Market Movement
A first: E&P stocks lag price rise
For the first time in history, the stock performance of exploration and production companies hasn't improved with a rise in oil prices, perhaps signaling a major change in investors' evaluations of those firms, says Simmons & Co. International, a boutique industry investment firm in Houston.
Investors apparently are starting to judge oil and gas companies like other industries-by their rates of return on capital invested-rather than by producers' cash flows, as in the past, says W. Mark Meyer, the new vice-president of E&P research at Simmons & Co.: "Capital efficiency is the buzzword now. More than ever, the E&P business is about effective management of operations and spending. Those companies that best execute [that management role] will win in this environment."
New world order?
Previously, an independent's cash flow was equated with market value, and volume growth in production and reserves was enough for most investors, who rarely bothered to look at a producer's return on investment capital employed, Meyer says. Rising wellhead prices historically lifted the equity value of all publicly traded upstream companies-the poor performers along with the good.
But as WTI soared 41% since third quarter 1999, stock values for E&P companies inched up a mere 4%, said Meyer (see chart). He sees that as investors' emerging emphasis on capital efficiency in the face of recent lackluster returns by upstream energy companies.
"By buying back their stock during the downturn, the majors taught the market to focus on the return on capital employed [ROCE]," Meyer said. "The ROCE track record among many independents hasn't been a pretty picture."
During 1993-98, he said, total E&P capital spending increased 22%/year. Yet annual production volumes grew only 8% in that same period.
Judged by that standard, oil company stocks may not be undervalued, as most managements claim, says Meyer: "Investors don't want to buy stocks whose value is being destroyed."
New value measures
Meyer claims many of the financial yardsticks previously used to determine the value of upstream companies have outlived their usefulness and must be replaced by new measures of corporate capital costs. Simmons & Co. is trying to find a new yardstick that will give both investors and corporate management a more transparent indication of a producer's real worth.
E&P requires significant capital expenditures, with producers usually putting more money back into drilling and other programs than the profits they produce. Yet, Meyer said, "None of the producers, including majors, have synchronized their spending with fluctuations in cash flow."
The resulting fluctuation in drilling activity also triggers wide swings in service and supply costs. But most producers can't afford to take a contrarian approach of concentrating spending programs during downturns, when costs and cash flow are low-"especially independents," said David A. Pursell, vice-president of upstream research at Simmons & Co.
"It's not just about taking costs out of the business. It's about improving overall performance for the best financial returns," Meyer said. That also means investors must sort through a deeper set of company-specific performance issues to pick the most promising companies, he said.
Simmons & Co. is focusing on full-cycle economics as the best means of providing fundamental valuation for E&P independents, through a concept that incorporates important financial drivers and eliminates accounting distortions. They acknowledge that the approach is limited, because not all necessary data are available publicly and reserve values are difficult to forecast for short-term investments. Yet those companies that outperform their peers on earnings should generate the best returns on capital in the long run, says Meyer.
Getting the message
Pursell says maybe a third of the publicly traded independents now show concern about their capital effectiveness. Development of such corporate awareness must come from the top down, he said.
Simmons officials figure it will take 6 months to 2 years for other company managers to "get" the new message that investors are sending. Some of the first signs of changes should appear in 2000 annual reports, said Pursell. "The majors were talking about it before it showed up in their returns and stock performance," he explained.
Meanwhile, Pursell said, "Some companies will fade away, some will be bought up, and some will decide strategically to get smaller, not bigger.
"This is a transition period for investors as well as companies," Pursell said. Nonetheless, he said, "External factors convince me that the market is not going to give up on returns."
Industry scoreboard
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Industry Trends
E-COMMERCE seems to be occupying the petroleum industry's collective mind even more than lofty oil and gas prices are these days (see related story, p. 30).
Two of the energy industry's most dynamic trendsetters, Houston's Dynegy and Tulsa's Williams, plan to take equity stakes-at a price tag of $25 million apiece-in eSpeed Inc., a New York-based interactive electronic marketplace engine for business-to-business commerce. ESpeed plans to develop at least four new commodity-specific electronic spot and futures marketplaces, in which the market unit of Dynegy and Williams will participate. The three plan over time to build B2B marketplaces for energy, bandwidth, petrochemicals, crude oil, and NGL.
ESpeed expects to make an electronic marketplace for natural gas and electricity available to market participants in the third quarter, with the development of additional marketplaces slated for yearend. The eSpeed infrastructure handles $150 billion/day in financial instrument transactions in fixed-income financial markets.
EVEN THE equipment-dominated Offshore Technology Conference last week was not safe from all the e-buzz.
After a virtual onslaught of B2B e-commerce site launches, the oil and gas industry is entering a period of evaluation and consolidation, according to speakers at an OTC panel on e-commerce.
Industry trends-such as the movement toward the creation and use of industry hubs, whether for e-commerce or information exchange-are likely to continue. Also, initial public offerings of internet companies will probably become a more-scarce occurrence, while consolidations among existing entities are expected to increase.
Thierry Pilenko, president of Schlumberger's GeoQuest division, forecasts that companies' revenues from e-commerce will grow 71%/year over the next 5 years.
Raising a cautionary flag was Landmark Graphics Pres. and CEO Bob Peebler: "...I hear a lot of people talking about that we have to spend $125 billion [and saying] we're going to have two thirds of that spending going through these e-commerce sites over the next year or so. And I just don't think that's going to happen. I think that it's much more complex than that. In fact, I think we have to be careful about the expectations that we set. One thing that's interesting about expectations in this e-world [is that] you can almost predict two things: No. 1, that it's not going to happen as fast as we think; and No. 2, when it does happen, it's going to feel a lot bigger than anyone had imagined. And that's a very dangerous thing."
BACK IN THE REAL-physical, at least-world, consolidation in the upstream oil and gas sector is likely to continue through at least the first part of the next decade, because the drivers for merger and acquisition activity remain mostly the same as in the 1990s, says Scott B. Gill, co-head of research for Simmons & Co. International, Houston.
Speaking at OTC, Gill said the main rationale for mergers and acquisitions is clear: "Everybody is focused on returns-and returns over a long period of time." Those who produce less return than the market demands will likely be merger targets, he says. He also warns, however, that while returns are the rationale for M&A activity, without growth, returns mean nothing.
Government Developments
THE US gas industry's hopes for cracking one of the major state power markets has taken a big blow.
Florida's Supreme Court has reversed a March 1999 Florida Public Service Commission (FPSC) ruling that would have allowed construction of Florida's first merchant power plant. The court ruled the plant is not permitted under current state regs covering the industry. In response, some Florida city officials have launched efforts to persuade state legislators to change the rules, and state legislators may set up a task force to study the deregulation of the industry. Duke Energy was to build the 514-Mw combined-cycle plant at New Smyrna Beach, Fla. After the FPSC decided last March to grant Duke's need petition, Florida Power, Florida Power & Light, and TECO Energy appealed to the Florida Supreme Court.
Duke says it is surprised and disappointed and maintains that merchant power plants are integral to meeting Florida's growing energy needs.
Panda Energy, another would-be merchant player in the potentially lucrative Florida energy market, says the ruling may keep the price benefits of merchant power plants from Floridians and is against their best interests. Panda last year announced plans to construct two 1,000-Mw merchant power plants in Lake and St. Lucie counties, Fla.
ALBERTA may pick up part of the estimated $227 million (Can.) cost of upgrading older sour natural gas plants to meet more-stringent emission standards.
Provincial Energy Minister Steve West says most Albertans would understand that, when there is a change in standards, they would share in that cost. Earlier, West had indicated the government would not be involved in cost-sharing. A new report to the Alberta Energy and Utilities Board recommends companies be given reduced provincial royalty rates to cover 50% of the cost of upgrading 64 older gas plants. Sulfur emissions and gas flaring by the industry in Alberta have been the target of complaints by environmentalists and residents in affected areas.
RUSSIAN President-elect Vladimir Putin has established the new post of Presidential Representative for the Caspian Region.
In creating this position, Putin is putting some muscle behind his promise to defend the interests of Russian companies abroad. Specifically, his goal in the Caspian Sea basin is to beef up the position of Russian oil majors in the petroleum-rich region, where they face stiff competition from US oil firms. Moreover, US oil majors can operate in the Caspian secure in the knowledge that Washington, DC, considers the area a zone of US national interests.
Lukoil stands to benefit the most from this new government initiative, as it is engaged in several development projects in the Caspian. The company recently announced an apparently major oil discovery in the Russian part of the Caspian shelf (OGJ, Apr. 3, 2000, p. 32).
Quick Takes
MORE US NORTHEAST gas pipeline capacity is slated to come on stream. Iroquois Gas Transmission System LP has filed with FERC to lay a $170 million gas pipeline extension from Long Island into New York City. The spur will deliver about 220 MMcfd of gas from Western Canada to the ConEd gas grid starting in 2002. The project includes a 30-mile extension from Iroquois' existing mainline on Long Island, new compressor stations and units, and other equipment maintenance and upgrades. F
In other transportation news, ExxonMobil has confirmed its entry into the Papua New Guinea-to-Queensland gas pipeline project with a formal agreement to dedicate natural gas reserves in Papua New Guinea's Hides field to the $3.5 billion (Aus.) project. The agreement calls for sale of 600 MMcfd for 30 years to Queensland. Reserves from the Chevron group's PNG fields alone would not have sufficed to sustain the pipeline in the long term. ExxonMobil will join the group and may take a 40% stake. x MCN Energy agreed to sell its 35% interest in joint venture Jonah Gas Gathering Co. to partner Green River Pipeline LLC for $45 million. JGG owns and operates a system that gathers 340 MMcfd of gas in Jonah field in Sublette County, Wyo. x TotalFinaElf and French authorities have chosen Coflexip Stena and Stolt Offshore to pump out the 13,000 tonnes of heavy fuel oil remaining in the Erika tanker, which sank in 110-120 m of water off Brittany, France, last year (OGJ, Dec. 20, 1999, p. 38). The firms will handle the entire operation, from preparing the wreckage to installing the flood gates, subsea pumps, and transfer module; connecting the flexible lines; and evacuating the pumped fuel to shore. The operation, to start this month, should be completed by the end of September and will cost TotalFinaElf about 400 million francs.
ULTRAMAR DIAMOND SHAMROCK plans to spend $40 million to expand capacity at its Quebec refinery to 190,000 b/d from 160,000 b/d. The expansion will reduce operating and intermediate feedstock costs plus produce another 20,000 b/d of gasoline, distillate, and jet fuel, as well as 10,000 b/d of cat-cracker feed, propane, and butane, says UDS. Completion is set for second half 2001. x Elsewhere on the processing news front, Nigeria plans to shut in its 150,000 b/d refinery in Port Harcourt in mid-May for turnaround maintenance. Its other three refineries will undergo similar projects soon, says Jackson Gaius-Obaseki, group managing director of state-run Nigerian National Petroleum Corp. Plans call for eventually privatizing the four plants, which provide only 40% of domestic refined products supply. x Formosa Plastics Group unit Formosa Petrochemical expects to begin domestic sales of diesel fuel refined at its new Taiwan petrochemical complex within the next few weeks. And it has won approval to export diesel, with the first cargo of 30,000 tonnes bound for Japan soon. The firm can now export most refined products, except for gasoline. x Mitchell Energy will expand capacity at its Bridgeport, Tex., natural gas processing plant to 310 MMcfd from 210 MMcfd. Gas liquids production from the plant would increase to over 27,000 b/d from 19,000 b/d. Project cost is put at about $15 million, construction start is in July, and start-up is in December. Ethane recovery will reach 90%.
THE GULF OF MEXICO has another sizable deepwater strike. After testing its Entrada discovery well on GB 782, Vastar estimated the field could hold 150 million boe. Drilled in 4,642 ft of water to 15,717 TVD, it cut more than 360 ft of net pay in four intervals. Vastar plans to keep the Ocean Victory on site for appraisal drilling.
Next on Vastar's list of deepwater gulf prospects to drill is Aspen, on GC 243. It also plans to accelerate production start-up, to late 2002 from mid-2004, for its Horn Mountain field, on MC Blocks 126 and 127.
ROWAN COS. will design and construct a $190 million Super Gorilla class jack up, the Gorilla VIII. It will have 708 ft of leg, 134 ft more than previous Super Gorillas, and have 30% larger spud cans, enabling operation in 550 ft of water in the Gulf of Mexico and in 400 ft in hostile environments. The jack up will be built at Rowan affiliate LeTourneau Inc.'s facility at Vicksburg, Miss. Delivery is slated for third quarter 2003.
In other drilling-production activity, BP Amoco let a $12 million offshore design engineering contract to Mustang Engineering for work on the Crazy Horse and Holstein oil and gas developments in the deepwater Gulf of Mexico (OGJ, July 19, 1999, Newsletter). Mustang will provide preliminary topsides design and project services for the deepwater project. x BP Amoco installed what Cidra Optical Sensing Systems says is the first-of-its-kind, all-fiber-optic permanent monitoring system in the Gulf of Mexico. The pressure and temperature system was deployed on BP Amoco's Pompano platform on Mississippi Canyon Block 27, in Well A-26 at more than 15,000 ft MD. The system contains no in-well electronics and has no moving parts, says Cidra. x TotalFinaElf and Agip let a $10 million subcontract related to the $1 billion redevelopment of giant Doroud oil field off Iran. Under terms of the contract, Stolt Offshore and the UAE's Maritime Industries Services will provide a production platform and pipeline facilities. TotalFinaElf and Agip won the 10-year, $540 million buy-back contract from National Iranian Oil Co. last year. Doroud lies mostly off Kharg Island, although part of it is onshore. Elf and Agip will use water and gas injection and additional drilling to increase Doroud output from the current 145,000 b/d to 220,000 b/d by 2003. Contracts for the main onshore injection and other facilities, pegged at $500 million, have not been let.
OTC Snapshots
COST-CUTTING, innovative technology, and new frontiers-in cyberspace as well as in ever-deeper waters and in new-play theaters-were, as always, the dominant themes of the Offshore Technology Conference last week in Houston.
OTC, the petroleum industry's biggest annual conference and equipment showcase, attracted an estimated 44,750 delegates during its 4-day span last week.
The overwhelmingly dominant new theme at OTC was e-commerce (see Industry Trends in this Newsletter). About 40% of the 200 new vendors exhibiting at OTC for the first time this year were e-commerce-related firms, officials reported.
Here are some snapshots of other key themes sounded at OTC:
- This year's OTC was memorable for the first industry-wide discussion of the electronic oil and gas field-or "e-field"-of the future, said Wolfgang Schollnberger, technology vice-president of BP Amoco and OTC chairman.
The e-field concept is a marriage of the industry's need to eliminate some of the cyclical ups and downs of the oil and gas market and the technology being developed for better planning, monitoring, and exploitation of future fields. Most of the technology developed by the industry in recent years has been geared toward exploration drilling. But the next wave of new technology will concentrate on accelerating development and increasing production at lower costs, said other industry officials.
That includes "smart well" downhole equipment now being developed to keep wells operating at peak efficiency, especially in deep waters, where maintenance and workovers are so expensive. Schollnberger and others in the industry now foresee a day when those downhole monitors will be connected to e-commerce market equipment to adjust oil and gas production to changes in market supplies and demand.
- Designers of offshore facilities hope to combine the lower-cost, fit-for-purpose practices of the Gulf of Mexico with the big-project management know-how of the North Sea to do marine projects better and cheaper worldwide. Participants must combine lessons learned in those two mature areas that are the world's most prolific offshore development regions, says Kenneth E Arnold, president of Paragon Engineering Services.
Paragon did one of the first comparisons of projects in the North Sea and Gulf of Mexico at the 1985 OTC. The study showed that a $100 million gulf project escalated to $300 million when designed by North Sea standards. More recent studies confirm that 3:1 price differential, says Arnold.
About $100 million of the additional cost is because of more-complex systems for life-support and hazard mitigation required for the harsher environment of the North Sea. But Arnold blames "cultural differences" for the rest of the added cost. Gulf-based projects are "more cost-effective, with shorter life cycles to first development," he said. He acknowledges that gulf projects are usually smaller than the large, complex projects in the North Sea. However, Arnold questions whether North Sea projects may be designed to be more complex and require more offshore workers than needed.
- "There is no question that the future of offshore exploration lies in deep and ultradeep water," said Rhys J. Best, chairman and CEO of Lone Star Technologies Inc. and PESA chairman.. "Petroleum companies will increase capital spending on deepwater oil and gas developments by 85% during the next 5 years." Deepwater fields account for 90% of the reserves involved in future developments off Brazil, 89% in the Gulf of Mexico, 45% off West Africa, and 46% in the North Sea, he said. The number of discoveries in water depths exceeding 1,500 ft grew to 65 in 1999 from 33 in 1998, Best said.
- The Atlantic area off Nova Scotia, Newfoundland, and Labrador is shaping up as "another North Sea" with enough reserves to supply an additional 2 tcf of natural gas to the growing US Northeast market within a few years, Canadian officials claim.
"On the East Coast of Canada, the petroleum industry momentum is growing," said John Hamm, premier of Nova Scotia. Brian Tobin, premier of Newfoundland and Labrador, said his province has only 125 offshore exploration wells drilled "in an area of petroleum potential...that could be as large as, and possibly larger than, the state of TexasellipseOur total undiscovered oil resource is currently estimated to be over 6 billion bbl. Our undiscovered natural gas resource is estimated at over 50 tcf." Hamm thinks the Scotian basin potential may soon be proven to be well beyond the official estimates of 18 tcf.
And deepwater exploration will be starting soon, with a 2-year, 3D seismic program of 6,000 sq miles-"the largest ever conducted on the East Coast of Canada"-to be completed this year.
- IADC is pushing the WTO to include energy-related services in the global General Agreement on Trade in Services (GATS), the first multilateral agreement to provide legally enforceable rights to trade in all services. But when the present GATS classifications were devised in the early 1990s, energy generation and supply was largely the domain of state-owned monopolies in many countries, says John R. Irwin, president and CEO of Atwood Oceanics and IADC chairman.
With more countries now privatizing their energy monopolies, Irwin wants energy-related services included in GATS to "level the playing field" for IADC members. "There are numerous practical barriers to drilling companies," he said. "These include sometimes-arbitrary customs levies in some nations that can take as much as 18 months to work out before a rig can be cleared to enter a country. They can also result in import duties so high that it effectively confiscates the equipment."
- US natural gas prices "definitely" will climb to $4/Mcf this fall, with world oil prices escalating to $40/bbl probably within a year, unless producers dramatically increase spending to offset depletion and to supply growing demand, says University of Houston Prof. Michael J. Economides. But that's nothing compared with what will happen when the real gas shortage hits North America within 2 or 3 years. With rapid depletion of current gas resources and steady escalation of demand, Economides says, freezing Chicago residents will be paying a whopping $40/Mcf for gas in the middle of some not-too-distant winter. "It's the biggest energy story not being written about," he claimed.
Economides said US gas producers are not discovering enough new gas reserves to offset rapid depletion of current reserves and meet growing demand that is expected to hit 30 tcf by 2010. Moreover, Economides said many of the gas-fired power plants now being planned won't be built in time to meet demand projections. "You couldn't buy a turbine today if you wanted to. General Electric has a 3-year backlog," he said.
Still, he predicted, "We'll see $4 gas before $40 oil." Nonetheless, says Economides, an average oil price of more than $25/bbl for the next 2-3 years "is not unrealistic."