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Gold/Mining/Energy : Strictly: Drilling and oil-field services
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To: BigBull who wrote (37932)2/21/1999 6:46:00 PM
From: Razorbak  Read Replies (2) of 95453
 
Cash Flow, Not Profits

I didn't mean to suggest they were "profitable"... more like cash flow positive from a production standpoint. Once a well is drilled, the exploration and development costs are considered "sunk", and are no longer used to cloud the marginal economic decision about when (if at all) to shut in production when prices drop. Oil companies are slashing exploration budgets because economic models run on future developments using current prices fail to meet their economic hurdle rates for return on investment. But that doesn't mean that they will shut in production on existing wells. That usually only happens when the cash flow produced from selling the oil is insufficient to cover the cash cost of the production itself.

Same type of phenomenon has been occurring for almost two decades in the refining industry. Crack spreads have been too dismal to warrant new investment in any new grass roots refinery projects, but refinery "creep" (growing incremental production) continued to plague the industry every year because marginal economics of upgrades and expansions to existing plants always made sense. Furthermore, existing refineries continued to produce at historically high utilization rates (95-99% year after year) even though they were grossly unprofitable after depreciation and amortization (which are non-cash costs), simply because they were still cash flow positive. In fact, many of the integrated players used their unprofitable refineries as "cash cows" running at maximum capacity just to provide cash to fund their E&P units.

Doesn't seem to make sense at a superficial level, but it is a true economic dilemma for the players in the game.

Razor
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