U.S. PETROLEUM INDUSTRY ADJUSTS TO TOUGH ECONOMY

A.D. Koen
Gulf Coast News Editor

Oil and gas companies in the U.S. are curbing costs and redirecting spending to survive the worst decline of petroleum industry activity on record.

Persistently weak U.S. natural gas prices and shaky oil prices worldwide have put pressure on domestic companies to become low cost producers. Efforts to cut exploration and development costs have depressed activity in the U.S., one of the world's most mature oil and gas provinces.

Several studies show the drive to reduce E&D costs is prompting many U.S. companies to seek reserves in other countries. Independent operators especially are beginning to put more emphasis on international projects.

International E&D hot spots include the U.K. North Sea, Yemen, Thailand, Myanmar, Pakistan, and Latin America. Prospects in the Commonwealth of Independent States also continue to generate considerable enthusiasm.

Operators struggling to survive or searching for funds to spend on non-U.S. prospects are trying to shuck noncore U.S. assets.

Other favored cost cutting strategies include reducing and restructuring debt, operating and administrative staffs, and internal organizations.

Major integrated companies are able to add value by refocusing refining, petrochemical, or marketing operations. But independents must adapt operations close to the wellhead to become low cost producers.

Whatever tactics are used to mitigate effects of low U.S. activity, no domestic company-from the largest integrated major to the smallest independent producer-has proven to be immune from the downturn.

GROWING GLOBALIZATION

Growing petroleum industry globalization was underscored most recently by Arthur Andersen & Co.'s annual survey of publicly traded U.S. oil and gas companies. The survey is based on data filed by 241 companies with the Securities and Exchange Commission for 1987 through 1991.

In 1991, non-U.S. exploration and development spending by companies covered in Andersen's reserves disclosure study totaled $31.4 billion, a 27% increase over such spending in 1990. By comparison, combined group E&D spending in the U.S. in 1991 declined by 4% to $17.7 billion.

Included in Arthur Andersen's group of 241 companies were 18 Canadian companies and six other non-U.S. majors-British Gas plc, British Petroleum Co. plc, Broken Hill Proprietary Ltd., Ste. Nationale Elf Aquitaine, Norsk Hydro AS, and Royal Dutch/Shell-that must meet U.S. financial reporting requirements because of subsidiaries' U.S. activities.

Andersen earlier concluded that investment in non-U.S. projects in 1991 accounted for 60% of combined exploration and development spending by 30 of the largest U.S. oil and gas companies (OGJ, June 15, p. 19).

An Oil & Gas Journal analysis of activity in 1991 by 22 major integrated companies found combined group net income 24.2% lower than in 1990 (OGJ, May 25, p. 13).

An OGJ analysis last month of 50 independent U.S. oil and gas companies found combined group net profit in 1991 totaled slightly more than $552 million, down from more than $1 billion in 1990 (OGJ, June 29, p. 23). However, combined group revenue in 1991 increased slightly to a little more than $12 billion from more than $11.8 billion in 1990.

SYMPTOMS OF HARD TIMES

Signs of hard times are evident in practically every measurement of U.S. oil and gas operations.

Baker Hughes Inc.'s count of active U.S. rotary rigs in mid-June dropped to less than 600 for the first time since record keeping began in 1940 (OGJ, June 22, p. 36). An estimated 1,400 U.S. rotary rigs are idle.

Meantime, the American Petroleum Institute cites the following indicators of the U.S. petroleum industry's plight:

In the past decade ending May 1992 the U.S. petroleum industry has lost more than 400,000 jobs, including 51% of domestic exploration and production jobs and 28% of jobs in refining.
Combined net income of 20 major oil companies during first quarter 1992 fell 57.2% compared with first quarter 1991. In 1991, the group's net income fell more than 20% compared with 1990.
U.S. crude oil production in the first 5 months of 1992 averaged 7.2 million b/d, the lowest January-May average in more than 30 years. In May, U.S. oil production averaged 7.055 million b/d.
During first quarter 1992, estimated oil and gas well completions fell 22.3% below total completions in first quarter 1991.

Said API, "The bottom line is the oil industry is going through a 'Great Depression' unmatched in severity by any other industry. And a general economic recovery will not bring a quick turnaround to this vital industry."

For many U.S. independents, tactics for becoming low cost producers equate to survival strategies. Effects of low petroleum industry activity have become so pronounced that the Texas Independent Producers & Royalty Owners Association (Tipro) in April sponsored a workshop in Houston in which members shared tactics for surviving the slump.

COMMON DENOMINATOR

Victor A. Burk, managing director of Andersen's oil and gas services, said the 241 companies included in his company's survey in the past 5 years spent $30 billion more outside the U.S. than in the U.S. Companies surveyed account for more than 60% of all U.S. reserves and production.

While combined non-U.S. E&D spending by members of the survey group was increasing an average of more than 20%/year, average group E&D spending in the U.S. increased less than 5%/year.

Major companies in the survey in 1991 spent $27.8 billion on non-U.S. E&D, an increase of $6.5 billion or 31% more than in 1990. By comparison, major company E&D spending in the U.S. in 1991 declined 2% to $12 billion.

Nonmajor companies surveyed, including independents, smaller diversified companies, pipelines, and utilities, continued to spend more on E&D in the U.S. than abroad, but the gap is narrowing. The group's U.S. E&D spending in 1991 totaled $5.7, down 8% from 1990, while foreign E&D spending increased slightly to about $3.6 billion.

Total E&D spending by independents surveyed in 1991 fell 9% to $4 billion, 60% of which occurred in the U.S.

However, Burke said, the size and continuing increases of E&D spending outside the U.S. does not mean companies are abandoning the U.S.

"While many companies are making major investments outside the U.S., many also continue significant commitments to find successful niches here in the U.S.," he said. "The common denominator among companies that survive and grow in today's environment is the ability to operate as an efficient, low cost finder and producer of oil and gas, and to anticipate and meet changing market demands quickly."

OTHER SURVEY HIGHLIGHTS

Andersen's study of 1991 activity confirmed several trends related to growing petroleum industry globalization:

About 64% of E&D spending in 1991, including 70% of major companies' E&D dollars, went outside the U.S.
For exploration only, non-U.S. expenditures of $9.4 billion almost doubled U.S. spending of $4.9 billion.
In the past 5 years in the U.S., with new discoveries, field extensions, and improved recovery, survey companies replaced 52% of their oil production and 62% of their gas production. When reserve revisions, purchases, and sales are included, replacement rates in the U.S. increase to 87% for oil and 94% for gas.
By comparison, from all sources, surveyed companies replaced 130% of non-U.S. oil production and 147% of non-U.S. gas production in the past 5 years.
On the basis of additions only, the 1991 survey cost of replacing reserves increased 14% to $8.09/bbl of oil equivalent (BOE) in the U.S., ending a 2 year decline, and increased 33% to $8.23/BOE in non-U.S. operations.

Proved U.S. gas reserves of companies surveyed in 1991 slipped 3% to 105.4 tcf, about a 10 1/2 year reserve life at 1991 production rates. Non-U.S. gas reserves tallied in the survey in 1991 increased 2% to 141.2 tcf, about an 18 year supply based on 1991 production.

Combined 1991 production by survey companies totaled about 10.2 tcf in the U.S. and 7.8 tcf overseas, about a 3% non-U.S. increase.

Meanwhile, survey group companies in 1991 increased U.S. oil production to about 2 billion bbl and non-U.S. oil production about 4% to 2.5 billion bbl. Proved oil reserves held at the end of 1991 by companies surveyed decreased slightly overseas to 25.8 billion bbl and fell 4% in the U.S. to 21 billion bbl.

INTERNATIONAL EMPHASIS

Union Texas Petroleum Holdings Inc., Houston, is a prime example of a U.S. company that is concentrating on international projects while slashing U.S. operations.

The independent oil and gas producer last year realized a one time net gain of $203 million from the sale of U.S. oil and gas interests and gas processing assets. It also is trying to sell remaining U.S. petrochemical operations.

Union Texas this month disclosed a business plan through 1995 that includes $234 million of capital spending in 1993, and about $180 million each in 1994 and 1995. Capital spending this year is estimated at about $340 million, more than half for work in Piper and Saltire fields in the U.K. North Sea.

Union Texas' capital outlays show increasing emphasis on operations outside the U.S. Non-U.S. arenas claimed about 62% of capital spending of $379 million in 1990 and 84% of $387 million in 1991. About 94% of 1992 and 1993 budgets is expected to go overseas.

About 80% of 1993 capital spending will go to core development projects in the North Sea, Indonesia, and Pakistan, including about $43 million for Piper and Saltire fields. Exploration ventures in the North Sea, Indonesia, Pakistan, Alaska, Papua New Guinea, offshore Argentina, and coalbed methane projects in Europe will garner most of the other 20%.

Union Texas expects to bring Piper on production in first quarter 1993 and Saltire about 60 days later. After startup of those fields, the company's net North Sea production will increase to about 45,000 b/d from 13,900 b/d in 1991. Union Texas owns a 20% interest in each field.

A. Clark Johnson, Union Texas chairman and chief executive officer, said expected cash flow beginning in 1993 will position the company to take advantage of development opportunities, prepay debt, and find other ways to share its improved financial results with stockholders.

However, Johnson said, the business plan could vary, depending on world energy markets and business opportunities.

In an example of the spread of operations into non-U.S. frontiers, Santa Fe Energy Resources Inc., Houston, in late June increased its net acreage in Myanmar to about 900,000 acres when subsidiary Trend International (Bermuda) Ltd. signed production sharing contracts with Myanma Oil & Gas Enterprise, the national oil company.

The agreements include 2 year exploration programs on two onshore blocks covering about 400,000 acres in the Central Myanmar basin of the northern Irrawaddy River valley adjacent to Chauk oil field in Myanmar's central oil producing region about 300 miles northwest of the capital city of Yangon. Santa Fe Energy owns 100% interest in each tract.

Another Santa Fe Energy subsidiary recently agreed with an Apache Corp. subsidiary to take 50% interests in two Myanmar tracts in the Irrawaddy Delta basin about 150 miles south of the new blocks.

SURVEY SURPRISES

Arthur Andersen's analysis of 1991 survey data turned up some unexpected results.

For one, despite the large increase in non-U.S. spending, U.S. E&D spending in 1991 decreased only 4% from 1991. More specifically, Burk said, major company E&D spending declined only 2%.

"That is less a surprise if one breaks out exploration spending, which declined 14%, from development spending, which increased 4%," he said

Increased development spending signals that majors are emphasizing exploitation of domestic reserves to boost the value of properties in the U.S, Burk said. That strategy led majors to focus on adding reserves and abating production declines with low risk development drilling.

"In the future," Burk said, "we expect U.S. E&D spending to decline at a faster rate...as companies follow through on the large E&D investments they have made overseas."

Companies also will continue shifting focus in the U.S. to areas where they have competitive advantages, such as well established infrastructures that can help reduce operating costs.

HIGH REPLACEMENT COSTS

Another surprise in Andersen's 1991 reserves disclosure study were large increases in the costs of replacing U.S. and non-U.S. reserves.

Based on all sources, surveyed companies in 1991 replaced U.S. reserves at a rate of $5.98/BOE, a 21% increase from 1990's survey. Meanwhile, the replacement cost of non-U.S. reserves in 1991 averaged $6.35/BOE, an increase of 53%.

Burk attributed part of the large increase in non-U.S. replacement costs to spending on projects in the early phases of exploration before reserves can be classified as proved.

"Elf Aquitaine, British Gas, and Mobil Corp. are examples of companies that increased foreign exploration spending during 1991 but reported significantly lower reserves additions than in 1990," he said.

Much of the higher 1991 U.S. replacement cost occurred because some major companies, notably Conoco Inc. and Royal Dutch/Shell, reduced reserve estimates.

"Without these revisions, U.S. reserve replacement costs would have better reflected cost reductions and selective drilling strategies by most companies," Burk said.

SALES OF ASSETS

Andersen's survey also showed the effects of U.S. companies' sales of assets.

Burk said sales of proved U.S. oil and gas reserves by surveyed companies doubled in 1991, despite an average sale price of only $3.81/BOE, the lowest in the past 5 years.

Altogether, companies surveyed reported selling 600 million bbl of proved oil reserves and 3.5 tcf of proved gas reserves. The volume of oil reserves sold was the highest recorded by the survey in 5 years.

Among last year's notable publicized divestitures of U.S. properties:

Oryx Energy Co. sold about 140 million BOE to ARCO.
Union Texas sold 90 million BOE of reserves onshore and offshore to Burlington Resources Inc. and Nerco Oil & Gas Inc.
Amoco Corp. sold about 110 million BOE to Apache Corp.

Burk estimated proved oil and gas reserves worth about $10 billion are for sale in North America, mostly in the U.S.

But not all assets changing hands involve only oil and gas reserves.

For example, Cabot Oil & Gas Corp., Houston, earlier this month said it will buy 147 gross gas wells from CNG Transmission Corp., Clarksburg, W.V. The deal will include 150 miles of production, gathering, and transmission pipeline, 3 compressor stations, 219 measuring and regulating stations, and leaseholds totaling 35,000 acres.

Cabot in January outlined a 1992 capital and exploration budget of $44 million, down from $55 million in 1991. Cabot blamed the cut on poor economic conditions in the U.S. gas industry.

FEWER JOBS

Burk said petroleum industry globalization will continue to cause the loss of U.S. exploration, production, and oil field service/supply jobs.

According to the U.S. Bureau of Labor Statistics (BLS), during May 1982-May 1992 oil and gas extraction companies lost nearly 375,000 jobs and U.S. refiners another 46,000, API said. By comparison, the overall U.S. economy at the end of May supported nearly 20 million more jobs than 10 years earlier.

The latest federal statistics show the U.S. economic recession has been worsening. BLS, for example, said the U.S. unemployment rate in June increased by 0.3% to 7.8%, the highest rate in more than 8 years.

By contrast, BLS data show that in the past decade U.S. service industries gained 19 million jobs, up nearly 29%, state and local government payrolls grew by 2.5 million jobs, up 18.5%, and federal government added 250,000 jobs, a 9.1% increase.

Only job losses in the steel industry-about 160,000 fewer workers, down almost 39%-rival the thinning of oil and gas worker ranks during the past decade.

But unlike other U.S. industries, the petroleum industry has little hope of recovery when the recession ends, API said. That is mainly because public policy denies access to promising oil and gas provinces in Alaska and on the U.S. Outer Continental Shelf.

Burk said he expects U.S. petroleum industry employment to decrease by another 40,000-50,000 jobs in the next year.

IDEAS FOR INDEPENDENTS

Rick Riseden, president of Riseden Services Inc., Houston, cochaired Tipro's survival seminar in April. He said it is nearly impossible for small independent companies to maintain in-house expertise in all areas needed to operate at the highest levels of efficiency.

In many ways, Riseden's company is typical of the thousands of small independent operating companies that have survived the industry down-turn.

Riseden Services operates about 100 wells, mostly in Texas scattered from the Louisiana-Texas border south and west to Hidalgo County in South Texas. About two-thirds are wells in which Riseden Services owns varying interests. Production from wells in which the company owns partial interests provides more than half of Riseden's revenues.

Like most independents, Riseden said his company has altered wellsite operations in scores of small ways to increase profitability. For 1992, the company budgeted a 44% reduction in lease operating expenses, "and we are below budget so far," he said.

Tactics Riseden has adopted include:

Requiring a purchase order approved by middle level managers for expenditures of more than $100.
Renegotiating fees for legal services, a tip suggested at Tipro's survival workshop.
Adding a marketing specialist to the company's staff to handle gas sales and offering gas marketing services for a fee to other independents to help offset the cost.

Since adding the gas marketer, Riseden said, "people are starting to call us about our gas marketing service because with a flat fee, as opposed to a percentage, they know how much they will have to pay."

TIPRO WORKSHOP

At Tipro's workshop, a series of panels suggested ideas independents can use to trim costs without sacrificing efficiency.

Many suggestions aimed at controlling costs of professional services independents are using more as they trim the work force. Other ideas involved things independents can do to improve profitability by curbing operating costs without diminishing efficiency.

Among ideas offered to make the most of contracting services, panelists said independents should:

Define work within very narrow boundaries.
Prepare and review legal documents in house and have outside counsel review them only if necessary.
Make sure service companies know overruns will not be tolerated without prior notice that extra work will be required.
Not be reluctant to discuss fees. If an operator isn't comfortable talking about fees, he doesn't have the right relationship with the service company representative.
Require an engagement letter capping costs or an up front estimate of all but the most insignificant fees.
Demand discounts because of industry conditions.
Buy nonoperating partners' interests in marginal properties.
Renegotiate leases on office space, seeking rental reductions in return for extensions.

Among the ideas that can reduce lease operating expenses (LOEs), panelists suggested:

Monitor chemical programs closely to avoid overtreating of wells.
Always run tubing anchor catchers on pumping wells.
Open discussions with vendors about reducing chemical costs, lease roustabout work, or equipment rentals when production is interrupted during well maintenance and work-overs.
Maintain close control of salt water disposal systems to avoid spills or overflows.
Recalculate internal LOEs on each well to make sure strong wells aren't carrying weak wells and sell properties that can't make the cut.
Review compression requirements regularly and downsize rental units, purchase rental units, or eliminate compression where that would be profitable or possible.
Pressure high cost contract operators to bring lifting costs in line.
Monitor and audit third party operators more closely.