Despite recent surveys revealing that exploration and production companies' worldwide E&P spending for 2003 will be flat to slightly elevated compared with last year, a recent research note released by Raymond James & Associates Inc. RJA stated that outlays would in fact likely be more than 20% higher than originally anticipated.
The typical annual surveys, said RJA analyst Marshall Adkins, overlook two critical points: "1) E&P companies have no incentive to tell the truth to surveyors, and 2) Actual cash flows (not budgets) drive actual E&P capital spending." Most surveys this year, Adkins noted, take into consideration a sub-$3.50/Mcf natural gas expectation, whereas the current 12-month gas futures strip hovers around $4.60/Mcf.
Adkins expects E&P firms to "generate substantially larger amounts of free cash flow" due to this gas price discrepancy. "That means that when it is all said and done, E&P spending in 2003 is likely to be at least 20% higher than it was last year," he said.
In an analysis of the last 10 years of E&P spending, in 9 of those years, E&P firms spent more than they generated. "The reason E&P companies typically don't generate (free cash flow) is that they adjust their spending over the year to match cash flows," Adkins said. "Because of this history, it seems pretty safe to assume that cash flow is the driver for capital spending and the budgets only serve as a guideline if commodity prices meet managements expectations for the year."
However, there will be a limitation placed on this increase in spending, Adkins noted. "The limitation on the increase in spending will be readily drillable prospects, rigs, and people rather than available cash."
He added, "On the oil field service side, these higher-than-expected E&P cash flows should lead to increased activity for the oil field service companies and an increase in the rig count in 2003 over 2002."