Analysis:What's on tap for 2003? Depending on the forecast methodology, oil and gas expenditures will show modest increases in 2003—or jump 20 percent.
This disparity typifies the energy forecast business in times of geopolitical and economic uncertainty.
On one side, there are the two major spending surveys published by Lehman Brothers and Salomon Smith Barney. Both use direct survey techniques to poll management at Exploration and Production firms for specific figures on budgeted expenditures. The size of the sample ranges up to 320 companies who account for a major percentage of worldwide expenditures.
The spending surveys expect global E&P expenditures to top $130 billion in 2003, a four percent increase over 2002.
On the other side of the question is a business spending model published by the energy analysts at Raymond James Associates that extrapolates expenditures from the free cash flow generated through industry economics. The Raymond James survey notes that operators historically spend more cash in the field than they generate. The challenge in 2003 is that higher commodity prices will throw off so much extra cash that operators will be hard-pressed to spend it because of constraints on how quickly the oil service sector can respond to expanding demand.
As a result, higher natural gas prices will generate domestic E&P spending at least 20 percent greater than 2002.
So which glass is half full? First, some details. The spending surveys indicate Canadian operators will lead 2003 investment with increases of five to seven percent. Both spending surveys identified budgets totaling $12.5 billion among approximately 80 companies involved in Canadian activity. Mergers have characterized the Canadian oil patch over the last couple of years, which have dampened activity as companies attempt to integrate their new corporate structure. However, spending increases on a dollar basis for 2003 are noted for Petro-Canada, up $195 million to $1.5 billion, Canadian Natural Resources Ltd, up $394 million to $1.4 billion, and Encana, up $190 to $1.8 billion.
Next up is the international arena, where survey projections call for $89.4 billion in E&P allocations, an increase of five to five and one-half percent, depending on the survey. State-owned oil companies and the European majors account for the larger increases internationally.
In Latin America, the big question for 2003 spending revolves around PDVSA, the state-owned oil company in Venezuela. Oil production has plummeted from three million bbls/d to estimates of between 200,000 and 800,000 bbls/d, depending on who makes the public pronouncements as the month-old strike challenging the political legitimacy of Hugo Chavez grows increasingly acrimonious. Outside of PDVSA, Petroleos Mexicanos (Pemex) projects spending increases of 15 percent to $9.3 billion, an increase of more than $1.2 billion as Mexico attempts to increase its oil and gas production over the next three years. This number is significant in that it accounts for nearly 60 percent of the identified increase in international spending.
In Brazil, Petrobras reports a ten percent increase in 2003 spending to $4.4 billion, according to the Lehman Brothers survey.
Elsewhere internationally, Russian spending will rise 14 percent to $7.3 billion, led primarily by Gazprom and Lukoil.
It is in the U.S. where the news is mixed—and the major item of contention between the direct survey method and the business spending model. Part of the fog surrounding the U.S. market stems from reduced spending at independent companies with merchant trading operations. But other intangibles abound, including balance sheet issues, perception of a decline in quality prospects, and uncertainty regarding commodity prices. Meanwhile, larger independents are following the majors overseas in search of better economics while those who remain have taken conservative views on pricing and cash flow.
As a result, independents are looking at a reduction in U.S. spending of about one half percent to approximately $17 billion, depending on the survey. The major oil companies will either cut spending about one percent to $13.4 billion, according to the Lehman Brothers survey, or increase it nearly one percent to $14.3 billion according to the Solomon Smith Barney survey. The discrepancy involves the size of the sample in each survey.
Spending growth in the U.S. domestic market on a percentage basis is most evident in smaller U.S. companies, which could increase volatility in 2003. Additionally, U.S. spending involves two dollars offshore for every dollar spent onshore.
The key to 2003 spending levels involves the commodity price assumptions, admittedly a difficult target thanks to geopolitical and economic turmoil. Both spending surveys identified price assumptions that are lower than the current market, which means upward revisions are possible—even likely—as the year unfolds.
Nonetheless, the conservative outlook among both independents and majors reflected in the spending surveys has led to a round of lower earnings estimates for energy firms among observers in the financial community.
And this is where the energy analysts at Raymond James take issue. The Raymond James group as a whole is noted for insightful research angles, original thinking on energy issues, and occasional irreverence in their role as the energy industry's most bullish forecasters. The group bases their spending model on the premise that cash flow is the chief driver for capital spending while budgets are simply planning guidelines.
Higher commodity prices, specifically for natural gas, will generate greater free cash flow in 2003—so much so that E&P firms will be challenged to spend it all on drillable prospects. Using a natural gas price forecast of $5 per Mcf, the Raymond James model assumes E&P companies will apply a little more than half of expanding free cash flow to increased spending and a little less than half to debt reduction. "Even in this conservative case, 2003 E&P capital spending would increase over 25 percent versus last year and E&P balance sheets would get a huge shot in the arm," writes analyst Marshall Adkins.
What is different this time around is that the group using the spending model questioned the results from the group using direct survey methods in a humorous though nonetheless barbed manner that belies the energy industry's usual collegiality.
How does one reconcile the differences? It is the context that counts. Certainly the two spending surveys sport differences in reported expenditures for the same companies in some cases but come in remarkably close on total expenditures. In the particulars, they reflect a buttoned-down approach that describes operator mindset as 2003 gets underway. For the most part, that mindset is cautious, tentative, and not entirely trusting of commodity prices.
The more bullish business spending model indicates potentialities if all goes well. There is abundant room for enormous economic return for oil and gas operators inherent in the current high commodity price scenario. Those returns can flow over into field work, debt reduction, acquisitions, and shareholder portfolios. Ultimately, the issue is not about which methodology is correct. Oil and gas is a dynamic industry subject to frequent, unexpected changes as the last 18 months demonstrates. This is why the industry as a whole benefits when more information, perspective, analysis, or data is available in the public arena—even if the views on similar topics display wide-ranging divergence.
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