they lean heavily on the service providers for activities such as drilling and completing wells. But they aim to avoid surrendering so much of the know how for critical parts of the business that they become irrelevant.

The dilemma has been sharpened by increasingly assertive resource-rich countries, which would rather do business with service companies that are paid some type of agreed fees, rather than production groups that will insist on taking a share of the oil and gas they help extract.

Gerald Schotman, Shell's executive vice-president of R&D, says service companies are sometimes suppliers to production groups, and competitors on other occasions. This makes it more important for the production companies to develop their own technological strength, he adds.

"When national oil companies need technology, they can do it in two different ways: they can go to production companies or they can go to service companies," he says.

"How we differentiate ourselves is by deploying technologies better and cheaper than anyone else."

The service companies spend a much higher proportion of their revenue on R&D than the production groups: last year it was 2.6 per cent for Schlumberger and 2 per cent for Halliburton, compared with 0.29 per cent for Shell.

In absolute terms, Schlumberger, the world's largest oil services company by market capitalisation, was not far behind Shell and ahead of Exxon, spending $1.17bn last year. Halliburton spent $588m.

That research focus seems to pay off. Schlumberger was granted 507 US patents last year, compared with 368 for Halliburton, 227 for Exxon's engineering and production operations, and 189 for Shell.

ft.com