Low oil prices cause U.S. and Canadian firms to curtail capital outlays in 1999

Robert J. Beck
Associate Managing Editor-Economics

How U.S. Petroleum Capital Spending Has Varied [89,506 bytes]
Where funds go for 1999 U.S. Projects [116,339 bytes]
Non-north American spending plans of 32 U.S. companies [116,339 bytes]
Canadian spending plans [111,379 bytes]
Oil and gas company U.S. capital spending is expected to fall sharply in 1999, driven by extremely low oil prices and weak natural gas prices.

Companies also plan to slash investments in areas outside of the U.S. and Canada for the same reasons, and because of uncertainty concerning future price and demand levels.

A year ago, spending for 1998 was expected to increase, for the fourth year in a row and to the highest industry investment level since 1985. However, at the time, oil prices were falling, and there was some skepticism about whether companies would actually spend the amounts budgeted (OGJ, Mar. 23, 1998, p. 40).

Prices continued to plummet, and spending was cut later in the year-particularly upstream outlays. Total 1998 outlays ended down 7% from 1997 levels.

Current plans call for significant spending cuts in the U.S. again this year, both upstream and downstream. Oil & Gas Journal's annual capital expenditure survey shows companies plan to spend $32.6 billion on U.S. projects in 1999, down 20.6% from about $41 billion in 1998 .(see table, p. 46) [262,144 bytes]

Oil and gas industry total U.S. capital spending hit a high of $83 billion in 1981. Subsequent decreases in oil prices, company revenues, and company profits led to a sharp decline in industry spending, which hit a low of $25.2 billion in 1987.

Since then, during 1988-98, industry capital spending movements have been somewhat less volatile, and outlays have averaged $34.5 billion/year.

For 1999, weak crude oil and natural gas prices, together with slowing growth in worldwide petroleum demand, have cut company cash flow and profits. That has reduced the funds available for new project investment.

The view of the immediate future is still clouded, with economic turmoil continuing in a number of Asian and South American countries, coupled with the collapse of oil prices.

Prices and demand

The growth in worldwide demand for petroleum products and crude oil stagnated in 1998, due to economic turmoil in many of the developing industrial countries of Asia and South America. According to the International Energy Agency (IEA), worldwide demand for oil averaged 73.8 million b/d in 1998, up only 0.5% from the 73.4 million b/d in 1997.

Crude oil production capacity was developed to meet earlier projections of much stronger demand growth. As a consequence, excess supply was made available and forced down crude oil prices.

It is roughly estimated that 1998 production exceeded demand by 1.4 million b/d, which went into storage. Some production capacity was shut in last year, however, due to slumping prices and lower demand.

The average price for world export crude oil fell to $11.92/bbl in 1998, down 35% from $18.38/bbl in 1997. And prices remained weak at the start of 1999. In February this year, the average price of world export crude oil fell to a low of $9.47/bbl.

The price for West Texas intermediate (WTI) crude oil dropped to an average $13.55/bbl for 1998, down 31% from an average $19.73/bbl in 1997. In February this year, the average WTI price slipped as low as $10.75/bbl, with producers in many areas often getting considerably less for their crude oil production.

For 1999, the IEA is projecting worldwide demand of 74.7 million b/d, up 1.2% from 1998. This may result in some upward pressure on prices later in the year, after some of the huge crude and product inventories have been worked off.

Upward price pressure could also come from production cuts by Organization of Petroleum Exporting Countries (OPEC) producers, and by non-OPEC countries such as Mexico, Norway, Oman, and Russia. These countries recently have made pledges to cut output significantly (OGJ, Mar. 29, 1999, p. 18). And OPEC is adjusting quotas to reflect current market conditions.

These pronouncements have resulted in a recent rise in crude oil prices. In the longer run, however, many market analysts are skeptical, since past pledges of production cuts have not been effective.

Natural gas prices also slipped in 1998 and were weak at the start of this year. The Nymex futures market price for natural gas averaged $2.16/MM-BTU in 1998, down 12% from $2.46/ MMBTU in 1997. And the price slip- ped as low as $1.67/MMBTU in late February this year.

The Henry Hub spot price for natural gas averaged $2.09/MMBTU in 1998, down 15% from $2.47/MMBTU in 1997. The Henry Hub price has slipped further this year, to $1.69/MMBTU in early March.

Demand for natural gas in the U.S. weakened in 1998. Initial estimates by the Energy Information Administration (EIA) show 1998 U.S. natural gas consumption at 21.331 tcf, down from 21.967 tcf in 1997. Warmer-than-normal winter weather reduced residential, commercial, and industrial demand.

Expectations for 1999 are for slightly higher demand with a return to closer-to-normal weather. However, in some natural gas markets there will be stiff price competition from petroleum products, distillate, and residual fuel oil.

U.S. upstream spending

Budgets for U.S. exploration and production call for a sharp drop in spending in 1999, down 24.3% to $18.8 billion. Falling crude oil and natural gas prices also led to a drop in 1998 E&P spending, down 13.1% from 1997, to $24.8 billion.

The level of E&P outlays in 1998 was significantly lower than the plans reported by OGJ a year ago. Last year, industry plans were for E&P spending of $27.9 billion, down 2%. As the year progressed and prices weakened, companies cut back on authorized outlays for E&P projects.

In recent years, new discoveries have significantly boosted interest in offshore prospects. This increased outer continental shelf (OCS) lease bonus payments to $1.411 billion in 1997. There was a slight drop in OCS lease bonus payments in 1998, however, when they were down 6.4% to $1.32 billion.

The drop in cash flow is expected to reduce lease payments further in 1999. The U.S. Minerals Management Service (MMS) is estimating OCS bonus payments of only $725 million in 1999.

Although interest remains high, current depressed oil and natural gas prices do not produce sufficient revenue to justify costly offshore projects.

The drop in commodity prices also resulted in a sharp decline in U.S. wellhead revenues in 1998. In 1996, wellhead revenues had risen to $86.4 billion, the highest level since 1985. Crude oil prices slipped marginally in 1997, and wellhead revenues dipped to $85 billion. In 1998, wellhead revenues plummeted, falling 30% to $59 billion. This dried up a significant portion of funds for exploration, drilling, and production activity.

Capital spending on exploration and drilling fell 13.1% in 1998 to $19.8 billion. One year ago, a decline of only 1% was projected for 1998, however.

Plans for this year call for a sharp decline in E&D spending, down 23.1% to $15.2 billion.

Capital spending on production and new enhanced-recovery project facilities fell 15.6% in 1998 to $3.8 billion. Spending is projected to slip further this year, by 23% to $2.9 billion.

U.S. E&P spending peaked at $57.8 billion in 1981. Following the subsequent plunge in oil prices, E&P outlays dipped to $14.2 billion in 1987.

During the past 10 years, E&P spending has shifted with changes in oil and gas prices. The outlays have ranged from $12.8 billion in 1992 to $22.7 billion in 1997.

The level of spending is reflected in the U.S. rig count and U.S. well completions. The number of active rotary drilling rigs in the U.S., measured by Baker Hughes Inc. since 1944, hit its peak in 1981, averaging 3,970 for the year. The rig count then plummeted to a low of 717 in 1992 and remained below 800 during 1992-96.

With the increase in wellhead revenues, there was a modest recovery in 1997, and the Baker Hughes count of active rotary rigs increased to an averaged 945. But as prices fell last year, so did drilling activity, and the rig count dipped to average 831 active rigs for the year.

The rig count fell sharply at the end of last year and into the start of 1999. The rig count set modern record weekly and monthly lows in February this year. A weekly low of only 531 active rigs was set on Feb. 19, 1999, and a record average monthly low of 542 active rigs was set for the month.

The number of U.S. well completions peaked in 1981 at 89,234. Well completions for 1998 are estimated at only 23,900. OGJ is expecting rig activity and well completions to drop again in 1999 due to lower oil and gas prices and reduced wellhead revenues. OGJ has forecast rig activity averaging a modern record low 700 and well completions at 20,970 in 1999 (OGJ, Jan. 25, 1999, p. 73).

With the slow start to the year, both the rig count and number of well completions could be even lower than forecast in January. Rig activity may drop as low as an annual average of only 650 active rigs, and well completions could fall below 20,000.

U.S. downstream spending

U.S. non-E&P spending is also projected to drop significantly in 1999, down 15% to $13.8 billion. This follows an increase in downstream spending of 4.4% in 1998 to $16.2 billion.

A decline in spending is expected in almost all categories, including marketing, petrochemicals, pipelines, transport, and other activities. The one exception could be refining, where increased petroleum product demand is helping to sustain outlays.

Last year, there was a substantial increase in refining spending and a modest increase in petrochemicals, marketing, pipelines, and transport outlays. Most downstream projects have long lead times, so the outlays were supported by revenues generated in earlier years, and by increased petroleum and petrochemical demand, spurred by low prices and continued economic growth.

Total spending on pipelines was up 2% in 1998 at $2.617 billion. Pipeline spending is expected to fall 17.7% in 1999 to $2.153 billion.

Plans call for 1,734 miles of natural gas pipeline and 1,540 miles of crude oil and product pipeline to be laid in the U.S. in 1999 (OGJ, Feb. 8, 1999, p. 36). This is down from 3,104 miles of natural gas pipeline and 2,498 miles of crude oil and petroleum product pipeline planned in the U.S. in 1998 (OGJ, Feb. 9, 1998, p. 37).

Refining capital spending moved up 12.4% in 1998 to $3.486 billion. Spending in the refining sector is estimated to increase another 1.1% in 1999 to $3.525 billion. Outlays in 1999 will include spending aimed at increasing capacity, upgrading existing facilities, and meeting ever-changing environmental standards.

Capital spending in the refining sector hit a record high $6.1 billion in 1992, as outlays for environmental projects peaked. Spending in this sector has reflected the steadily increasing U.S. demand for petroleum products. U.S product demand has increased for 7 consecutive years and is projected to increase again this year.

The refining sector has opted to boost U.S. refining capacity rather than let petroleum product imports meet increased demand. To meet steadily rising demand, U.S. refiners have been slowly adding incremental capacity at existing plants. This has been done by renovating and restarting idled units and by adding new units.

According to the American Petroleum Institute (API), U.S. operable refining capacity increased from an average 15.239 million b/d for 1996 to 15.594 million b/d for 1997, and further to 15.785 million b/d for 1998.

It remains to be seen whether there is a physical limit to this type of incremental addition, and if the U.S. refining industry will be able to meet the projected future increases in domestic product demand.

According to API, the U.S. refinery utilization rate averaged 95.2% in 1997 and 95.4% in 1998. That is close to maximum sustainable capacity utilization.

Capital spending on petrochemical facilities is projected to fall 30.1% in 1999, to $2 billion. Spending in this sector increased 3.9% last year to $2.87 billion. Worldwide, the petrochemical industry has a history of increasing capacity sharply in response to higher demand, and that has produced periods of excess capacity and sagging earnings. Those capacity cycles are also characterized by periodic sharp swings in capital outlays.

Capital spending on products marketing facilities is expected to fall 13.6% in 1999 to $2.6 billion. Last year, marketing outlays increased 2.2% to $3.024 billion. But this was less than the expected 1998 outlay of $3.46 billion projected a year ago.

Changing market strategies and locations, increased motor gasoline demand, restructuring, competition, and a shifting consumer preference for convenience stores have pushed up marketing outlays in recent years. But lower cash flow in 1998 and 1999 has resulted in budget cuts this year.

Capital spending on transport equipment other than pipelines is expected to drop 9.2% in 1999 to $681 million, compared with an increase of 3.9% in 1998 to $750 million. Spending in this sector is sensitive to changes in the location of petroleum product demand and changes in the volume of imports.

Capital spending by petroleum firms on non-petroleum activities in the U.S. will fall 19.3% in 1999 to $2.8 billion. Non-petroleum spending by industry companies increased 1.1% in 1998 to $3.5 billion. Spending in these areas is also greatly influenced by recent cash flow levels.

Capital spending in Canada

Another significant decline is expected in total capital and exploration spending for the Canadian petroleum industry. Plans show a drop of 9.8% in 1999 to $11 billion.

Last year, Canadian capital spending fell 14.9% to $12.2 billion. The decline in outlays in 1998 and the lower spending plans for 1999 are due to a significant drop in upstream spending.

Canadian E&P spending was somewhat depressed during the early 1990s, averaging only $5.5 billion/year. But Canadian E&P spending increased during 1994-97, averaging $9.7 billion/year.

Canadian gas production increased significantly to provide greater exports to U.S. markets, and to support rising domestic demand. And higher oil prices and production sparked increased drilling activity.

But the slump in gas demand in the U.S., and lower oil and gas prices, have had a negative impact on spending in 1998, and on spending plans for 1999.

E&P spending is projected to fall 13.2% in 1999 to $8.2 billion. This follows a decline of 20.7% last year, when E&P spending was an estimated $9.4 billion.

Canadian E&P spending hit a recent high of $11.9 billion in 1997.

The number of active rotary drilling rigs in Canada increased to an average of 375 in 1997, from 270 in 1996 and 229 in 1995. The 1997 figure was the highest since the 1980 record of 401 active rigs. The number of active rigs in Canada averaged only 97 in 1992.

Last year, the Canadian rig count started off strong, then dropped sharply starting in the second quarter. The annual average active rig count fell to 260 for 1998.

The slump in Canadian drilling continued into the first part of 1999. In February this year, there was an average 331 rigs working, down from 507 a year earlier.

This will reduce well completions for the year. OGJ projects a decline in Canadian well completions for 1999, down 12.4% to 8,223 (OGJ, Jan. 25, 1999, p. 73).

Canadian downstream spending is expected to increase slightly in 1999 due to higher pipeline outlays. Total downstream capital spending is projected to be up 1.6% at $2.832 billion. Last year, downstream spending increased 13.1% to $2.788 billion.

Canadian refining spending will be off 8.3% in 1999 at $319 million. Last year, refining outlays were up 12.6% at $348 million.

Petrochemical spending will drop 11.5% in 1999 to $100 million. And marketing outlays are projected to be off 1.4% in 1999 at $344 million. Last year, marketing spending increased 8.4% to $349 million.

In 1999, spending for crude oil and petroleum product pipelines is expected to increase 8.4% to $1.23 billion, from $1.135 billion in 1998 and only $495 million in 1997. Outlays for natural gas pipelines will increase a marginal 0.6% to $321 million vs. $319 million in 1998.

A total of 1,835 miles of new pipeline construction is planned for Canada in 1999 (OGJ, Feb. 8, 1999, p. 36). This is down from 2,637 miles planned last year (OGJ, Feb. 9, 1998, p. 37).

Spending on all other types of transportation will drop 23.1% to $80 million vs. $104 million in 1998.

Spending on mining and other energy projects, which include oilsands development, is planned to move up 7% in 1999 to $321 million. Outlays in this sector were up 6.8% in 1998 at $300 million.

Canadian oil and gas industry capital spending on non-petroleum activities is planned to be down in 1999, at $117 million compared with $120 million in 1998.

Spending outside U.S., Canada

U.S. and Canadian companies are also planning to cut spending on projects outside of the U.S. and Canada.

Over the past decade, there has been a shift in industry capital spending to areas outside of North America. That trend is not ending. But companies are closely scrutinizing outlays on all projects due to changing global and industry economics.

The OGJ survey collected data from 32 U.S. and Canadian companies that are planning capital and exploration expenditures outside of the U.S. and Canada. These companies plan to spend a total of $23.5 billion in 1999, down 23.7% from $30.8 billion in 1998. Outlays for these companies totaled $29.5 billion in 1997.

Upstream spending is planned to be down 24.9% at $17.4 billion. This compares with $23.1 billion in 1998 and $22.1 billion in 1997.

The international rig count for activity outside of the U.S. and Canada averaged 809 rigs in 1997 but fell to 755 in 1998. The international rig count started this year with an average of only 634 active rigs in January, down from 819 a year earlier.

Non-E&P spending outside the U.S. and Canada is expected to be down 20.1% at $6.1 billion. Downstream outlays were $7.7 billion in 1998, up 4% from $7.4 billion in 1997.

Spending is expected to be down for all downstream sectors except pipe- lines. Refining outlays for this group will be down 17% at $1.2 billion. Petrochemical spending will be off 30% at $2.1 billion. Marketing spending is planned to be down 17.7% in 1999 at $2.2 billion.

Pipeline spending by these companies will rise to $309 million from $198 million last year. All other spending outside the U.S. and Canada for this group will be down 10% at $280 million. Other outlays totaled $310 million in 1998 and $631 million in 1997.