Don Stowers
Editor
Oil & Gas
Financial Journal
The cover of this issue of Oil & Gas Financial Journal asks the question - “Can oil reach $150?” While some might think this price level is preposterous, others - including respected energy analyst Bernard Picchi, a senior director with Foresight Research Solutions - believe a “superspike” in oil prices to as much as $100 to $150/bbl could occur in the event of a calamitous loss of production somewhere in the world - say, Saudi Arabia.
The world leaders in proven oil reserves, in descending order, are Saudi Arabia, Iran, Iraq, the United Arab Emirates, Kuwait, Venezuela, Russia, Libya, Nigeria, and the US. Many - perhaps most - of those countries at least have the potential for political turmoil that could shut off the spigot on a moment’s notice.
As we have all read, the world’s appetite for petroleum products has expanded in recent years. China and India, for example, have seen exponential growth in their economic output and standard of living, which has resulted in a huge demand for all forms of energy to fuel their economies. Indonesia, an OPEC member, has become a net importer of oil. Energy usage in China is expected to surpass that of the US in a few short years.
It doesn’t take a Nobel Prize winner in economics to figure out that burgeoning demand and a sudden precipitous drop in production most likely would bring about dramatic price increases.
For the short term, Picchi doesn’t believe that current oil prices, which continue to flirt with the $50 level, can be sustained. He maintains that commodity prices are influenced by cheap credit, the tremendous number of futures contracts, as well as traders’ need for volatility.
Under present conditions, with energy production capacity barely meeting demand and with geopolitical uncertainty in oil-producing countries, prices are not likely to drop - at least not for long, he says.
It’s fair to ask why energy companies aren’t responding to the current period of sustained high prices with increased exploration efforts. Clearly, the market exists for more oil and natural gas. Yet spending and exploration activity have not kept pace with rebounding oil and gas prices.
In a recent report, Wood Mackenzie, the Edinburgh, Scotland-based energy consulting firm, offers several observations as to why high energy prices have not triggered a corresponding increase in exploration spending.
• Development spending on upstream projects is up from an aggregate of $34.6 billion in 1998 to $49.5 billion in 2003. This has been driven by expenditures on projects in the Gulf of Mexico, deepwater West Africa, and the Caspian Sea areas, which saw much exploration success in the 1990s. Development spending will continue to increase because it is less risky than exploration spending.
• This development spending will translate into an upturn in production. The top 10 companies, which account for about 20 percent of the world’s oil production, will see production increase by an average of 3.5 percent per year between 2003 and 2008.
• On the other hand, exploration spending has fallen from over $11 billion in 1998 to around $8 billion in 2003 - a 27 percent decline. This can be attributed in part to the impact of the mega-mergers in the industry, which created “cost synergies” by cutting exploration budgets. In addition, the rise in development spending has put the squeeze on exploration budgets, as companies seek to achieve greater financial discipline.
• The decline in exploration just happens to have coincided with a recent downturn in new discoveries. The average level of new discoveries from 2001 to 2003 was significantly lower than during the period 1997 to 2000.
Wood Mackenzie sees “some evidence” that exploration expenditures may rise, but adds that reserve replacement through exploration will continue to prove a challenge.
Simmons & Company International, Houston, paints a similar picture. That company’s analysis shows that, while balance sheets are stronger than ever and surplus cash continues to build, drillbit reinvestment rates remain at all-time low levels, having persisted under 70 percent for more than two years.
Simmons’ research suggests that reinvesting excess capital is more difficult in practice than in theory due to more selective prospect screening, increasingly competitive M&A markets, and real human resource limitations. As a result, many companies are choosing to “sit on their hands” with respect to investing additional capital.
Traditionally, oil company executives would look at the data and take a calculated gamble on a hot new prospect, even when the percentage of dry holes was much higher than it is with modern exploration technology. They knew you do not get a hit every time you step up to the plate, and they were comfortable with that. In today’s risk-adverse environment, it seems increasingly likely that many of the players will remain in the dugout rather than venture onto the playing field.
Don Stowers
