E&P companies face investment challenge for their cash

The annual study on oil and gas E&P business by US independent petroleum research company John S. Herold and UK-based global oil and gas corporate adviser Harrison Lovegrove & Company has consistently provided an excellent guide to current trends and once again comes up with some surprising conclusions. We publish here an abridged version of the report, now in its 39th year, which is based on the performance of some 200 companies representing a cross section of the global upstream sector. Tight markets and escalating prices fuelled a 32% jump in the average price per barrel oil equivalent (boe) realized by the Global Upstream Performance Review universe of over 200 oil companies in 2005; the sector enjoyed a revenue gain of $190 billion over the prior year. Clearly, it is a challenge for the industry to invest such a surge of funds, particularly given the restrictions on access to basins with large resource potential. For context, the entire indus-try’s finding and development investment during 2004 was $164 billion. Upstream capital investment did soar to a record for the third consecutive year, increasing by 31% to $277 billion. Yet the incremental outlays represented only 35% of 2005’s incremental revenue. Reserve purchases also set a new high in dollar terms, rising 13% to $54 billion. In spite of the increased capital and acquisition programmes, the industry still found itself with surplus capital. Rather than going back into the ground, $128 billion of this money was channelled back to stakeholders through dividends and share repurchases. In fact, funds devoted by the oils to stock buybacks exceeded proved reserve purchases by almost 20% and were nearly 80% higher than exploration outlays last year. On a regional basis, budget allocations have been shifting rather slowly. The US continues to draw a smaller share of finding and development outlays, even though profitability per barrel in the US is the highest among our six global regions. Over the last several years, the industry has been making an effort to direct its capital toward areas where relatively large targets may be drilled. But competition for these areas is intense and accessing adequate opportunities is challenging. Although total exploration investment rose to a record $36 billion, it drew the smallest share of industry investment over the last five years (13% versus 15% in 2001). Exploration remains under a magnifying glass because discovered volumes continue to disappoint. This is a significant problem. Without access to some of the prolific hydrocarbon regions currently closed to most major oils, new field discoveries are likely to continue getting smaller. The industry will be forced to choose between reliance on higher cost resources such as tar sands, LNG and GTL, or development of ever-smaller accumulations, which also implies continually rising investment per new barrel. Our work has shown that the historical allocation of upstream capital to development activities fluctuates little over time: development outlays receive a smaller share of the total budget when acquisitions claim a larger part of the pie. Since the timing of development wells can be highly discretionary, and desirable acquisitions can present themselves with little notice, this cyclic diversion of funds is not surprising.