Conservative exploration and development strategies andacquisitions, coupled with a growing demand for energy, enabled theworld’s largest oil and gas companies to reduce reserve replacementcosts 14% from a year ago, and dramatically increase net profits -by as much as 900%, according to an analysis by energy researchfirm John S. Herold Inc.

In fact, the John S. Herold 33rd Reserves Replacement CostAnalysis – Advance Report found that the 150 largest worldwide oiland gas companies actually increased net profits mostly because ofrising crude oil and natural gas prices and lower production costs.There were no incredible discoveries in the past year; nearly allof the profits were tied to proven reserves and the skyrocketingmarket.

Capital spending worldwide declined 20% ($19 billion) for thefirst time since 1996, while reserve levels climbed 3.5% to 144.2billion BOE. After-tax cash flow was also more than the investmentdollars spent. “Reserve replacement costs (RRC) and finding anddevelopment costs declined mightily, while production costscontinue to fall,” said the study.

Data showed that reserve levels climbed 3.5% to 144.2 billionBOE, despite a “dramatic” 20% ($19 billion) decline in capitalspending. Year-end 1999 proved reserves climbed 4% to 82.5 billionbarrels, and natural gas reserves rose to 371 Tcf.

Calling 1999 a “banner year” for the upstream oil and gasindustry, the study found that the strong upstream performanceresulted from a “confluence of rising oil prices and the reluctanceof petroleum companies to jettison their cost containment approachdeveloped during the last oil price crash.”

But the companies are spending money and obtaining acquisitionsin several ways, including buying proved reserves.

“Another conservative way to replace production is buying provedreserves, and our analysis showed that acquisition spending rose11% in 1999,” said Herold Chairman Arthur Smith.

However, while the analysis predicts that this year’s resultswill even show a “much, much better year,” it did offer warnings,based on past history.

“This relative affluence is precisely what worries us,” said thereport. “The upstream sector of the oil and gas industry does notdeal well with prosperity.” Smith said that while the revenueforecasts for 2000 “remain extremely rosy,” he said that “recentrises in rig counts and rig utilization rates indicate that capitalspending increases may exceed our forecasts of 20% to 25%.”

Smith said companies are currently succeeding because they tookcautionary steps following the oil price crash of 1998, which”forced upstream companies to rein in spending by deferring morespeculative exploration and development.” He added that worldwide,these expenditures declined more than 26%, or by $22 billion.

The 1998 oil crash “caused an eschewing of the riskier E&Dendeavors in favor of purchasing proved reserves,” said the report.Oil reserve replacement actually increased in 1999 to 128% ofproduction, and natural gas replacement dropped to 142% ofproduction and only 119% through the drill bit.

Although the analysis does not specifically separate oilreserves from gas reserves, data show that worldwide, provednatural gas reserves grew 2.9% in 1999, and have jumped 23% since1995, to 371 TCF. Gas reserves in Latin America increased the most— 500% since 1995, when reserves were 539 Bcf. However, most ofthe Latin American reserves are undeveloped, and the currentreserve base is 44%, compared with 95% in 1995.

Other regions, including the U.S., showed “modest” growth in gasreserves, but Canada’s reserves actually declined by nearly 2% to26.6 Tcf.

Royal Dutch Shell is still the world’s largest holder of gasreserves, with nearly 59 Tcf, and ExxonMobil is not far behind,with 57 Tcf. Rounding out the top five were BP Amoco, 45 Tcf,PetroChina, 24 Tcf and Total Fina Elf, 19 Tcf.

Of the 150 companies studied, Shell Canada Ltd. was the bestperforming company overall in the oil and gas reserves area, comingin first in reserve replacement costs for the three-year($10.5/BOE) and five-year ($1.37/BOE) measurement periods. In thepast five years, Shell Canada has invested nearly $1.4 billion inthe upstream market, almost entirely in the drill-bit area – a goodmove, according to analysts.

“Wise spending made Shell Canada the top performer,” said thereport, which also called the company “impressive, since Shellachieved this success in Canada, a ‘quasi-mature region,’ showingthat a skilled workforce and sound planning can overcome geologicalroadblocks to success.”

“Perennial premier achievers” round out the top five performingcompanies in the five-year reserve replacement cost report:Evergreen Resources ($1.52/BOE), Tipperary Corp. ($1.70/BOE),Caltex Energy ($2.07/BOE) and Petroglyph Energy ($2.11/BOE).”Virtually all of this success was achieved through the drill-bit.”

The “frontier” or less developed oil and gas producing regionsof the world hold the best cost advantages for adding reserves -defined as Africa/Middle East ($2.19/BOE), Latin America($2.43/BOE) and Asia Pacific ($3.47/BOE). In these regions, theposted reserve replacement costs were below the worldwide averageof $4.28/BOE. Herold defines Canada as a “quasi-mature” region withmany E&P opportunities remaining, and the United States andEurope as “mature” regions.

“Over the past five years, there has been a nearly $4.00/BOEdifference in finding and development costs between the frontieroil and gas producing basins and the mature basins of Europe andthe U.S,” said the study. The figures also highlight the rationalefor U.S. E&P companies’ interest in Canada: since 1995, findingand development costs there have been about $1.50/BOE lower than inthe U.S.

Top spenders worldwide included many of the “usual suspects,”ExxonMobil ($7.9 billion), Royal Dutch Shell ($5.1 billion),Chevron ($4.8 billion) and BP Amoco ($4.4 billion). The secondbiggest spender in 1999 was a surprise – Norsk Hydro, which spent$6.2 billion in upstream projects. Devon Energy was the largestspending independent, and ranked 10th by spending $2.3 billion in1999.

“Spending in 1999 only increased in Latin America, where cap-exrose 5% to $1.6 billion,” said Herold. “A moderate spending declineof 15% was seen in Canada, where proved acquisition spending wasdown slightly more than drill-bit expenditures, in contrast to theworldwide trend. Capital outlays in the U.S., Asia Pacific andAfrica/Middle East were down approximately 30% each in 1999.”

The analysis is based upon a compilation of operating andfinancial data of publicly traded oil and gas companies with theworld’s largest inventories of proved oil and gas reserves. Basedin Stamford, CT, John S. Herold specializes in research andconsulting on the petroleum industry. For a copy of the report ormore information, contact Tom Biracree at (203) 359-4339.

Carolyn Davis, Houston

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