How strong are the barriers to entry in the oil and gas sector?

The barriers to entry in the oil and gas sector are extremely strong and include high resource ownership, high startup costs, patents and copyrights in association with proprietary technology, government and environmental regulations, and high fixed operating costs.

Barriers to Entry

Barriers to entry are aspects of an industry that include any institutional, government, technological or economic restrictions on the entry of potential participants into that market or industry. There are two types of barriers to entry: supply-side and demand-side barriers. Companies in the oil and gas sector make a product that virtually everyone needs and the sector is faced with supply-side barriers to entry, so it’s hard for a potential oil and gas company to enter the sector as a supplier.

Barriers in the Oil & Gas Sector

Demand for oil and gas is high, and the number of suppliers remains low due to the high barriers to entry. This gives existing oil and gas companies a huge advantage and huge profit potential.

The specific barriers to entry faced by the oil and gas sector are as follows:

• High startup costs mean that very few companies even attempt to enter the sector. This lowers potential competition from the start.
• Proprietary technology forces even those with high startup capital to face an immediate operating disadvantage upon entering the sector.
• High fixed operating costs make companies with startup capital wary of entering the sector.
• Local and foreign governments force companies within the industry to closely comply with environmental regulations. These regulations often require capital to comply, forcing smaller companies out of the sector.

Research, development and capital-intensive production are typically the barriers to entry in the field oil and gas. While consumers may use generic commodities like gasoline or fuel oil, oil exploration relies on expensive and laborious work in finding the right geology and drilling test wells to see if that research pays off.

Oil & gas firms have also invested billions of dollars in developing patents and acquiring cutting-edge technology for finding oil and gas and extracting it. New firms may be forced to either license processes and technology from established firms or tie up capital in an attempt to match established firms’ capabilities.

Understanding Exploration & Production (E&P)

Oil and gas companies locate and extract nonrenewable resources from the Earth; the process of oil and gas exploration and production typically involves four stages that are all capital intensive and produce barriers to entry among new players:

Exploration

At this stage, the search for hydrocarbons beneath the ground entails geophysical prospecting for shale formations that hold deposits of oil and natural gas. One method of exploration involves seismology, a process whereby substantial vibrations, via explosives or machinery, are produced at the Earth’s surface. Seismic waves travel to the Earth’s mantle, and the respondent force is analyzed at the surface to identify layers of rock that trap reservoirs of oil and natural gas. Exxon Mobil Corporation maintains many large exploratory fields in the Gulf of Mexico, extending operations to 339 deepwater blocks.

Well Development

After identifying potentially viable fields, engineers determine the number of wells needed to meet production requirements and the method of extraction of the liquid hydrocarbons. Platform construction costs are estimated with regard to the site, offshore or onshore, and designs are rendered for systems used to facilitate environmental protections. Newer drilling technologies, prominent in the Marcellus and Bennett shale fields in Pennsylvania and Texas, allow companies such as Chesapeake Energy Corporation to extend horizontal legs about 5,000 feet from vertical wells in search of natural gas pockets, producing four times as much gas at only twice the cost of a vertical well.

Production

Liquid hydrocarbons extracted from wells are separated from the non-saleable components such as water and solid residuals. Natural gas is often processed onsite while oil is piped to a refinery before being offered for sale.

Abandonment

As exploratory sites are deemed unproductive or existing operations exhaust capacity, companies plug wells and attempt to restore the areas to environmental states that existed prior to drilling activities. As natural gas prices descended to historic lows in January 2016, many exploratory wells were shuttered as high production costs rendered extraction unprofitable. As an example, in 2014, the state of Ohio ramped up efforts to plug nearly 600 orphan wells that posed hazards to surface water and aquifers.