High oil and gas prices, fundamental change mark global energy industry scene in 1996

John Kennedy
Editor

How oil, gas prices hit recent highs [37124 bytes]

Mergers and acquisitions, a realignment of energy markets and players, high oil and gas prices, and deepwater enthusiasm defined the global energy scene in 1996.

Some industry segments fared better than others. But all in all, it was a good year for energy companies.

Throughout the world, company organization and purpose were again major concerns. Executives and managers still wrestled with how to organize, what type of work to do, where to do it, and with whom to do it.

Both private and state-owned oil and gas companies took dramatic steps in pursuit of operating efficiency, a competitive edge, and a bigger market share.

Upstream and downstream, traditional competitors agreed to work together to leverage financial and technical resources, reduce operating costs, and gain market clout. More state companies decided to privatize-or at least consider privatizing.

Oil service and supply companies formed alliances to enhance their ability to package more technology and service.

And electric utilities joined forces with natural gas companies, gas pipelines, and other energy producers to offer energy in whatever form the customer wants.

All of this activity was fueled by the search for ways to grow and profit in a world energy market marked by fierce competition and volatile prices.

Higher prices

In 1996, oil and gas prices were better than anyone had hoped, let alone forecast.

This unexpected price strength, slimmer corporate structures that boosted cash flow, and new technology brought more drilling and more E&D spending.

Nowhere was enthusiasm greater than in the U.S. Gulf of Mexico, where deepwater royalty relief also helped set lease sale records and fuel development activity.

For refiners and marketers-and energy customers-it was a slightly different story. Refiners were not thrilled with market conditions in 1996, and consumers were vocal about higher product prices.

High oil prices put further pressure on already-weak refinery operating margins in the U.S. and Europe. To cope, refiners resorted to business consolidations and joint ventures aimed at reducing costs and increasing regional market shares.

Twice during the year, U.S. companies faced the ire of consumers and calls for government intervention in the market when prices increased as a result of higher demand and new inventory strategies. In the end, the government kept its hands off the market.

Few are ready to conclude that the high oil and gas prices of 1996 mean a permanently higher price level. So most companies continue their quest for lower costs and higher operating efficiency.

What to do with whom

In whatever form-joint ventures, alliances, mergers, acquisitions, sales-the redistribution of assets and resources in the year just past spanned petroleum industry operations from exploration through refining and marketing. And these strategies began to integrate the petroleum and electric power industries in a big way.

There was continued activity in oil and gas exploration and development, but some of the biggest deals announced were downstream. Units of the world's largest oil producer and the world's largest refiner agreed to combine their U.S. refining and marketing operations.

Multibillion-dollar acquisitions and mergers involving natural gas firms and electric utilities took the energy convergence phenomenon from theory to reality. This concept of integrating power and petroleum markets expanded to encompass low-value refinery products and even a geothermal energy producer.

And from Indonesia to Italy, from small companies to the world's largest natural gas company, privatization of formerly state-owned firms gathered momentum.

It is difficult to merge cultures, assets, and egos, and not all the announced plans went smoothly. The 2-year effort by Amoco and Shell to form a joint venture to explore and develop in the Permian basin reportedly almost came apart at mid-December. A week later, the problem was said to be solved.

BTUs in any form

Much was said about the convergence of markets for natural gas and electricity in the early 1990s.

In 1996, multibillion dollar deals between gas pipelines and utilities made it a year of action, not just talk. Natural gas companies bought utilities, and electric power companies bought natural gas pipelines.

This convergence is expected to continue. It will spread across national boundaries and include other sources of energy. In the last days of the year, for example, the Wall Street Journal reported that CalEnergy, a U.S. independent power producer that sells energy produced from geothermal and other sources to utilities, claimed control of Britain's Northern Electric plc.

Integration of refining and electric power production is growing, too. Refiners are becoming power producers as they start projects to produce electricity, along with steam, hydrogen, and petrochemical feedstocks.

Integrated gasification combined cycle (IGCC) plants can turn low quality refinery streams into electricity and other products. Major commercial projects are under way in the U.S., Netherlands, and Italy (OGJ, Dec. 9, 1996, p. 40).

Refiners get together

Refining joint ventures are as old as...well, as old as the 1980s.

Early deals often were driven by one party's need for crude and the other party's need for market entry.

Deals disclosed in 1996 were different. They were done to trim operating costs and find other ways to become more competitive.

These deals took refining rationalization to a new level.

Much work still lies ahead before the deals are closed.

In the U.S., for example, antitrust questions will focus on regional market shares rather than national competition. Even the Texaco/Shell/Star combination would have only about 15% of the national market, but a much larger share of some regional markets.

More consolidation is ahead in refining and marketing in the U.S. and Europe, say analysts.

High prices, low costs

Iraq did not reenter the global crude market until the last few days of the year, so growing worldwide energy demand and diminished excess producing capacity drove crude prices higher in 1996.

Adding the effect of new inventory strategies produced jumps in product prices during seasonal demand peaks.

At the same time, finding, developing, and operating costs continued to decline.

The overall effect was generally good news for oil and gas producers but a mixed blessing for refiners and marketers.

Available cash flow and operating costs are critically important in exploration and development decisions. But there is no question that prices are a key driver of petroleum industry activity and events.

And last year, oil prices were higher than at any time since 1990 (see chart). Average U.S. wellhead oil prices, in nominal terms, were 25% higher than in 1995; average natural gas prices were up more than 40%.

Total U.S. wellhead revenues were the highest since 1985.

Operating costs continued to fall, and cash flow improved.

This fortunate combination was responsible for an upstream recovery in the U.S. that was particularly bright in the Gulf of Mexico, where rig demand, utilization rates, and day rates all reached the highest levels in recent years. (OGJ, Nov. 25, 1996, p. 24).

Outside the gulf, drilling activity was up across the board in North America and in other regions.

Some say the oil market may have established a new trading range. But OGJ's upcoming forecast is for prices to recede in 1997. The end of the winter heating season in the Northern Hemisphere and Iraq's increasing export capacity will put downward pressure on prices.

Even if oil prices return to less than $20/bbl, however, cost and efficiency improvements taken in response to the market of the late '80s and early '90s will leave a margin of safety for producers. And lower feedstock costs will enhance the effect of cost cutting steps taken by refiners.

Events behind the trends

Of the many important events and announcements during 1996, these have special significance:

Refiners announced joint ventures, alliances, and mergers in the U.S. and Europe aimed at cutting costs and boosting market dominance. First Mobil and BP said they would combine their European refining and marketing operations. Then Texaco, Shell, and Star Enterprise-a joint venture of Texaco and Saudi Aramco-disclosed they would combine their U.S. downstream units. Following that were announced combinations of Elf and Chevron in the U.K. and Ultramar and Diamond Shamrock in the U.S. Tosco intends to buy Unocal's West Coast refining marketing division, making Tosco the biggest independent refiner in the U.S.

Japan's product markets opened. On Apr. 1, Japan marked the beginning of deregulation of its downstream markets when Tokyo allowed a law limiting refined product imports to expire. Previously, Japanese gasoline, kerosine, and gas oil retailers were protected from competition at the expense of refiners. Increasing retail competition is expected to spur service station closures, switches to self-serve, and reduced refinery runs. The move is controversial.

Electric utility Duke Power Co. and natural gas pipeline and marketer PanEnergy Corp. agreed to merge in a deal valued at $7.7 billion. The combination is especially significant because it is aimed at carving out a national-rather than regional-market share in both gas and power.

Earlier in the year, announced mergers included Houston Industries (electric utility) and Noram (gas utility); Enron (gas pipeline) and Portland General (electric utility); El Paso (gas pipeline) and Tenneco (gas pipeline); Pacific Enterprises/Enova (electric utility/gas utility); and Texas Utilities (electric utility) and Enserch (gas utility).

Electricity futures contracts began trading. DuPont Power Marketing Inc., Houston, a unit of Conoco parent Du Pont Co., traded the first of more than 1,200 wholesale power contracts when trading of that contract began on Nymex Mar. 29. The advent of electricity futures is another factor bolstering competition in the rapidly deregulating North American power sector. Orders 888 and 889 issued last year by the Federal Energy Regulatory Commission will begin the restructuring of the wholesale bulk power market (OGJ, Aug. 12, 1996, p. 59).

Refining's role in power production was the subject of a 3-day conference in San Francisco sponsored by electric power and natural gas interests that drew 300 from the U.S. and abroad (OGJ, Dec. 9, 1996, p. 40).

Oil prices hit 6-year highs. Despite the threat-and eventual reality-of renewed Iraqi exports to world markets, high oil and gas prices fueled more U.S. E&D activity and optimism. With the exception of 1990, when the Persian Gulf crisis caused a price spike, 1996 average U.S. wellhead crude prices were higher than at any time since 1985. Average wellhead price of U.S. oil production was $18.33/bbl, compared with $14.62 in 1995. At yearend 1996, West Texas intermediate, at more than $24/bbl, was almost $6/bbl above its year-ago price.

U.S. gas demand set a record. American Gas Association estimated 1996 natural gas consumption at 22.76 quads (OGJ, Dec. 23, 1996, p. 36), breaking the 1972 record. AGA's base case prediction for 1997 consumption shows another increase to more than 23 quads. U.S. natural gas prices averaged $2.25/Mcf last year, the highest level since 1985.

Iraq exports resumed, but only a few days before the end of the year and in modest volumes. The long-delayed event had little effect on crude oil prices, causing only minor, short-lived dips from levels that were as high as they had been since the gulf war.

Saudi Arabia's leadership was transferred, and the global oil market did not falter. True, the transfer was described as temporary and smooth, but it still was an indication of oil market strength in 1996 and how views about energy security have changed.

Two record OCS lease sales in the U.S. Gulf of Mexico showed industry liked the Deepwater Royalty Relief Act and market prospects (OGJ, Nov. 20, 1995, p. 41). Minerals Management Service Sale 157 set records for the number of bids offered and the number of tracts receiving bids (OGJ, Apr. 29, 1996, Newsletter). Of the 924 tracts receiving bids, 442 were in more than 400 m of water. Outer Continental Shelf Lease Sale 161 brought more bids than any western gulf sale and doubled the amount of acreage available for drilling in the western Gulf of Mexico (OGJ, Sept. 30, 1996, p. 26). It included 3,585 blocks in water 200 m and deeper.

Efforts to gain approval to drill and develop an 11-block area in federal waters off Florida were launched by a Chevron-led group. The group said it will try to get approval to develop a discovery on the Destin Dome that may hold 17 tcf of gas (OGJ, Dec. 9, 1996, Newsletter). Leasing in federal waters off Florida was put under a 10-year moratorium in 1990. Chevron expects the process to be lengthy.

Caspian Sea export plans took a big step. The proposed 900-mile crude oil pipeline to move oil from Kazakhstan via Russia to the Black Sea for shipment to world markets is closer to reality (OGJ, Dec. 16, 1996, p. 22). Mobil signed an agreement in Moscow Dec. 6 to restructure the Caspian Pipeline Consortium (CPC), following signing of a protocol earlier in the year to restructure CPC (OGJ, May 6, 1996, Newsletter). Initial phase will be on stream by late 1999 at a cost of $2.1 billion. After an expansion set for completion in 2010 that will cost another $2 billion, the line will handle 1.4 million b/d of Russian and Kazakh exports.

Latin America projects got under way to expand the gas pipeline infrastructure there. Petrobras' memorandum of understanding with British Gas, BHP, and Tenneco to transport gas from Bolivia to Southeast Brazil was another step in the development of an integrated gas grid in the so-called "Southern Cone" of South America. The $2 billion, 2,000-mile, 32-in. Bolivia-Brazil project will transport 1 bcfd. And construction began on GasAndes, the line that will move Argentina gas to Chile (OGJ, Feb. 5, 1996, p. 27).

First Troll gas was delivered to Germany. Troll field in the Norwegian North Sea began supplying gas to Europe through a platform that is the largest structure ever moved by man. It will supply gas for the next 50 years. Troll East gas platform is the world's tallest and heaviest at 430 m high and 1.05 million metric tons (OGJ, Oct. 7, 1996, p. 43).

Construction began on Trinidad and Tobago's Atlantic LNG project, the first grassroots liquefied natural gas export project in the Western Hemisphere in more than 25 years. The project, conceived in 1992, calls for building a single-train, $1 billion LNG complex at Point Fortin, Trinidad. First gas will ship in mid-1999. The plant's entire output will go to markets in the Northeast U.S. and Spain. This and other projects and commitments marked a renewed interest during 1996 in liquefied natural gas (LNG) projects. Healthy natural gas demand growth and lower costs for plants and carriers are behind the resurgence. Ras Laffan Liquefied Natural Gas Co. awarded a $1 billion contract for engineering, procurement, and construction of a gas liquefaction plant in Qatar's Ras Laffan industrial area on the Persian Gulf coast (OGJ, Mar. 25, 1996, p. 36). Contracts were also let for a plant in Oman and an expansion of Australia's North West Shelf project that will double capacity.

Petroleos de Venezuela SA (Pdvsa) offered its first exploration and production profit-sharing contracts. It is Venezuela's most extensive offering of this type for private investment since nationalization 20 years ago, and the first offering of exploration acreage in Venezuela since 1958. Interest in developing Orinoco heavy oil shows foreign operators expect such development to be economic under future market conditions. This vast area, with more than 1.2 trillion bbl of 6-13° gravity oil in place, is the world's largest conventional liquid hydrocarbon accumulation (OGJ, July 8, 1996, p. 62).

Texaco settled a discrimination lawsuit for $176 million and unveiled a far-reaching plan to bolster minorities' roles in and with Texaco, heading off a boycott of Texaco products. As part of the settlement, Texaco will let a task force that includes three members selected by the plaintiffs have direct influence on personnel policies (OGJ, Nov. 25, 1996, Newsletter).

Royalty underpayment audits were started by MMS (OGJ, Sept. 2, 1996, p. 28). New allegations may not be resolved soon. The latest disputes are large and widespread and threaten to hang over the industry for decades. A half dozen producing states were investigating possible severance tax and royalty revenue underpayments in 1996, and private leaseholders filed class-action suits against producers. The Justice Department started a nationwide review of how oil companies value crude oil for royalty purposes, in preparation for a possible false claims lawsuit.

Bill Clinton was reelected U.S. President, and Congress remained Republican. The presidential campaign was marked by a lack of discussion of energy issues. But the American Petroleum Institute voiced concerns that the administration will press for dramatic measures in response to fears of global warming.