Experts Caution Oil Firms on Big Profits
Oil companies, riding a wave of sustained commodity price strength, have been generating copious amounts of cash and sharing it generously with their shareholders. But while their profitability has been stellar, some measures of operational performance have been less impressive and could spell trouble in the longer term.
In its latest annual upstream performance review - a treasure trove for statistics buffs - energy research firm John S. Herold noteds that average net income rose 38 percent to $6.41 per barrel of oil equivalent in 2003. On the other hand, reserve replacement rates continued a five-year slide.
A sampling of some 194 companies from around the world shows that the oil and gas industry saw its cash flow climb 27 percent to $197 billion last year versus 2002, but upstream investment rose by a relatively modest 9 percent to $161 billion.
This combination of strong earnings and high energy prices for consumers could result in "political heat," increased government scruting and more onerous fiscal terms if low levels of reinvestment persist, the Herold team warns.
Last year was the fourth in a row in which upstream investment - money spent on exploration, development and acquisitions fell short of cash flow.
Drillbit reserve replacement which measures a company's own exploration efforts and excludes additions resulting from acquisitions fell to 109% last year from 140% back in 1999. Oil discoveries by the companies covered in the Herold study have been running at an annual pace of slightly less than seven billion barrels for the last five years, but production has been running at over 10 billion barrels per year.
Gains from technical revisions lift the overall total, enabling companies to grind out an average annual increase in oil reserves of around 1%. Fortunately, the industry has had a better discovery record on the natural gas side in recent years.
Development spending captured almost two thirds of upstream expenditure last year, amounting to $100 billion, as companies stepped up development work to boost output while prices are high.
Exploration activity soaked up $24.5 billion, holding steady its share of overall upstream spending at around 15%. Completion of known development projects should spur increased exploration, but as Herold remarks: "It is easy to advocate increased exploration investment, but harder to find economic drill sites." Acquisitions can provide a relatively quick fix to the challenge of replacing reserves and growing production, so merger and acquisition deal values could be poised to pick up again after falling sharply from the levels reached during the round of mega-mergers in the late 1990s.
Rising costs pose a potential threat to companies' profitability. While soaring earnings have grabbed most of the attention recently, reserve replacement costs continue to ratchet higher, jumping 20% to $6.36 per barrel of oil equivalent in 2003 and rising about 15% per year since 1999.
Finding and development costs have been escalating in mature areas like North America and Europe since 1999. But, last year, frontier areas such as Africa and the Middle East and South and Central America also began to experience significant cost pressures. Herold collaborated with upstream acquisitions and divestitures firm Harrison Lovegrove on its 37th upstream performance review.
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