Costs soar, replacement rates dropped in 1998

U.S. Oil company operational performance* [94,600 bytes]

Nineteen ninety-eight was an abysmal year for the U.S. upstream oil and gas industry, according to John S. Herold Inc., Stamford, Conn.

In its annual reserve replacement cost analysis, Herold revealed just how poorly the U.S. exploration and production sector performed last year. After-tax profits for a group of 50 companies fell 86% last year vs. 1997 levels.

"With respect to upstream investment performanceellipse1998 was a year most U.S. oil industry executives would like to forget," said Herold. "As wellhead crude prices plunged in value by over a third and U.S. natural gas price slumped 13%, E&P executives doggedly moved ahead and invested exploration and production capital at a near-record pace (for recent years).

"With rising oil field costs and a rising industry commitment to higher-cost exploration projects, 1998 (U.S.) resource development results were abysmal, as reserve volume additions were subpar and per-unit costs soared to uneconomic levels."

Internationally, the industry fared only slightly better. In Herold's survey of global industry operations, 140 public companies revealed a total drop in profits of 83%.

Reserves

For Herold's U.S. upstream analysis, spending and performance data were summarized for 50 publicly traded oil and gas companies. These firms account for about 50% of U.S. proved oil reserves, 55% of U.S. natural gas reserves, and 54% of U.S. oil and gas production.

Among Herold's findings was that, for the first time in 5 years, U.S. proved oil reserves declined. The net loss was "an alarming" 895 million bbl, or nearly 5%, said Herold, taking reserves to 18.2 billion bbl.

U.S. oil reserves additions from all sources declined almost 65% to 1.23 billion bbl. And oil reserves additions from finding and development (F&D) activities were down an astounding 78% to 511 million bbl.

"U.S. natural gas reserves fared much better in 1998," said Herold, "in part reflecting a more sanguine pricing environment." Gas reserves fell less than 1% to 93.3 tcf. Gas additions from all sources were down 12%, and drillbit additions declined by 7%, "mainly reflecting declines in extensions and discoveries, which were offset further by a near-23% reduction in gas reserve purchases."

In the worldwide analysis, proved oil and gas reserves for the 140 firms posted an increase for the fifth year in a row, up 4% in 1998 to 121.8 billion boe. Developed reserves rose about 16%, yielding a less-developed worldwide reserve base, compared with yearend 1997.

"Royal Dutch/Shell was the largest holder of worldwide oil and gas reserves," said Herold, "boasting about 20 billion boe at the end of 1998. BP Amoco (plc) and Exxon (Corp.) were distant second and third-place finishers, with 14.8 billion boe and 13.9 billion boe, respectively."

Herold Chairman Arthur L. Smith said, "With the completion of in-progress mergers, all three mega-internationals will be within 10% of each other in reserve size."

Spending

Capital spending for the U.S. firms totaled $29.5 billion in 1998, a decline of 6.1% from 1997. Herold considers this "a surprisingly moderate decline, in light of the dramatic plunge in energy prices over the year."

U.S. outlays for proved reserves took the biggest hit, falling 30% to $5.0 billion. This was offset by a slight increase in E&D spending to $24.5 billion, however.

For the global group, capital spending rose 3% to $93.4 billion. "This marks the fifth consecutive year of spending increases," said Smith, "although at a slower pace than in previous years."

According to Herold, "The strength of the (global) spending increase in 1998 was due primarily to a 5.6% increase in finding and development expenditures, (which was partially) offset by a 6.8% decrease in proved acquisition spending. Exploration costs, including the acquisition of unproved property, posted the largest increase, rising nearly 10%, to $26.8 billion, compared with 1997.

"Proved reserve acquisition costs increased 19%," Herold continued, "but still remained the most economical source of reserve additions."

The largest spending increases occurred in developing producing areas, said Herold. In the Africa-Middle East region, which contains what is probably the world's hottest play-offshore West Africa-outlays were up 44% over 1997. On the opposite end of the spectrum, Canadian spending was off more than 25% last year, while U.S. outlays for the group fell 3%.

Revenues

U.S. wellhead production revenues from oil and gas returned to 1994-95 levels, with a fall of nearly $12.6 billion, or 25%, from 1997's $49.3 billion.

"The lost production income devastated the bottom line of (U.S.) petroleum producers," said Herold. "After-tax profits (for the 50 firms analyzed) declined by $10.2 billion-a catastrophic 86% level of erosion." Meanwhile, pretax cash flow decline about 34% to $23 billion.

"At this level, pretax cash flow accounted for only 78% of upstream capital spending in 1998," said Herold, "and this is before capital charges, interest, and some income tax burden must be considered. That 1998 (U.S.) E&P (spending) activity continued at the prior year's robust pace remains puzzling." Herold calls the phenomenon "upstream planning inertia," meaning that spending is reined in during bad times at a much slower pace than it is ramped up during market upswings.

For the global group, upstream oil and gas revenues fell by more than 24% last year, to $112.7 billion. This was the largest 1-year decline in at least 5 years, said Herold.

"Plunging (global) profitability was a result of lower revenues and higher exploration spending in 1998," said Herold. "Pretax profits free-fell a whopping 83% to $10.1 billion."

Perhaps the most striking of Herold's findings was this: Of the 140 companies surveyed, only 64 were profitable in 1998.

Reserve replacement

U.S. reserve replacement costs for the 50 firms surged during 1998 to an average $8.95/boe from $5.34/boe in 1997. Even more disturbing than this 68% increase, according to Herold, was the near doubling of U.S. F&D costs to $12.26/boe (see table).

Herold noted that some "modest consolation" could be had by realizing that "increased exploration spending may have delayed the recognition of new additions" for some companies.

"The unavoidable truth is that the numbers were just plain awful and indicate that the industry destroyed significant economic value in 1998."

Worldwide reserve replacement costs rose 32% to $5.43/boe vs. $4.12/boe in 1997. Global F&D costs grew 36% to $5.89/boe in 1998.

Herold's evaluation of U.S. reserve replacement rates for the 50 firms revealed that they replaced only a little over half of their 1998 oil production. Natural gas reserve replacement rates were satisfactory last year, says Herold, but they continued a downward trend, reaching 92%-a 5-year low.

The bright spot in this snapshot of 1998 U.S. operations was production costs, which reached a new recent-year low of $3.77/boe. This, in part, reflects the beneficial effects low oil prices had on production taxes, said Herold, but it is also an indication of continued efforts to improve the efficiency of field operations.

"Despite higher spending, reserve replacement rates were lower in all upstream areas, when compared with 1997," said Herold. According to Smith, "Increased costs for drilling and other services contributed significantly to the cost of adding reserves from the drillbit in 1998."

For the group of 140 firms, the oil and gas reserve replacement rate for their U.S. operations was 78% overall and 59% through the drillbit only. For their European operations, the rate was 82% from all sources and 83% through E&D activities.

"While Europe managed a marginally better performance than the U.S., it was still mediocre from a global point of view," said Nicholas Cacchione, Herold's co-director of research. "Emerging oil producing regions such as Latin America, Africa-Middle East, and Asia-Pacific replaced substantially more reserves than were produced last year."

Conclusions

The differences between the two groups that Herold studied indicate that internationally focused E&P programs enjoy significant cost advantages over U.S.-oriented programs.

"A review of 5-year performance data confirms the cost advantages of international E&P programs," said Cacchione. "Large integrated producers added reserves at an average of just more than $4.00/boe, while (U.S.) producers added reserves for more than $7.00/boe."

In addition, large U.S. E&P firms posted a reserve replacement cost of $7.34/boe vs. $9.75/boe for mid-sized and small firms. The same trends hold true for Canadian producers, where large firms achieved a replacement cost of $6.04/boe vs. $6.99/boe for the other group.

Herold's conclusion: "In low-cost reserve replacement, size apparently is an advantage."