After years of experiencing boom and bust cycles-the most recent one reaching its trough at the latter part of 1998 and early 1999-the oil and gas industry is primed for sustainable growth. Also, integrated oil and gas firms in general, and exploration and production companies in particular, are starting to show signs of learning from the more challenging, leaner times.
A study published last month by John S. Herold Inc., Norwalk, Conn., entitled "From Renaissance to Requiem to Rebirth" offers insight into the devastating effects of commodity price volatility-among other fundamentals-on oil and gas firms over the last 30 years.
In its study, the independent research and consulting firm notes some signs that industry executives have reworked their strategies based on the harsh lessons learned from the most recent cycle.
"Oil and gas companies are now exhibiting capital constraint," the study says, "focusing on the bottom line, and planning for the future based on conservative projections of commodity prices and demand. At the same time, private capital investors and institutional investors are being diligent in selecting quality energy investments and steering away from high risk exploration companies."
The study concludes that this "more reasonable, cautious view of the volatile energy industry portends more sustainable, attractive growth for major and independent oil companies."
Renaissance to requiem
The study's authors, Herold Chairman and CEO Arthur L. Smith and Vice-Pres. Aliza Fan, note that of 82 oil and gas companies tracked by Herold in 1970, only 7 remain today. And, of 157 firms followed in 1990, Smith and Fan point out that only 63, or 40%, are still in business.
The study says, "The 1998-99 oil and gas wellhead price meltdown was particularly brutal, dealing body blows to all petroleum producers and oil service providers; some staggered, some fell, and many merged or were acquired."
Another driver behind industry's movement toward consolidation, the study notes, is the withdrawal of massive amounts of investment capital from the energy sector. "Energy industry weighting in the Standard & Poor's 500 plunged from 26% in 1982 to a low of less than 5% in early 2000," the study says.
As a consequence of this consolidation, independents experienced a period of strong growth in the early 1990s. "As major oil firms exited the US upstream with great fanfare, smaller E&P companies quickly filled the void, snapping up majors' divested properties, increasing their extraction rates, and improving operational efficiencies."
By 1997, however, this "revival" quickly transformed into "mania," Herold says: "A drilling [prospects] acquisition frenzy in 1997 resulted in impressive reserve and production growth for many companies whose shares then commanded premium valuations on Wall Street.
"But, at the same time, in order to achieve growth for growth's sake, many of these companies leveraged balance sheets to alarmingly high levels and spent capital inefficiently," the study says.
The outcome of this shift, Herold says, was devastating. "Producer realization plunged in 1998-99. The consequences were massive reserve writedowns, bankruptcies, and plenty of red ink."
Requiem to rebirth
Herold reckons that industry-and chiefly the North American E&P sector-will undergo a "vibrant, and sustainable" recovery, especially with regard to natural gas production.
"With the exception of industry employment-which is likely to continue to erode through the end of the year (reflecting the completion of corporate downsizing programs among the supermajors ExxonMobil [Corp.], BP, TotalFinaElf [SA])-other measures of US oil industry health (including offshore rig utilization and seismic activity) continue to show signs of accelerating."
This renewal will be largely driven by higher commodity prices mixed with learning from past experiences: "So far, 2000 has been quite an anomaly for the oil and gas industry. While commodity prices continue to levitate at $35/bbl and $5/Mcf...oil and gas companies have exhibited capital spending discipline."
At a time when E&P firms, now flush with cash, would have likely gone on a spending spree, Herold says, "oil executives have judiciously limited upstream spending." Independents, in particular, stand to gain the most ground, having been able to "extract real value from the majors' divested properties by increasing extraction rates and improving operating efficiency." While now accounting for about 45% of US production, the study says, E&P firms have been able to replace the bulk of the majors' depletion of US reserves-a trend Herold sees as continuing in the future.
Some of the other trends noted by the research firm are: the continuation of "mergers of equals;" (see related story, p. 28) the stepping up of the majors' divestiture of US assets; the slowing of the consolidation of Gulf of Mexico shelf properties; and the continuation of independents following majors into the deepwater Gulf of Mexico.
"A rebirth of the E&P sector... preordained," Herold says.