Worldwide capital outlays expected to moderate in 2004

April 5, 2004
Oil and natural gas industry capital spending in the US and Canada will be little changed in 2004 from last year's increased investment.

Oil and natural gas industry capital spending in the US and Canada will be little changed in 2004 from last year's increased investment.

Following sizable gains last year, capital expenditures for exploration, drilling, and production will increase modestly this year in the US but will see a small decline in Canada.

Companies will spend a bit more this year on downstream projects in the US, with the exception of natural gas pipelines.

The brunt of spending that will be required to ramp up LNG receiving and regasification capacity in North America will not be felt this year, as many plans are still being made and companies endure a strenuous round of permitting to bring such projects to fruition.

Outside the US and Canada, capital expenditures will grow slightly, with a mixed bag of changes among individual companies' spending plans.

As oil and gas prices have remained at elevated levels for an unusually long time, most companies expect that strong commodity prices will allow them to fund their 2004 projects through cash flow.

The results of this report are taken from Oil & Gas Journal's annual capital spending survey of oil and gas companies based in the US and Canada. All figures are in US dollars.

Oil and products market

Inventories of oil are tight, and the Organization of Petroleum Exporting Countries has planned to cut output during the second quarter. These factors have contributed to keeping oil prices high for a sustained period.

The US Energy Information Administration reported that for the week ended Mar. 12, US commercial crude oil inventories, excluding those in the Strategic Petroleum Reserve, were 23.4 million bbl below the 5-year average for that time of year.

Other likely factors sustaining oil price strength are the weak US dollar and high oil demand in China. The International Energy Agency estimates that Chinese oil demand grew 550,000 b/d last year to average 5.5 million b/d. The Paris-based agency projects that oil demand in China will grow another 580,000 b/d this year.

The March contract for crude oil on the New York Mercantile Exchange closed at $35.60/bbl. Last year the March delivery contract closed at $36.79/bbl. In 2002, the same contract closed at $20.29/bbl.

For the first time since Oct. 16, 1990, the NYMEX near-month futures contract closed over $38/bbl last month following terrorist attacks in Madrid and Iraq.

"The oil market is facing a bizarre dichotomy, with soaring prices at the same time that the supply-demand balance appears to be worsening rapidly. This reflects in part the fact that inventories drive prices and—while tight—are a lagging indicator," said Michael C. Lynch, president of Strategic Energy & Economic Research Inc.

"But also," he added, "large speculators have taken heavy long positions expecting some combination of supply disruptions and gasoline price spikes in the US. Their positions almost certainly represent an extreme, which can only be unwound, perhaps precipitously, leading to an abrupt cliff for the price trend."

Product inventories have been tight recently also, causing concerns and prices to rise. EIA reported that for the week ended Mar. 12, stocks of motor gasoline were 9.8 million bbl below the 5-year average.

Lynch said that it appears that too much is being made of low reformulated gasoline inventories. "The increased used of ethanol blends means a shift to last-minute blending and thus lower inventories for finished gasoline and higher inventories for blending components. Speculators don't seem to have caught this," he said.

"And the early [gasoline] price spike will attract higher imports and see prices drop by the summer driving season, as they did in 2001, rather than move even higher. Localized problems in New York and California won't have much impact on the rest of the country, being due to the ban on [methyl tertiary butyl ether]," Lynch concluded.

US natural gas market

Tight supplies and high prices also have strained the US natural gas market. The NYMEX near-month gas price has not dipped below $5/Mcf since late November 2003.

LNG imports will continue to grow this year, alleviating some of the pain caused by declining domestic supplies.

Total US gas imports declined last year despite a more than doubling of LNG imports. The US imported 229 bcf of LNG in 2002. LNG imports grew to 507 bcf last year as security concerns eased and additional receiving capacity became available.

Almost 14% less gas reached the US from Canada in 2003 than during 2002.

Demand for gas in Mexico absorbed all of the gas that was being exported from that country to the US.

The amount of working gas in storage has recovered somewhat from a year ago, when levels hit the bottom of their 5-year average range. Working gas in storage was 1,097 bcf as of Mar. 12, according to EIA estimates. Stocks were 443 bcf higher than last year at this time and 68 bcf below the 5-year average of 1,165 bcf.

Finding costs

Analysts Thomas Driscoll and Sangita Jain of Lehman Bros. reported last month that while all-in finding and development costs for the large, US-based E&P companies declined in 2003 for the first time in 5 years, drillbit-only costs increased 5-10% in the US and Canada.

Driscoll and Jain believe that marginal drilling earns unacceptable returns in North America despite high prices. "As a result of increasing costs, oil and gas companies may consider cutting reinvestment rates," the analyst said in a recent report.

"Increasingly investors are rewarding those companies that cut budgets and use the free cash flow to make acquisitions, increase dividends, or reduce debt," the report said.

The analysis added that drilling capital has fallen to 65% of cash flow in 2003 from 73% in 1999 for the large US E&P companies.

The Lehman analysis of finding cost trends also concluded that drillbit costs in Canada have been higher than in the US for its survey group of companies in each of the past 4 years.

"Several US companies have cut back or deemphasized Canadian operations. The recent appreciation of the Canadian dollar has further hurt Canadian drilling economics," the report said.

US upstream spending

Capital budgets call for a 5% increase in E&P spending in the US this year. This follows a 24% jump in spending last year.

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Companies ramped up spending last year as the recovering economy gave a boost to demand. Commodity prices were strong following a period of constrained supplies.

Flush with cash, oil and gas producers turned back to drilling and exploration. For 2003, the average Baker Hughes Inc. count of active rotary rigs in the US was 1,032, up 201 from the year before.

Continued strength in the sector has kept the rig count elevated this year, averaging 1,101 in January and 1,119 in February.

Total upstream expenditures in the US will be $52.9 billion this year. OGJ estimates that spending for drilling and exploration will be $44 billion, up from $42 billion last year.

Geological and geophysical outlays will account for $5.7 billion of this year's exploration and drilling budgets.

Capital expenditures for production and enhanced recovery projects will be $8.4 billion this year, posting a 4.7% gain from last year.

There are three Outer Continental Shelf lease sales scheduled for this year, two in the Gulf of Mexico (GOM) and one in Alaska.

The US Minerals Management Service forecast that total lease bonus payments from these three sales will be $500 million.

OCS lease bonus payments were $452 million last year with three GOM lease sales and $504 million in 2002 with two lease sales in the GOM.

Other US expenditures

Total US spending for all other activities in the oil and gas industry will decline in 2004.

A large reduction in the amount of money spent on natural gas pipelines this year will offset increases in all other categories.

OGJ projects that total US nonupstream oil and gas spending will decline 6% to $18.3 billion.

Pipeline construction—specifically for gas lines—will decline this year in the US, causing pipeline spending to plunge.

Plans call for only 164 miles of gas pipelines to be constructed this year (OGJ, Feb. 2, 2004, p. 60). This will bring gas pipeline spending to an estimated $2.4 billion, down from $5.3 billion last year.

Conversely, the amount of construction planned for crude and products pipelines is up from a year ago.

Plans call for 558 miles of crude and products lines to be built in the US, pushing expenditures to $297 million vs. $253 million last year.

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Refiners will spend more money this year on capital projects. As a result of growing demand for petroleum products, refineries are running in excess of 90% of capacity.

Capital expenditures this year will be allocated not only for expansion projects but also for the continuing effort to bring gasoline and diesel up to new environmental specifications.

Refining capital spending in 2004 will total an estimated $7 billion in the US, up 11% from a year ago. Petrochemical spending will rise nearly 8% to $700 million.

Outlays for transportation equipment other than pipelines will increase slightly to $720 million this year. Spending in this sector is sensitive to geographic changes in petroleum product demand and changes in the volume of imports.

Spending on marketing vehicles, including convenience stores, will increase less than 3% to $2 billion following a decline a year ago.

Expenditures for mining and other nonpetroleum projects, which generally fluctuate with cash flow, will climb 12.5% following a large jump last year.

All other capital expenditures will increase as well.

Capital expenditures in Canada

Total capital spending in the Canadian oil and gas industry this year will be nearly unchanged this year, declining just 1%. While upstream investments will decline, other outlays will increase slightly.

Total expenditures will be $20 billion, with more than two thirds allocated to the upstream sector.

E&P spending will remain strong as long as oil and gas prices and demand are robust.

The Baker Hughes count of active rotary rigs in Canada jumped last year to average 372 vs. 266 a year earlier. So far this year, the count has climbed, averaging 554 in January and 568 in February, up from 417 in December. The count has also revealed year-on-year gains during 2004.

Upstream spending in Canada will decline 2% this year. This follows a 24% surge last year.

OGJ estimates indicate that the number of well completions in Canada last year increased to 20,333 from 13,380 in 2002 (OGJ, Jan. 27, 2004, p. 47). OGJ projects that well completions in Canada will moderate to 18,843 this year.

This will reduce exploration and drilling outlays to $9.7 billion from $9.9 billion last year. In 2002, spending for exploration and drilling totaled $8 billion.

Production expenditures will total $4.1 billion, down minimally from last year. In 2002, production spending dipped to $3.4 billion from $4 billion the previous year.

Downstream capital expenditures in Canada will barely increase this year. A decline in petrochemical sector spending will offset increases in refining and pipeline outlays.

Total downstream spending will be $6.3 billion, up from $6.2 billion last year.

An uptick this year in pipeline construction will result in an increase from anemic pipeline expenditures last year. Adequate capacity following a boom in 2002 construction has left little need for new lines.

Construction plans call for 164 miles of new natural gas pipelines and 60 miles of crude and product lines this year in Canada.

OGJ expects that gas line expenditures will total $119 million, up from $106 million last year.

This compares with $762 million in gas pipeline construction spending 2 years ago.

Spending for crude and products pipelines this year in Canada will move up to $43 million vs. $29 million last year and $738 million in 2002.

Capital expenditures for modes of transportation other than pipelines will increase 10% this year following steady outlays of $200 million the past 2 years.

Capital outlays in Canada's refining sector will increase 14% this year. Much of the estimated $370 million in expenditures will be devoted to helping refineries meet new low-sulfur diesel requirements.

Petrochemical and marketing expenditures will decline, but spending for mining and other energy projects, including oil sands development, will increase. Capital budgets will allocate $4.4 billion to mining and other projects this year, up from $4.3 billion a year ago.

Canadian oil and gas industry spending for all other activities, including corporate and information technology expenses, will be unchanged at $550 million this year.

Spending outside the US, Canada

Outside the US and Canada, capital expenditures will increase, but by a smaller margin than during 2003.

The companies in OGJ's survey will spend more on drilling this year, and production expenditures will be unchanged following a 30% gain last year.

Collectively the companies in this year's survey will boost drilling outlays 2% in areas other than the US and Canada.

Last year these companies spent 9% more on such projects than during 2002.

Burlington Resources Inc. reported in December 2003 that it would allocate about 15% of its 2004 capital budget to projects outside North America, down from the 2003 allocation of 25%.

The decline was due to the completion of several major development projects in Algeria, the South China Sea, and the East Irish Sea.

Burlington plans to spend $59 million on exploration outside the US and Canada this year, up from $37 million last year, but development spending this year will decline to $140 million from $236 million a year ago.

Expenditures for plants, pipelines, and other facilities in these locations will decline to $14 million this year from $129 million in 2003.

Anadarko Petroleum Corp. said in February that its capital spending program for Algeria will remain flat compared with 2003.

The company plans to spend less than $70 million, with an increased emphasis on exploration this year, drilling or participating in about 25 development wells to further develop Ourhoud and Block 404 fields.

Elsewhere, Anadarko plans to spend about $100 million, primarily for ongoing development projects in Venezuela and exploration drilling in Qatar and Tunisia.