Worldwide upstream spending for oil and natural gas increased by 9% to $161 billion in 2003, rebounding from a 4.4% decline the previous year, according to the latest annual global review of upstream performance by John S. Herold Inc. and Harrison Lovegrove & Co. Ltd.
As a result of higher oil and gas prices, the analysts said, "Cash flow was at a 5-year high in every region in 2003. Cash flow exceeded spending in five out of six regions. The lone exception was Africa and the Middle East, where the 36% year-over-year increase in spending led to a $3 billion cash deficit."
In Canada, they said, costs incurred have exceeded cash flow by nearly 40% over the last 5 years as a result of "massive spending on mineable oil sands projects for which production gains are expected in the years ahead."
But while "cash is pouring in," researchers said, "so far reinvestment has not risen at nearly the pace witnessed in prior oil and gas bull markets. Companies appear to be investing relatively cautiously and seeking to maintain capital discipline." They expect investments by oil and gas producers to increase, yet still "lag cash flow by a wider margin this year than last, simply because it will take an extended period of time to rebuild the [investment] opportunity set."
Spending details
Based on their study of the public records of 194 oil and gas companies, researchers said last year's spending increase was led "by a 16% surge to $132.1 billion in finding and development outlays, a category that has shown annual growth of 14% since 1999." Meanwhile, proved acquisition spending was down 16% to $28.9 billion, 40% below its 2000 peak level.
Development spending registered the biggest increase last year, up nearly 21% to $100.1 billion. Exploration spending, on the other hand, inched up less than 1% to $30 billion as unproved property purchases fell 42% to $5.5 billion. Analysts reported BP PLC was the biggest upstream capital investor at $14.7 billion in 2003, $3.6 billion ahead of runner-up ExxonMobil Corp.
Analysts see "a marked shift toward investment in development projects" over the past 5 years, while exploration spending has remained "relatively static at 15% of total outlays" and acquisition spending has declined.
"We view the development of the existing asset base as rational behavior, maximizing deliverability in a time of perceived shortage and high commodity prices," analysts said. "As the available opportunity set within companies is developed, however, the challenge of creating new investment opportunities could spur increases in exploration and M&A spending."
While some might suggest that the oil and gas industry is underinvesting the cash generated by higher commodity prices, Arthur L. Smith, Herold chairman and CEO, said, "By two different and possibly more important yardsticks, the industry in our study group has, we believe, been investing sufficient capital:
- "Total production of the surveyed companies has risen more quickly than world demand.
- "At the same time, the industry has been increasing its reserve base, admittedly slowly, but still keeping natural depletion from whittling away at intrinsic value."
Analysts said, "The ultimate constraints facing the industry relate to where significant quantities of reserves remain to be found and whether these potential fields are accessible."
Annual oil discovery volumes booked by companies in the study "have not fluctuated much over the last 5 years," averaging just under 7 billion bbl.
"Unfortunately, production is well in excess of 10 billion bbl. However, when technical revisions and improved recovery are added to discoveries and extensions, the industry has managed to grind out modest annual gains in oil reserves of an average of 1% over the past 5 years.
"The record on the natural gas side is much better, with discoveries averaging more than 36 tcf/year, slightly in excess of production," said analysts.
Shifting funds
They see a strategic shift among many oil companies in directing capital to areas where they can create superior returns, by shifting funds from mature areas, such as North America and Europe.
Since 2001, upstream spending in North America has fallen 22% while spending in South and Central America, Africa, and the Middle East has increased more than 60%.
As a result of the weakening of the US dollar against the euro, upstream spending in Europe has increased 13% since 2001. Spending also has increased in the Asia-Pacific region, "though given the large, rapidly increasing volume of dollars spent in the region, on a percentage basis, the growth has been slower," analysts said.
Reserve replacement costs and finding and development costs increased in 2003 in every region except Canada. Cost increases were particularly sharp in Africa, the Middle East, South and Central America, and the Asia-Pacific regions, said researchers.
Worldwide production replacement rates have declined in every region over the past 5 years but are "the most robust" in Africa, the Middle East, and Asia-Pacific regions "where the high percentage of proved undeveloped reserves has attracted capital flow, but sharp declines in replacement rates during 2003 in these regions have brought them much closer to worldwide averages," analysts reported.
Production, reserves
Both production and oil and gas reserves increased about 2% worldwide in 2003, a little below the 5-year average, analysts said. "Only two regions, however, Canada and Asia-Pacific, showed reserve gains," they said. Canada registered "a strong 4%" gain as a result of oil sand reserve additions, while Asia-Pacific reserves were up 3% in gas reserve volumes.
Among the surveyed companies, production has risen annually since 1999 while the worldwide ratio of reserves to production has fallen to 13.5 years from 13.9 years.
"Interestingly, North America has given support to the global [reserves to production] ratio as it has increased from 10.9 to 11.3 years due mainly to a growing emphasis on Canada's mineable oil sands projects," analysts said.
"The majors' R/P ratios have also grown over the study period mainly due to redistribution of capital from the US to lesser developed regions with large reserves and their participation in development of large volumes of stranded gas either through pipeline or LNG projects.
"Independents, the buyers of properties divested by the majors, have attempted to maximize returns by escalating production from the fields they purchased, shortening the reserve life," researchers said.
Rising production coupled with increased development investment also effectively raised finding and development costs by bringing proven, undeveloped reserves into the producing category with total reserves unchanged, they said. "In contrast, pure finding costs/boe, defined as exploration expense divided by extensions plus discoveries, have remained relatively flat," analysts said.
"In a high-price environment, companies are choosing to develop their assets as expediently as possible," said analysts. However, they noted, companies need to grow production and reserves.
"It is easy to advocate increased exploration investment, but harder to find economic drillsites," they concluded. And even if companies have the prospects, they observed, "Experienced people are needed to mange the operations, and the service sector already has capacity constraints for certain equipment categories."
Acquisitions of properties or companies can provide a "quick fix" for producers looking to grow reserves. "But prices are generally high in the current market," said analysts. "For the largest companies, there could be regulatory restrictions on further significant deals (mostly in respect of the downstream operations)
"As a consequence, most corporate activity is likely to occur between independents or by majors buying stakes in government enterprises," they said.
Investment capital
The study noted, "Dividend payments have increased modestly relative to capital investment over the last 5 years, which is not too surprising in light of the surge in net income. Share repurchasesUhave soared since industry profits reached a nadir in 1998 and now account for over 25% of capital returned to shareholders."
Analysts said share repurchases are likely to become "a more important component of shareholder return and for more companies to employ the strategy."
Even with the return of funds to shareholders, analysts said, "More surplus capital for investment is available now than at any time in the last 20 years."
Global oil reserve growth increased by 1.2% to 141.3 billion bbl in 203, compared to an average annual growth of 1% since 1999. "Oil production has outpaced reserve adds, rising 3.3% in 2003 to 10.9 billion bbl and averaging just under 2.5%/year since 1999," analysts reported. Worldwide gas reserves grew by 2.2% to 520.3 tcf in 2003, "about the average rate of growth since 1999," they said.
