J.S. Herold: North American E&P back on track

Last year may have confirmed a turnaround for exploration and production in North America.

Through technology and operating efficiencies, the North American upstream oil and gas industry has cut its costs of replacing oil and gas reserves to levels competitive with its best performances of the past 50 years, says John S. Herold Inc., Stamford, Conn.

"With costs down and the present value of proved reserves strengthening, the E&P activities of oil companies are creating meaningful economic value again," the firm declares in the advance report of its annual reserve replacement cost (RRC) analysis.

What's more, RRCs in the U.S. are now competitive with worldwide costs. As a result, North American exploration and development spending by oil and gas companies is moving back toward balance with worldwide investment.

Of the $51.5 billion that 102 companies tracked by Herold invested last year in E&P, about 49% went to North American projects, compared with 42% in 1992.

U.S. E&P spending by companies on the Herold list totaled $19.9 billion in 1995, up 6% from the year before and the third consecutive yearly increase. The U.S. figure represented 39% of worldwide budgets, compared with 37% in 1992.

Canadian E&P investment fell 21% from 1994's elevated level to $5.1 billion but was still nearly twice 1992's total.

Herold estimated worldwide RRC in 1995 at $4.35/bbl of oil equivalent (BOE) added. For a larger group of companies in the firm's final RRC study for 1994, RRC was $4.77/BOE.

"RRC" in Herold's analysis covers reserves added through all means. The firm also estimates finding and development costs (FDCs), which exclude effects of proved property purchases and essentially measure costs of adding reserves through drilling.

Average worldwide FDCs for the Herold group fell to $4.53/BOE in 1995 from $4.98/BOE in 1994.

In the U.S. last year, RRCs fell to $4.13/BOE from $4.72/BOE in 1994, FDCs to $4.16/BOE from $4.77/BOE.

Herold notes that, beginning in 1993, RRCs in the U.S. and worldwide have fallen below the value of reserves as indicated by merger and acquisition activity. In each of the 3 years since then, the margin has increased.

"Value is being created by upstream activity," the firm said, predicting E&P capital expenditures will continue to increase.

Key trends

Among trends noted by Herold in its advance report is a return to exploration.

Development drilling and acquisitions of reserves have represented a growing share of company budgets since 1990, the firm noted. But spending on acreage and exploration in the analysis climbed faster than overall spending did in 1995, rising by 10% to $13.7 billion worldwide.

Herold cites anecdotal evidence of the trend, including tough competition in the acquisitions market and consequently higher reserves values, rising compensation for experienced geologists and geophysicists, and improved margins for drilling and service firms. Because the change will raise costs per barrel for adding reserves, Herold predicts that 1995's RRCs and FDCs will represent low points in a cycle.

Another trend noted in the report is increasing focus on rapid investment turnover and quick payoffs. Instead of favoring projects with slow depletion rates and high reserves-to-production ratios, as they did in the past, companies now seek to "quickly recycle cash flows while earning significant returns on invested capital."

The firm expects North America to retain the gains it has made since 1992 in share of worldwide E&P capital spending. Large discoveries are more probable elsewhere but are no longer economically preferable on the basis of sheer size. Part of the reason for that is the comparatively long time required for start of production from large fields in remote areas.

Herold also says the retreat of major integrated oil companies from North America may be ending. What it calls the "downsizing/dumbsizing" of companies "may have run its course."

Major companies are better able to compete with independents for prospects than they were before they restructured, Herold says. In 1995, integrated oil companies were net buyers of natural gas reserves in North America.