Investors see strong capital outlook in 2005
In a word, the outlook for capital investment in the oil and gas patch in 2005 is “robust,” according to some of the investors and players in the sector who were contacted in the waning days of last year. In some quarters, though, there may be more dollars available than viable projects in which to invest, given a supply-limited market.
Outlooks for the new year can vary depending on:
• parts of the sector (upstream, midstream or downstream);
• project size; and
• geographic location.
While all three segments anticipated continued growth in capital investments, the degree of the growth varies markedly from modest two percent increases to fully 25 to 50 percent hikes in investment. Projections can be further segregated among private capital, institutional investment, and retail investors.
The irony is that the big major international companies that everyone wants to lend money to aren’t interested in doing more drilling on any sort of widespread scale, and the smaller companies that are in the best position to do more effective E&P work are shut out somewhat by investor-lenders wary of smaller companies with lower credit ratings and shorter track records, says Steven King, a principal with PetroInvest, Houston, a firm concentrating on the small to mid-sized independents that he says currently make up 40 to 50 percent of the annual drilling activity nationally.
A private capital expert with offices in New York City, Houston, and western Canada, Cameron O. Smith, founder and senior managing director of COSCO Capital Management LLC, sees private investment as being more pervasive and more calculating, with strong investments next year in the upstream sector, “stronger” yet in the midstream, and “less strong” in the downstream plays. Collectively, the private dollars ought to increase by 50 percent, Smith thinks, noting there could be an additional $8 billion to $10 billion invested in oil and gas in 2005.
Everyone agrees the right economic fundamentals are in place to attract investment, but not everyone will find a play, and those that do won’t necessarily receive the same returns as some of the veteran private capital people who pick their spots wisely.
“There is going to have to be a fairly sizable up-tick in the level of investment, and I think we’re seeing that in some of the investments being made in places like China, South America, and some of the fairly large resource acquisitions that are taking place in the former Soviet Union, in Russia, and in the Far East,” says James Kipp, managing director, energy production, Wachovia Securities, Houston. “Clearly, I don’t see there being any shortage in terms of the levels of investment being made into the energy and power sectors.”
Fitch Rating Service just before the Christmas holiday predicted another bullish year for upstream oil and natural gas activity in 2005, looking for overall capital spending to increase beyond 2004 levels. The continued upswing will be driven mostly by increased oilfield service costs and higher steel prices, along with organic growth capital that the independents possess in the form of considerable drilling prospects obtained from acquisitions in 2003-04, Fitch said in its report.
Lehman Brothers’ survey concluded that capital spending for drilling operations would grow by nearly eight percent in the new year, but not at the truly robust 16 percent it attributed to capital spending growth last year.
Smith Barney’s early 2004 survey was more modest, concluding that 61 percent of its survey respondents expected to increase spending across a broad range of one to 10 percent, but, of course, the overall growth in spending was a whole lot more.
“Assuming expenditure creep continues, 2005 could be another active year, outstripping the estimates,” says PetroInvest’s King. “But remember there are two elements to higher expenditures - the number of wells drilled and the cost per well. For the most part, 2004 did not see a major run-up in the cost per well.”
A thicket of thorny, sometimes counter-intuitive, issues was identified by industry stakeholders who offered a consensus view predicting continued oil and gas industry investment growth. Both historic and more newly coined trends are among the prime actors. Whether they will emerge as protagonists or antagonists is still in doubt in the early days of 2005.
Surprisingly, war in the energy-sensitive Middle East and domestic political developments were not raised as issues to watch affecting energy investment levels. Instead variables such as global energy prices, demand, technology advances, rig counts, and innovation in the energy services sector received plenty of ‘what ifs’, ‘shoulds’ and ‘coulds.’
Brad Beago, equity research director at the global corporate/investment bank, Calyon, finds a briarpatch of opportunities and challenges for assessing new investment in what he called “one of the hottest plays in the country” - the Barnett Shale in north-central Texas. While the companies he follows have never been healthier financially, the tools they need to keep up with the sophisticated horizontal drilling approaches to the field raise questions in his mind as to whether they will get to do all they would like to do this year.
“My companies currently have their best balance sheets since the early 1990s,” says Beago, whose career in the industry has spanned that 12-year period. “You’re seeing banks just throwing money at the sector. The equity markets are wide open for anyone who wants to sell equity. Ultimately, what this means is companies will continue to reduce their debt-to-equity ratios and will be more concerned about leveraging up and quicker to sell equity in this sort of environment.
“I can think of five to seven companies off the top of my head that plan to radically increase drilling in the Barnett Shale. My question to them is, with all of you flush with cash and wanting to increase drilling, where are you going to get the equipment? I think we are going to start to see that as an issue.”
As do his other investment colleagues, Beago thinks technology is “huge” in the sector and can help drive more investment by creating more confidence in the exploration and development work, nailing down economic plays, and getting them in place expeditiously.
The new year will see continued high drilling rig utilization levels (85 percent and above) with 1,500 available rigs, and the investment capital is there to support even more, but for the long term, the question is what are the investors getting for their buck? Many of the stakeholders and investors are skeptical here.
Bill Berilgen, executive vice president for fuel at national power plant developer/operator, Calpine Corp., thinks, “exploration dollars have not really increased,” from his perspective managing Calpine’s multi-billion-dollar cache of North American natural gas reserves and production.
“In North America, the exploration has not been that successful. It has been more a case of going after known, but hard-to-get-to oil and gas deposits in existing production areas. That’s where the dollars are being spent,” he said.
Berilgen is not convinced that technology is making as big a difference as it should. “Three-D was the last technological enhancement we had. Since then, nothing newer has come along. It is not because dollars aren’t being spent. The dollars are coming at a record pace. We’re just not finding the reserves.”
But the majority of the other professionals contacted for this article disagreed and placed technological developments as a major stimulant that should assure continued growth in investments. It allows quicker take-downs and ramping up of rigs, puts PC controls on all the major drilling operations and has ushered in so-called “streamers” with wide-offset, 3-D exploration equipment in the Gulf of Mexico that have made the significant deep-shelf finds possible.
“That is the kind of thing that would have been drilled 10 years ago, but we didn’t have the type of equipment to identify it back then,” said Calyon’s Beago.
From the perspective of a publicly held California oil and gas independent, Lynn Blystone, CEO at Tri-Valley Corp. in the San Joaquin Valley, the high commodity prices and technology advances are attracting more “high-end” investors, with at least $1 million to invest. They are driven by the recent down years in the high-tech and biotech sectors and the prospect of higher multiples in energy.
“We’re doing quite well in raising money and have for some time now,” says Blystone, who has about 100 of what he classified as “upscale” investors, and his firm expects to “kick up a notch” its search for new investment capital in 2005, reaching out to broker-dealers who would seek a mass of small investors in limited partnerships.
“In 2005, I think it will continue very strongly, with more people interested in it,” Blystone says. “We could have sold about $100 million of drilling funds at year-end if we had set ourselves up to do that. Right now we don’t do anything through broker-dealers, but we will be doing that in ‘05.”
Upstream-focused energy investors like Wachovia’s James Kipp see the move back to so-called “MLPs,” or master limited partnerships, as more viable in the midstream plays. He personally knows of several companies looking at the MLP possibilities, although he doesn’t think anything short of traditional royalty trusts is viable for upstream investments.
PetroInvest’s King thinks it all gets back to rig availability. What he calls the “real question” is whether 2005 will see another 15 percent addition to the rig fleet. “Below this number, the cost per well should climb, but above that, the cost per well should moderate,” he says.
“That is not to say we will not see any price movement. Consider pipe costs that increased 20 percent during 2004 because China is sucking down steel for major building projects,” said King. “This trend shouldn’t end until the Beijing Olympics are over in 2008.”
It appears certain that plenty of new money will be flowing into the energy sector, but the still-unanswered question is how much more oil and gas will flow as a result. OGFJ
Richard Nemec is OGFJ’s West Coast correspondent, based in Los Angeles. He can be reached via e-mail at [email protected].