Analysts At Odds Over 2003 E&P Spending

Lehman Brothers Original E&P Spending Survey, which included responses from 323 oil and gas companies, revealed that global E&P expenditures are expected to rise 4.2% in 2003. Lehman Brothers had originally expected to see an increase of 7% globally. Upon closer inspection, the driving force behind the unexpectedly low increase in E&P spending becomes clear: U.S. E&P expenditures are essentially flat with a projected decline of 0.7%.

According to the results of the Original E&P Spending Survey, the international market is the place to be in 2003. International E&P spending is set to increase by a healthy 5.5%, with Canada serving as North America's bright spot where a spending increase of 7.2% is projected. European majors and government owned companies are expected to blaze the trail in international spending in 2003, with the largest percent increases coming from India's ONCG with an increase of 152% and Trinidad's Petrotrin with an increase of 140%. Pemex and Petrobras plan to increase E&P spending by 10% and 15%, respectively. A trio of Russian companies, Lukoil, Gazprom and Yukos plan E&P spending increases of 10%, 33% and 22%, respectively. Norwegian heavyweights Statoil and Norsk Hydro both plan to increase spending by 13% and 20%, respectively.

The super majors will present a mixed bag next year, with E&P spending running the gamut. ExxonMobil predicts an increase in international E&P spending of 13%. BP rings in with a modest 4% increase, as does ChevronTexaco, which expects to spend 3% more on international E&P in 2003 than in 2002. ConocoPhillips intends to spend less than the companies did separately last year and Royal Dutch/Shell plans a 19% decline in international E&P spending. According to Lehman Brothers, Shell's 19% decline is due primarily to 2002 cost overruns and extra E&P spending related to a 2002 acquisition.

In stark contrast to the generally rosy international marketplace, the U.S. oil patch may face some rough times over the coming year, as it appears to have been out-competed by international regions for the world's E&P dollars. According to Lehman Brothers, the majors are spending more of their money internationally and many operators active in the U.S. market are limited by leveraged balance sheets or a lack of quality prospects. Majors budgeting U.S. E&P declines include ConocoPhillips, Royal Dutch/Shell and TotalFinaElf. Large independents who are planning to spend less in the U.S. E&P arena include Kerr-McGee, Unocal, Noble Energy, Nexen, J.M. Huber and Spinnaker.

2002 2003% Change Cos. Surveyed
U.S. Spending (Non-Majors) $17,002 $16,927-0.4% 220
U.S. Spending (Majors) $13,474 $13,330 -1.1% 11
Total U.S. Spending $30,476 $30,257 -0.7% 231
Canadian Spending $11,800 $12,652 7.2% 78
International Spending $84,786 $89,478 5.5% 109
Global E&P Spending $127,062 $132,387 4.2% 323

Among independents planning to increase spending Burlington Resources will lead the way with a planned 43% increase in U.S. E&P spending. Companies budgeting smaller increases include Forest Oil, Ocean Energy, Pioneer Resources and EOG. BP and ExxonMobil are the lone super majors planning U.S. E&P spending increases (see figure above). ExxonMobil projects an increase of 5% and BP plans to increase spending by 4%.

In aggregate, U.S. spending is projected to be approximately $30.2 billion, with independents outpacing majors with $16.9 billion earmarked for U.S. E&P spending, while majors are planning to spend $13.3 billion. Quest Offshore predicts a silver lining in potential U.S. activity with independents likely driving increased activity centered around natural gas plays. Canada will see $12.7 billion in E&P spending in 2003 and international markets, excluding Canada, are expected to receive $89.5 billion in E&P spending. Globally, the 323 surveyed companies are expected to spend $132.4 billion in 2003.

Producers used several criteria to determine their projected 2003 E&P expenditures. The primary factor in determining 2003 E&P spending budgets is the projected price of natural gas, which most companies are estimating a 2003 U.S. natural gas price of $3.42 Mcf. The next largest determinants of E&P spending projections were prospect availability and cash flow. Of the top four determinants, oil price was the least important factor in E&P spending plans; most companies expect WTI to average $23.22 b/o. Significantly higher rig rates would cause 75% of survey companies to reduce their drilling programs.

Lehman Brothers' findings are supported by the data generated from SalomonSmithBarney's The E&P Spending Survey. SalomonSmithBarney is slightly more optimistic concerning U.S. E&P spending and predicts a 0.1% increase where Lehman Brothers anticipates a reduction of 0.7%. However, SalomonSmithBarney predicts lower spending increases in the Canadian and international marketplaces. The E&P Spending Survey predicts Canadian E&P spending will grow by 5.7% versus Lehman Brothers' estimate of 7.2%. International spending is expected to rise by 4.9%, according to The E&P Spending Survey, versus a 5.5% increase as predicted by Lehman Brothers The Original E&P Spending Survey.

SalomonSmithBarney attributes the projected decline in U.S. E&P spending to a curtailment of spending by energy merchants, but sees a silver lining in that the gas price required to trigger a 10% increase in spending in the market remained flat at $4.10/Mcf.

Should producers continue with their 2003 spending plans, the U.S. oilfield service markets, from drilling to offshore construction, will lag far behind their corresponding markets in other regions of the world. The exodus of E&P dollars will continue to squeeze companies with significant exposure to the U.S. market, perpetuating already tough times for U.S. oilfield service providers.

Not all financial houses share Lehman Brothers and SalomonSmithBarney's dire outlook for E&P spending in 2002. Marshall Adkins with Raymond James & Associates anticipates E&P spending will increase by 25% over 2002 spending levels. Adkins predicts that operators are basing their 2003 E&P budgets on artificially low gas prices in the $3.50/Mcf area, while Raymond James predicts a "conservative" 2003 gas price around $5.00/Mcf.

Adkins believes that natural gas prices in the $5.00/Mcf area will spur E&P spending beyond current budgetary predictions. According to Adkins, E&P companies have traditionally tailored their actual expenditures to free cash flow, which would be dramatically increased by $5.00/Mcf gas. The limiting factor in Adkin's forecast is not operator unwillingness to spend or lack of available cash, but the lack of capacity in terms of readily drillable prospects, rigs and personnel. In light of his predictions regarding E&P spending, Adkins writes, "On the oilfield service side, these higher-than-expected E&P cash flows should lead to increased activity for the oilfield service companies and an increase in the rig count in 2003 over 2002."