Downturn hobbling upstream technology R&D

Dean E. Gaddy
Drilling Editor

New technology and the business cycle [87,903 bytes]
Cost comparison of top 24 U.S. Oil and gas producers [135,403 bytes]
Non-Opec 1999 Production Decline Scenario [67,766 bytes]
Serious concerns of declining capital availability, the lack of technology sponsorship, and the growing threat of depletion are among the top concerns over the state of drilling and production technology worldwide.

Those issues were at the forefront of the Society of Petroleum Engineers/ International Association of Drilling Contractors Drilling Conference in Amsterdam earlier this month.

According to one panel, service companies must find new and more efficient means to manage technology as the industry undergoes continued restructuring.

Managing cycles

Jon Cole, senior vice-president for Transocean Offshore Inc., said, "The role of technical innovation continues to be turned over to the service industry...and with the current (economic) issues in place, consolidation is accelerating this trend."

But Cole feels that service companies "cannot continue to do a good job" in managing technology development. "Because of the cyclic nature of the industry, small companies just aren't doing much in the way of R&D."

Cole noted that technologies are typically invented at the peak of a cycle, developed while commodity prices fall, and fully implemented at the bottom of the cycle (see chart, this page). Thus, during the current downturn, there is nothing going on in the way of technology development.

"With the operators' reduced role in technology (development)," Cole said there is a real need for a new business model that balances the respective profitability of both the operator and service company. This model should include a focus on cycle-time reduction, a new method of financial evaluation, and level-loading for service contracts. "We need to look at the economics of the projects as a whole instead of using day rates" as a key driver behind decision-making policies.

Rising costs

Matt Simmons, president of Simmons & Co., Houston, said finding costs have actually gone up, not down, despite advances in seismic, deepwater, and horizontal drilling technologies. Simmons referred to the Energy Information Administration's Annual Performance Profiles of Major Energy Producers, finding a substantial disagreement between two accounting methods.

Reviewing the numbers for 24 U.S. oil and gas producers with the GAAP (generally accepted accounting principles) accounting method, Simmons noted that in 1997, each barrel of oil equivalent earned revenues of $15.65, while total expenses, DD&A (depreciation, depletion, and amortization), and income taxes incurred costs of $12.44/boe (see table, this page). Factoring in unusual items, this resulted in per-barrel net income of $3.83, up $0.07 from a year earlier. However, "Cash accounting is not what it appears to be."

Simmons found in the same report what he feels is a more appropriate cost compilation. "When you subtract expensed and capitalized costs along with taxes paid from revenues, we come up with a (per-barrel) cost of $15.59, or $0.06 net cash before dividends." Therefore, "If we were to drop 1997 (oil) prices by 35% (as occurred over the past year), net cash would turn out to be a negative $28.6 billion for these 24 companies," he said.

Simmons also noted that, during 1988-97, the top 10 exploration and production firms raised daily oil and gas output a mere 0.7%/year, despite advances in technology. "These companies spent $82 million/day to keep production flat," Simmons said.

In the current environment, where most companies are cutting E&P budgets, depletion may severely affect oil and gas production. "Depletion is infinitely more powerful than the Asian crisis," even greater than the effect of shut-in wells, he said.

"Of the 24 companies presented in the EIA study, there was a per-annum depletion rate of 15%, of which it took $40 billion to just maintain a flat production rate."

Now that companies are cutting budgets, "there is no momentum to supply," and production is certain to fall, he said.

As the market reacts to low oil prices, Simmons feels the "supply drop could be far worse" than anticipated. February estimates by the EIA show a "non-OPEC supply gain of 400,000 b/d by fourth quarter 1999, while pessimists think it will be lower."

However, Simmons estimates there will instead be a 1 million b/d drop in non-OPEC supply, "and it could be far worse, as much as 3.5-4.0 million b/d (see table, this page)."

Focus on key technologies

Bernard J. Duroc-Danner, chairman and CEO of Weatherford International Inc., offered some solutions to the current plight of service companies in relation to technology development: "Do not spend money on science projects; instead focus on the problem at hand...(And) don't reinvent the wheel."

With the flight of capital away from the service sector, Duroc-Danner feels there are two approaches to technology development: consolidation and selective product and service development.

For the top 10 service companies, total equity capitalization has dropped to $53.5 billion, down $32.3 billion from a year ago. Through consolidation, he said, companies can achieve higher efficiencies in the service and manufacturing sectors by eliminating "duplication."

Duroc-Danner said "Mechanical (technologies) need to catch up with information (technologies)," citing the need for continued progress in intelligent well completions, reentries, and artificial lift.