Settle for a slowdown

Dec. 18, 2006
Elevated exploration and production activity has driven up costs for operators. This was bound to lead to a slowdown in companies’ ability to continue to drill and profit at the accelerated pace of the past couple of years, which originally was spurred by rising worldwide demand for oil and gas amid limited excess production capacity.

Elevated exploration and production activity has driven up costs for operators. This was bound to lead to a slowdown in companies’ ability to continue to drill and profit at the accelerated pace of the past couple of years, which originally was spurred by rising worldwide demand for oil and gas amid limited excess production capacity.

Earlier this month Devon Energy Corp. announced that it was reducing its 2007 capital budget projections from its 2006 E&P spending. In addition, the Oklahoma City oil and gas producer forecast that its production volumes next year and through 2009 will be lower than originally projected.

The reasons behind the reduced projections include rising costs of services and equipment in Canada, where the development of heavy oil demands abundant resources, human and otherwise.

Devon said it had cut activity levels on conventional gas projects in Canada until business conditions improve.

“Competitive pressures for equipment, services, and supplies in Canada have created a highly inflationary cost environment. In addition, the strengthening of the Canadian dollar relative to the US dollar has negatively impacted profit margins on these projects,” the company said. This curtailment of drilling activity in Canada is the largest factor contributing to the revisions from Devon’s previous estimates of production over the next 3 years.

Also, Devon said this year’s higher-than-expected oil prices and higher forecast prices for 2007-09 have reduced its expected production from areas where the company operates under production-sharing agreements. Under the terms of PSAs, higher oil prices increase revenues and profitability, but higher prices also reduce reported production volumes.

Devon is not the only company to forecast a slowdown in its investments for 2007. E&P spending in Canada this year will decline 8% following a 19% increase last year, according to the newest Lehman Bros. E&P spending survey.

In addition to reduced spending, there will be a decline in E&P of conventional oil and gas and a rise in the development of oil sands and coalbed methane in Canada. And a growing amount of natural gas will be required for oil sands development.

How high, how fast?

Oil sands now account for 39% of Canada’s total oil production at approximately 1 million b/d, according to the Canadian Association of Petroleum Producers (CAPP). By 2020, production will grow to 4 million b/d, CAPP says.

The association’s latest figures show that in 2005, capital spending on oil sands projects grew to $10.4 billion (Can.) from $6.2 billion (Can.) a year earlier. Over the same period, capital spending on conventional oil and gas projects in Canada grew 30% to $34.8 billion (Can.).

Growth in the number of wells drilled was not as pronounced as in 2005, though. The number of gas wells drilled in Canada grew 5%, while the number of oil wells drilled there last year climbed 21%.

A presentation by CAPP’s Greg Stringham to the 2006 annual meeting of the Independent Petroleum Association of America in October showed that the association expects the total number of wells drilled in Canada to decline 6% in 2007. The number of conventional gas wells drilled in western Canada is expected to decline next year, while the number of coalbed methane wells in that part of the country, especially in Alberta, is forecast to increase.

Finding and development costs for natural gas in Canada have risen dramatically since 1987. Stringham’s figures showed that the 5-year rolling average had soared to nearly $2.50/Mcf (Can.) in 2004 from less than 50¢/Mcf (Can.) in the late 1980s.

Stringham predicted that in 2007 lower commodity prices and reduced capital investment will be realities in Canada, as drilling and land sales decline. But he said costs will continue to rise. Globally, the cost of steel and other materials will rise next year but will begin to plateau.

In addition, the cost of labor will remain tight in Canada, as demand for workers to mine and upgrade oil sands stays strong. CAPP projects that capital expenditures for oil sands in 2007 will be the one growth area, with outlays up $1.5 billion (Can.) from this year. The good news is that the overall decrease in E&P activity should mean that land and drilling costs will begin to moderate.