MARKET ACTIVITY/ WEEKEND EDITION OF TRADING NOTES JULY 5, 1998 (8)
WEEK'S TOP STORIES, Con't
Global Oil & Gas Capital Spending Surges & Reserves Increase, But U.S. Finding & Development Costs Continue Rising in 1997
U.S. Share of Worldwide Capital Spending Reaches a High of 40%; Large Independents Outspend Majors in the U.S. for First Time: Arthur Andersen/John S. Herold Analysis
Global capital expenditures by the largest companies in the upstream oil and gas industry surged 30% to more than $91 billion during 1997, with 40% of the spending on projects in the U.S. -- the highest proportion in at least five years -- according to Global Upstream Performance Trends-Advance Edition, a joint study by Arthur Andersen and John S. Herold.
The benchmark study reviewed U.S. and international results for 131 publicly traded companies each with proved oil and natural gas reserves in excess of 20 million equivalent barrels of oil (BOE) as of the most recent fiscal year. The survey companies are classified into three groups: majors (integrated oil companies with reserves over 1 billion BOE), large independents (100 million to 1 billion BOE) and medium independents (20 million to 100 million BOE). These companies account for 56% of U.S. crude oil and 62% of U.S. natural gas production, and for 67% of U.S. oil and 64% of U.S. natural gas reserves.
In 1997, U.S. E&D spending rose 38% to $28.8 billion while international E&D spending by the survey companies increased 20% to $45.8 billion. In addition, proved property acquisitions jumped 59% in the U.S. to $8.3 billion and 40% outside the U.S. to $8.7 billion, including a 150% rise to $4.0 billion in Canada and a 200% jump to $1.5 billion in Latin America.
For the first time, large independent companies spent more than the major oil companies on total U.S. capital expenditures in 1997, topping the majors' total by almost 5%, $16.6 to $15.8 billion. This was primarily due to an increase of $2.8 billion in the large
independents' proved property acquisitions to $5.7 billion, compared to a rise of $860 million in the majors' proved property acquisitions to $1.4 billion. The large independents also increased their U.S. exploration spending 54% to $2.7 billion, their development spending 30% to $6.5 billion, and their domestic unproved property acquisitions by 66% to $1.7 billion. Outside the U.S., the large independents' capital spending grew 67% to $16.4 billion while the major's international capital expenditures rose 9% to $36.8 billion.
''1997 was the record breaking year in the 1990s for the E&P industry in terms of capital spending,'' said Victor A. Burk, Arthur Andersen's managing director of energy industry services, ''but what a difference a year makes. After five consecutive years of capital spending increases, now it's back to the future.
''Oil prices have plummeted, natural gas prices have weakened, and 1998 could see the first decline in capital spending since 1992. Companies are responding in different ways. Some have already announced reductions in capital spending, a few have announced
increases, but most are still holding the line and taking either a long term view or a wait and see attitude,'' Burk added.
From 1993 through 1997, the survey companies increased capital spending more than two-thirds by plowing-back 68%, or $329 billion, of their total netbacks (revenue less production costs) in capital expenditures. In the U.S., survey companies plowed-back 75% ($121 billion) of total netbacks during that period but managed to boost production and reserves by just 9% and 7% respectively. By comparison, in the Africa/Middle East region, the companies plowed-back 50% ($16 billion) of total netbacks and achieved reserve and production increases of 22% and 34% respectively. In Europe, primarily the North Sea, plowbacks of 51% ($69 billion) produced a 22% increase in production but a 2% decline in reserves. Notably, the reinvestment rate reached by the survey companies' Canadian operations for the five-year period was a high 126% of netbacks, producing growth of 37% and 35% in production and reserves.
''The industry's 1997 U.S. spending increase is particularly impressive given the common perception that the international arena offers better opportunities,'' said Brian J. Lidsky, executive vice president of John S. Herold, Inc. ''While the U.S. lags most regions of the world in finding and development and reserve replacement cost performance measures, the increased level of domestic spending suggests that the stability, infrastructure and market size in the U.S. remain highly attractive to the world's oil companies. Additionally, the ramp-up in 1997 spending is partially attributable to increasing investments made in the deepwater Gulf of Mexico, which is shaping up to be one of the world's highest-potential oil and gas basins. Herold expects this higher level of spending in the Gulf to bear fruit in the form of at least 25% average annual gains in production from the deepwater Gulf of Mexico over the next five years,'' Lidsky noted.
Capital Spending
A nearly 60% increase to $8.3 billion in proved reserve acquisitions led 1997's 42% rise in U.S. capital spending to $37.1 billion. Pioneer Natural Resources was the largest acquirer of proved reserves in 1997 at $2.6 billion, followed by Texaco ($1.1 billion) and Lomak Petroleum ($448.8 million). Costs of proved reserve acquisitions rose 21% to $4.45 per barrel of oil equivalent (BOE), but remained 35% below the $6.83/BOE average cost of adding reserves through the drillbit in the U.S.
U.S. exploration spending, including unproved property acquisitions, rose 48% to $11.5 billion in 1997 and development costs -- 47% of all U.S. capital spending -- increased 32% to $17.3 billion, partially reflecting higher drilling and completion costs. While all the independents in the survey group increased their combined U.S. exploration spending 53% to $3.9 billion, the majors increased their U.S. exploration expenditures just 6% to $3.2 billion, but significantly accelerated both their unproved (up 210% to $2.1 billion) and proved (up 149% to $1.4 billion) property acquisition spending in1997.
Internationally, proved reserve acquisition spending increased 40% to $8.7 billion in 1997, although per unit costs declined about 10% to $2.61/BOE. The large independents' increased their international proved property acquisition spending by135% to $5.2 billion, while the majors' activity level fell 12% to $3.3 billion. Top international acquirers in 1997 included Canadian Occidental Petroleum ($1.3 billion), Amoco ($872 million) and Pioneer Natural Resources ($718 million). Since 1993, proved property acquisitions almost tripled internationally as companies scrambled to get quick entry into non-U.S. markets.
International exploration spending rose 19% to $14.5 billion in 1997, while development expenditures -- 57% of all costs incurred -- increased 20% to $31.3 billion.
Reserves
U.S. oil reserves of the survey companies increased by one billion barrels, or 5%, to 20.0 billion barrels in 1997. Drillbit additions rose 38% to 2.0 billion barrels, and one billion barrels were added through acquisitions, 71% more than in the prior year. The largest U.S. oil reserve holder continued to be British Petroleum, with 2.8 billion barrels. Production remained steady at 1.8 billion barrels for the fifth consecutive year.
International oil reserves climbed 4.1 billion barrels, or 10%, to 45.7 billion barrels, the largest annual increase in the five year survey period. Drillbit additions rose 17% to 4.3 billion barrels, and purchases increased 41% to 1.9 billion barrels. The largest reserve increases occurred in Canada (up 18% to over 5 billion barrels), Latin America (up10% to 2.4 billion barrels) and the Africa/Middle East region (up 8% to 5.5 billion barrels). International oil production increased 4% to 4.1 billion barrels.
U.S. natural gas reserves increased less than 1% to 106.7 trillion cubic feet (Tcf) in1997, primarily because of huge net downward reserve revisions of 1.0 Tcf, most prominently EEX's 623 billion cubic feet (Bcf) revision of its East Texas properties. Drillbit additions increased 25%, or 2.5 Tcf, to 12.3 Tcf, led by Burlington Resources (1.0 Tcf) and Texaco (927 Bcf). Proved gas reserve purchases rose for the third consecutive year by 4% to 5.2 Tcf, but were largely counterbalanced by 3.9 Tcf in reserve sales. Pioneer Natural Resources accounted for 1.1 Tcf of the gas reserve purchases, and Amoco led the sellers by pruning 1.2 Tcf of U.S. reserves. Production continued its long-term upward trend, rising 2% to 11.6 Tcf -- one-half the 4% average annual growth rate from 1993 through 1996.
International gas reserves increased almost 5% to 221.3 Tcf, including an 80% rise in purchases of proved reserves to 8.5 Tcf -- led by Amoco's purchases of more than 2.4 Tcf of gas -- partially offset by a 122% increase to 4.2 Tcf in sales of gas reserves. Drillbit activity added 17.0 Tcf to international gas reserves, a 7% increase.
Revenues & Operating Results
Revenues from U.S. producing activities increased slightly to $54.7 billion in 1997, but results of operations declined to $13.0 billion, 11% below the 1996 results but still more than double the average in the 1993- 1995 period. Production costs were flat at $14.7 billion, but the big expense increase occurred in depletion, depreciation & amortization (DD&A) expenses, which rose 18% to $16.7 billion, primarily due to asset impairment writedowns. International revenues and results of operations each declined approximately 3% in 1997, to $104.1 billion and $21.8 billion respectively.
Netbacks -- operating revenues minus production costs, including production taxes -- were marginally higher in the U.S. at $40.0 billion, but fell $0.12 on a per barrel equivalent basis to $10.74/BOE. Internationally, netbacks declined 4% to $76.5 billion, with the per barrel equivalent sliding $0.82/BOE to $12.01/BOE.
Performance Measures
Global Upstream Performance Trends uses five measures of upstream performance:
-- Reserve Replacement Costs (RRC) - The implied cost of proved reserves added through all means, including extensions and discoveries, revisions, improved recovery and purchases of proved reserves.
U.S. reserve replacement costs rose a significant 16% to $6.10/BOE, the second consecutive annual increase and primarily the result of higher costs for leases, drilling rigs and oilfield services, equipment and supplies. When evaluating corporate performance, we use the three-year trend in order to eliminate many of the timing differences between when costs are incurred and when reserves are added. Exxon led the majors in three-year (1995-1997) average replacement costs at $2.68/BOE, Union Texas Petroleum was first among large independents at $1.44/BOE, and Evergreen Resources was the top-performing medium independent at $1.48/BOE.
International RRCs declined slightly ($0.04/BOE) to $3.77/BOE led by a 10% decrease in Canadian RRCs to $4.36/BOE. Amoco led the majors with a $2.47/BOE three-year average RRC, with spending mainly occurring in Latin America. Nuevo Energy was the top-performing large independent at $1.42/BOE, and Tesoro Petroleum was the lowest-cost medium independent at $0.80/BOE.
-- Finding & Development Costs (FDC) - The implied cost of reserves added through the drillbit, including extensions and discoveries, revisions and improved recovery, but excluding proved reserve purchases.
U.S. finding and development costs rose 16% to $6.83/BOE, while international FDCs increased 3% to $4.12/BOE. Canadian FDCs improved by 26% to $4.41/BOE and Asia/Pacific region FDCs declined 23% to $3.13/BOE, while European FDCs climbed 35% to $7.41/BOE.
As in RRC results, Exxon was the three-year FDC leader in the U.S. among majors at $2.69/BOE, and Union Texas was number-one among large independents at $1.44/BOE, with Evergreen Resources the top FDC performer among medium independents at $1.56/BOE. Outside the U.S., Royal Dutch/Shell led the majors with FDCs of $2.34/BOE, and Noble Affiliates paced the large independents at$1.38/BOE.
-- Proved Reserve Acquisition Costs - The reported cost paid to acquire proved reserves.
The cost of acquiring proved reserves in the U.S. jumped 21% in 1997 to $4.45/BOE on $8.3 billion of transactions. Pioneer Natural Resources accounted for 32% of U.S. acquisition spending, and Texaco 13%. U.S. low-cost acquirers in 1997 were Plains Resources ($28.2 million at $0.65/BOE), Coastal Corp. (NYSE:CGP; $48 million at $1.08/BOE), and Howell Corp. (NYSE:HWL; $82.7 million at $2.12/BOE).
International acquisition costs declined almost 10% to $2.61/BOE on $8.7 billion in volume; however, excluding Mobil's $1.5 billion 1996 acquisition of Ampolex Ltd. in the Asia/Pacific region, per unit international acquisition costs actually increased 14%. Canada accounted for 46% of international acquisition activity and costs increased 35% to $4.25/BOE -- on par with U.S. costs. Latin America acquisitions surged 200% to $1.5 billion with unit costs increasing 51% to $3.45/BOE.
-- Production Costs - Actual reported production costs.
Production costs remained under control throughout the world during 1997, largely due to stringent cost control measures and a rising production profile. U.S. production costs decreased to $3.96/BOE, off $0.07/BOE from 1996 and a $0.48/BOE reduction since 1993. International production costs declined 1% to $4.34/BOE, an overall decline of $0.39 since 1993.
-- Production Replacement Rates - All sources production replacement rates are calculated as net reserves added through extensions and discoveries, revisions, improved recovery and purchases and sales of reserves, divided by production for the period. Finding and development (F&D) production replacement rates exclude the effect of purchases and sales of reserves.
The U.S. all sources production replacement rate for oil and natural gas liquids rebounded strongly to 156% of production in 1997 from just 67% of production in 1993. International all sources oil production replacement continued at the high rate of199% compared with 142% in 1993. The turnaround in oil production was not due solely to acquisitions. U.S. drillbit additions climbed to 135% of production, up from 66% in 1993. Internationally, the survey companies replaced 173% of oil production on an F&D basis, compared with 98% in 1993.
The U.S. all sources natural gas production replacement rate of 106% continued a downward trend from the five-year high of 136% in 1995. Downward gas reserve revisions of more that 100 Bcf each by EEX, Amoco, Unocal, Mobil, TransTexas and Pioneer Natural Resources were largely responsible for the decline. International all sources gas production replacement rose 8% to 208%. From the drillbit only, U.S. gas reserve additions net of revisions did not even meet production, resulting in a production replacement rate of 94%. However, this is up 5% from the 1996 level of 89%. Internationally, the F&D gas production replacement rate was 175%, having climbed steadily since 1993.
Arthur Andersen is a global multidisciplinary professional services firm that helps its clients improve their business performance through assurance & business advisory services, business consulting, economic and financial consulting, and tax & business advisory services. With more than $5 billion in revenues and more than 60,000 employees, Arthur Andersen serves clients in more than 363 locations in 78 countries.
Founded in 1948, John S. Herold, Inc. is a specialized information services company. As ''the petroleum company research company,'' Herold focuses on valuation and performance measurement of the world's leading oil and gas companies. Herold closely monitors the world's energy capital markets and the dynamic merger, acquisition and divestiture marketplace for energy assets.
Energy Sector Set For Turn
Unsurprisingly for a natural resources fund manager, Konrad Krill believes the sector is set for a strong bounce and says that in the short term, consolidation in the sector will provide the spurt.
With just $4.0 million under management, Krill says that selling the Orbitex Natural Resources Fund which was launched in October last year has been difficult in a period when oil prices have fallen 40 percent.
"This sector has a strong offensive punch to it, as well as being defensive because valuations are so low," Krill said in an interview.
He notes that the percentage of money invested in the energy sector as a proportion of the S&P 500 has fallen from 27 percent in 1980 to around seven percent now, as investors have shifted their money into high tech stocks, financials and consumer goods.
"These stocks (high tech) are priced for perfection," Krill said.
He says that distressed oil and gas stocks will benefit from a new wave of mergers and acquisitions and cites stocks such as Seagull Energy Corp and Canada's Ranger Oil Ltd potential takeover targets.
He also believes that strong dividend yield from major oils and a reweighting of investor portfolios, albeit not back to 27 percent of the S&P 500, will drive valuations sharply higher.
Eventually too, production cuts from the Organization of the Petroleum Exporting Countries, combined with a pick up in demand from distressed Asian economies and a return to normal weather patterns will feed through into earnings.
He says that El Nino, which caused a warmer than normal winter in the northern hemisphere, is probably a bigger factor in the oil supply imbalance than Asian demand.
"If you get just normal weather for just 6-18 months that will eat into supply," Krill said.
The Orbitex fund is up one to two percent in the first half of this year as Krill benefited from owning oil service stocks such as Camco International Inc , Weatherford Enterra Inc and Western Atlas Inc , which have all been takeover targets.
Of his portfolio, 15 percent is invested in large cap oil stocks, 10 percent in oil services and 25 percent in exploration and production stocks.
He owns 55 stocks, a lot for such a small fund, but says that you need diversification in the exploration and production sector.
"When the tide rises it will lift them all," Krill said.
Other key holdings are in the Canadian energy sector, where distressed share prices, big reserves and the weak Canadian dollar has prompted a rash of acquisitions by U.S. companies.
"All of the negatives are out there," Krill said.
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