2002 E&P SPENDING

Annual survey signals spending plateau

Geoff Kieburtz, Mark S. Urness, Andrew C. Hoffman, Robert J. MacKenzie and W. Michael McNair, Salomon Smith Barney, New York

The 36-page report "The E&P Spending Survey," by Salomon Smith Barney (SSB), is the organization’s 20th annual survey of activities of major and independent oil/gas operating companies with interests in the U.S., Canada and International (outside North America). In this report, covering the year 2002, responses from 243 participating companies are presented and analyzed.

The authors say the survey indicates a sharp reduction in 2002 North American spending, offsetting modest growth overseas. Further, recent market dynamics and increased sensitivity to price changes suggest the survey results may even overstate likely activity. The survey, encompassing about 75% of global spending, indicates a modest potential 2002 decline of 0.5%, vs. 2001. This follows estimated growth of 24.8% in 2001, the highest year-over-year increase since 1981.

Assumed oil and natural gas prices are historically high. Respondents have estimated a $20.72/bbl oil price, 7% above the 12-yr average assumption of $19.39/bbl, and nearly a dollar above the current (late 2001) futures strip. Similarly, the $2.83/Mcf gas price assumption is 29% above the 12-yr average assumption of $2.19/Mcf, albeit 4% below the "current" strip.

North American spending is forecast to decline sharply. Oil/gas prices averaged about $26/bbl and $3.85/Mcf during 2001, yielding the industry’s fastest expansion in 20 years. However, due to falling oil/gas prices, North American spending is expected to decrease 14.7% in 2002. U.S. spending is forecast to decline 12.1%, following 2001’s 28.3% gain, while Canadian spending should fall 20.5% after last year’s 35.8% increase.

Conversely, international activity is expected to grow, but more modestly. Following 21.0% growth in 2001, international spending is forecast to increase 9.7%. The majors have shifted their focus from consolidation to expansion; however, growth should slow, due to a more conservative stance. Nearly 64% of projected spending is outside North America, compared to 57% in 2001.

However, survey results do reflect "tenuous" optimism. Trends in oil/gas prices were unclear at the time of the survey. Unusually warm North American weather, uncertain OPEC policy and soft economic conditions make downward revisions to initial budgets more likely than upward revisions. This bias is reflected in heightened sensitivities to lower oil/gas prices.

Overall, the survey indicates that, after two years of robust recovery from the 1999 contraction, 2002 spending will be essentially flat with 2001. In a predictable pattern, North American activity led the rebound in 2000 with a 40% increase, followed by an unexpectedly strong 30% increase in 2001. Gas has been – and will likely continue to be – the driving force behind North American spending.

Meanwhile, outside North America, the 1999 contraction was less severe and, consequently, 2000’s rebound of 8% was less dramatic. International expansion accelerated to 21% in 2001, yielding a worldwide growth rate of 25%, the fastest in two decades. The 2001 growth was in line with SSB’s mid-year forecast. The flattening of worldwide activity projected for 2002 comprises an almost 15% reduction in North American spending and a nearly 10% increase in international markets. These results are somewhat more positive than the pre-survey projection of a 20% North American decline and a flat international outlook.

Summary and outlook. Combined, the 243 oil/gas companies surveyed plan worldwide E&P expenditures of $112.6 billion in 2002, down 0.5% from the $113.1 billion now forecast for 2001. SSB believes these total expenditures, encompassing major, national and independent companies operating on six continents, represent a comprehensive survey of forecast 2002 investment. Of the planned spending, 64% is earmarked for international markets, 26% for the U.S. and 10% for Canada. The ten largest spenders account for 51% of total spending, and the top 50 represent 89%. The data does not include spending on acquisitions, so historical numbers have been adjusted to reflect acquisitions, as if they had occurred at the beginning of the survey period.

It should be noted that this summary article presents only four of the 50 tables detailing results of survey returns, and other related questions / analyses published in the complete December 17 report. Principal conclusions from data in the four tables, and other key observations are described here.

   U.S. Majors. The ten firms designated as Major oil companies plan to decrease their U.S. spending by just 2.3% in 2002. Several of the Majors have de-emphasized domestic onshore and shallow offshore operations in recent years, shifting their focus, instead, to international and deepwater regions. SSB believes the 2.3% decline comprises a larger level of decline in onshore and shallow offshore drilling, offset by an increase in activity in the deepwater Gulf of Mexico.

The Majors, in an international sense, have shifted their focus from consolidation to expansion. However, the uncertainty has yielded modest near-term growth plans. Strategically, "mega-majors" such as BP and ExxonMobil are moving from smaller targets and toward "elephant" fields in deepwater and remote locations.

   U.S. Independents. In the U.S., the 166 Independents surveyed plan a 19.0% decline in 2002 upstream expenditures, to $15.5 billion, from $19.2 billion in 2001. This compares to a 45.2% increase in 2001, the fastest pace of expansion since 1981. Reduced gas prices are the principal reason for the sharp decline. Secondarily, oil prices have fallen to around $19/bbl, after averaging $26 in 2001. Due to the industry’s strongest financial health since the early 1980s, as well as a scarcity of prospective targets, SSB does not expect the Independents to aggressively increase gas drilling activity until prices rise above $3.00/Mcf.

Further, respondents indicated that the downside sensitivity of spending plans is greater than the upside, although this appears to be more the case with oil-related projects – which currently account for just 20 – 25% of U.S. drilling – than gas projects. Among Independents planning the largest 2002 spending declines are Devon Energy, Apache Corp., Anadarko Petroleum, Burlington Resources and Kerr McGee.

Aggregate U.S. spending is forecast to fall by 12.1% in 2002, to $28.7 billion from $32.7 billion, compared to a 28.3% increase in 2001. Of the 176 respondents planning U.S. spending, just 20% anticipate higher year-over-year spending, including BP, ExxonMobil and Williams. Only 26% expect to overspend cash flow, reflecting an increasing level of conservatism among independents, as well as a reduced amount of attractive drilling targets. Since 1999, just 36% of respondents have overspent cash flow, compared to the 51% of the preceding nine years.

   In Canada, 81 companies plan a 20.5% spending decline in 2002, to $11.5 billion from $14.5 billion. This follows a 35.8% increase in 2001. Surging natural gas prices, as well as favorable weather conditions, propelled Canadian rig counts to record levels. As in the U.S., operators focused principally on quick payout – rapidly depleting fields – attempting to maximize cash flow as gas prices reached record levels. Under the current conditions of high storage levels and weak demand, SSB expects Canadian rig counts to decline further through the first half of 2002. Among respondents, the largest 2002 Canadian spending declines are expected from Devon Energy, Conoco, Burlington Resources and Rio Alto Exploration. Conversely, the largest increases are forecast from Shell Canada, Imperial Oil and Vintage Petroleum.

   International. The 88 companies surveyed with spending outside North America plan a 9.7% increase in 2002, to $72.3 billion, from $65.9 billion. This compares to 2001’s estimated growth rate of 21.0%, driven by oil prices that averaged $26/bbl. Major oil companies have finally returned to expansion mode, after nearly three years of cost reductions and consolidation. However, the recent oil price decline has muted 2002 international spending plans, which just six months ago were forecast to rise by 10 – 15%.

Moreover, large deepwater projects continue to take longer than anticipated for a variety of reasons. In fact, of the 9.7% forecast growth in 2002, SSB estimates that 4 – 5% is comprised of projects that were delayed or deferred from 2001. This also helps explain much of the difference between actual 2001 international spending growth of 21% and the 27.5% forecast given in the mid-year survey.

For 2002, SSB sees further risk to this forecast due to the high level of dependence by several nations on oil-related revenues. This is particularly relevant in Mexico and Venezuela, as well as several OPEC nations not included in this survey. As evidence of this trend, the Baker Hughes international rig count has fallen 3% during the last two months of 2001, coincident with the 20 – 25% decline in crude prices.

Some key observations. The following selected points of interest emerged from the survey, in addition to the preceding analyses:

• An across-the-board shift toward development projects from exploration is in contrast to respondents’ optimism regarding oil/gas prices. This is particularly true in North America, where the shift was most dramatic. In international markets, the percentage of respondents shifting toward exploration was the second lowest since 1994, reflecting both heightened conservatism and start of several large deepwater developments.
• Last year, availability of attractive drilling prospects was operators’ primary concern, with energy prices and cash flow having a lesser impact on spending plans. However, economic activity has since declined dramatically, causing the industry to shift to a more conservative mode as energy prices, and secondarily, cash flow, have again become the primary factors in spending plans. Additionally, operators continue to focus on return on invested capital, in many cases at the expense of production growth.
• There is an increase in the sensitivity of spending plans to oil price changes. Of total respondents, 48% are likely to increase budgets if oil prices are $3/bbl above planning assumptions. Notably, the level of sensitivity is highest outside the U.S. Further, of the 60% that would reduce budgets if oil prices declined $3 below budgeted assumptions, 90% stated that budgets would decline by at least 10%.
• A $0.30/Mcf increase in natural gas prices would prompt 44% to raise their spending budgets, in line with the 42% five-year average. This is significantly higher than the 26% level of a year ago. If gas prices fall $0.30 below budgeted assumptions, 57% plan to reduce spending plans, nearly double last year’s 32% response. This reflects a more conservative psychology among operators.
• For the fifth year, oil/gas companies have indicated an intention to increase the proportion of their budgets dedicated to gas, albeit at a slower pace than in the past. Canadian respondents drove this result, with operators in other regions expressing no significant preference. The result from U.S. Independents marks a departure from four consecutive years of increased focus on gas.
• In a shift from the past two years, E&P companies indicated a preference for development drilling over exploration, apparently due to the weakening commodity price. However, 29% still indicated that they expect to increase exploratory activity in 2002, as there is no pressure to get production to market quickly, indicating an emphasis on growing reserves now to prepare for stronger demand in the next several years.
• Consistent with the trend toward increased development work, 38% plan for a decreased budget share to be allocated to seismic, vs. 28% who plan an increase. If this turns out to be the case, 2002 would be only the second year in the past ten, in which seismic expenditures were reduced as a budget percentage. Once the fundamentals turn positive again, which is expected in mid-2002, a return to increased seismic expenditures is expected.
• By far, the most enduring trend in previous spending patterns has been the shift toward increased offshore activity. However, on a worldwide basis, this appears to be slowing, and has appeared to reverse itself in the U.S. While one data point does not break the trend, particularly given the volatile commodity price environment, it could portend a fundamental shift away from higher-risk offshore projects. During 2001, SSB saw a much stronger market for land rigs than was evident for offshore rigs, due to marginal economics of shallow-water offshore drilling in the U.S. Gulf.
• Respondents are overwhelmingly optimistic (94%) about the three-year outlook. The strong oil/gas prices during 2000 and early 2001 have led to E&P companies that are much stronger financially than during the last downturn. Notably, confidence is much higher than in the 1998 survey, as most companies believe the current slump is likely to be relatively mild and short.

Note: Salomon cautions that, since actual companies surveyed vary from year to year, it is not statistically accurate to compare total estimates with those from prior-year surveys.

	2001 – 2002 Canadian E&P expenditures, $ millions*
	2001 – 2002 U.S. expenditures by major oil & gas companies, $ millions*
	2001 – 2002 U.S. E&P expenditures by independents, $ millions*
	2001 – 2002 International (outside North America) E&P expenditures, $ millions*