UBS: Oil field services firms to have lower 2003 capex, earnings estimates

US oil field services companies likely will post a decline of 9% in upstream cash flow this year, according to analysts at UBS Warburg LLC.

By OGJ editors

HOUSTON, Oct. 17 -- US oil field services companies likely will post a decline of 9% in upstream cash flow this year, according to analysts at UBS Warburg LLC. The analyst defines "upstream cash flow" as the sum total of upstream net income plus depreciation, depletion, and amortization expenses plus exploration expense.

This year's decline follows a 5% decrease posted in 2001, the analyst said. UBS Warburg's findings are based on a study of exploration and development spending by more than 25 of the largest integrated and independent oil firms worldwide. "Over the past several years, this group of companies has spent about $55 billion on (exploration and development), which represents about 50-55% of global expenditures," UBS Warburg analyst James Stone said.

In 2003, Stone estimates that oil service firms' upstream cash flow will increase by "a meager 3%." This forecast is based on UBS Warburg's 2003 oil and natural gas price assumptions of $23/bbl and $3.35/Mcf, respectively. Stone said he expects 2003 cash flow to rise by 11% for independents and by 2% for integrated firms.

Emerging pattern
Over the last few years, Stone said, there has been an emerging pattern among both integrated and independent firms in terms of how much cash flow is reinvested in exploration and production. "For the independents, the mantra of financial discipline has meant that companies are generally reluctant to spend above cash flow from operations or seek outside financing for anything other than acquisitions," he said, adding, "However, it does not mean that companies will not reinvest incremental cash flow that results from higher prices."

For that reason, Stone expects independents to reinvest more than 90% of cash flow for exploration and development this year. "Furthermore," he noted, "based on conversations with a number of independents over the past year, it appears that spending on acquisitions is not necessarily seen as a clear alternative to exploration and development. In fact, it looks as if acquisition spending might have peaked (for the time being) in 2000 or 2001."

As for integrated companies, Stone recognized that looking solely at upstream cash flow might be misleading, but said he attempted to "isolate changes in capital spending based solely on the economics of exploration and development." Because integrated firms earn a large percentage of their money from upstream operations, however, Stone said, "it is fair to note that free cash flow from the upstream does tend to find its way into either downstream uses or dividend and stock buyback programs."

For this reason, Stone explained, integrated firms rarely have reinvestment rates greater than 70%. "In fact, in the past 3 years, there has only been one quarter in which upstream spending (excluding acquisitions) exceeded 70% of upstream cash flow," Stone noted. In its model, the analyst forecast that integrated firms will reinvest 66% of cash flow in exploration and development.

"One of our conclusions from this analysis is that if the companies maintain 'financial discipline' and only grow spending by a mid-single-digit figure in 2003, we think that it would be highly likely that US gas supply will continue to decline in 2003 and that production estimates for both the (integrated firms) and the independents could prove to be optimistic," Stone concluded.

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