ConocoPhillips has big plans for North America exploration in 2008. So do BP plc, Chevron Corp., Royal Dutch Shell and Total -- and that's just the majors. But can the majors or the independents deliver on their ambitious exploration and production (E&P) plans in the coming year, faced with tighter credit, expensive development costs and a dwindling workforce? Some energy analysts don't think it's possible.
A plethora of producers in recent weeks have announced plans to increase their U.S. E&P spending in 2008 (see NGI, Dec. 10, 2007), and a spending survey by Lehman Brothers seems to affirm it as well (see NGI, Dec. 17, 2007). Lehman said BP's U.S. upstream spending would increase by 21% in 2008; Chevron's is set to rise 7%; Shell's 15% and Total's 25%. Several of the larger independents have followed suit, including Devon Energy Corp. and EnCana Corp. (see NGI, Dec. 17, 2007; Nov. 12, 2007).
Citi Investment Research's 26th Annual E&P Spending Survey mirrored some of Lehman's findings -- Citi reported there will be a 6.5% increase in U.S. spending in 2008, a 3.1% decline in Canada and a 12% increase in international spending. Of the total $355 billion of upstream expenditures planned for 2008 by the 247 companies surveyed, more than two-thirds is directed at projects outside North America, but a healthy 24% is directed toward the United States, with 8% headed for Canada.
However, some energy analysts think there will be a lot of movement downward in the spending forecasts by midyear if some issues aren't resolved.
"The majors have painted a rather bullish picture for U.S. spending," Jefferies & Co. Inc. E&P analyst Subash Chandra told NGI. "We see that, the independents see it and have sort of echoed that as well. But really, we have to wonder how very variable those budgets are." Some of the independents may be upping their spending -- but only in one operating area, while they are cutting back in others. "We've seen some producers slash their budgets in some basins, others are moving out. Some might have thought by now that the Woodford Shale would be blowing and going But it's come full cycle, and some of them now are having to cut their capex [capital expenditures] in certain areas by big numbers."
The analyst doesn't think it likely there will too much of an increase in gas drilling as long as prices remain in the $7/Mcf range. "We need at least $8 for sustainability, to create sentiment. The producers put out these pretty releases, but they don't say that. It's far more variable than we think. One of the reasons for this, I think, is that the industry got away with it, spending lots of money, even if they ran out of results, and we're coming to the end of that cycle. For those that have high expectations, they may come to mid-year and say, 'we need more [for the] gas price, more dollars or we'll have to cut back...'"
2008 Prices Off
Credit Suisse Group in mid-December lowered its 2008 forecast for U.S. natural gas prices because it said an "investment boom" has created excess supply for 2008. Credit Suisse's Jonathan Wolff cut his forecast for Henry Hub gas futures on the New York Mercantile Exchange by 10% to $6.75/MMBtu from $7.50. The reduction, he said, reflects "an imbalanced market that appears poised for continued weakness without a reduction in U.S. onshore supply growth." And Fitch Ratings said the "fundamentals" point to lower gas prices in 2008, and longer term, they could fall to an average of around $4.50/Mcf (see NGI, Dec. 24, 2007).
The "investment boom" already has hurt some producers -- and more are likely to be hit in 2008.
"When you have good companies like Edge [Petroleum Corp.] looking for a seller (see NGI, Dec. 24, 2007), Enterra [Energy Trust] (see NGI, Sept. 17, 2007)...you have companies disappearing. These may not be huge companies, but you have to stack them up, and you have a lot of those folks at the margin, both public and mom-and-pop. If gas stays at $7, if costs stay up, then 2008 budgets will not [end up] any higher than 2007."
Unlike the heady earnings of just a few short years ago, "the market is very much focused now on staying power, not growing power," said Chandra. "It used to be that if you had a resource map, or you could draw something up on a bar napkin, and the market said gas prices were conducive to drilling and costs were low, the next second you would have the money."
The analyst said, "it was like, 'if your stuff looks like the Barnett [Shale], fine, here you go, here's the money.' Now, it's 'if you can show me the 2 Tcfs, I'll give you the money to develop.' In the second half of this year, the money went away and the producers now ask if they have enough money to last through the year."
The market is more pragmatic now, he said. If a producer has good results, if it can show a lender that the play is economic, then the banks will be willing to lend.
"I don't see it getting any better in the next few months," the Jefferies analyst said. "The rope was given to the producers, and that rope was okay if you made these promises, if you made your Barnett play work. Now 99% of those plays aren't panning out..." Producers, he said, "should consider everything that happened to them in the last three years a gift...A lot of companies got that 'I'm worth X' because the market told it so. Now the market wants to see the cash flow."
The Citi survey also found that the trend of increased E&P spending is "headed for a pause" in the coming year. "We believe this is primarily a consequence of project timing with a number of large projects, especially outside NAM [North America], moving into a period of heavy development spending."
Another concern for producers operating offshore are deepwater capacity constraints, which are likely to be a bigger problem for large integrated companies. About two-thirds of the respondents were concerned about capacity constraints versus 85% a year ago. The focus of capacity concerns also changed -- from hardware constraints to personnel issues.
Lack of Workers a Key Issue
"The current and prospective shortage of experienced, skilled personnel is a widely reported topic, but this is the first year in which half of respondents cited personnel as a concern," the Citi survey noted. "This is a long-term challenge for the industry and places greater importance on the effectiveness of hiring, training and retention at the service companies."
Nearly half of Conoco's employees are expected to be eligible for retirement within five years, and unless older workers are replaced, expansion plans by the major and its peers may cost more and take longer. In an interview with BusinessWeek, Conoco CEO James J. Mulva said that the lack of talent is one of the most dangerous threats to his company's long-term health. "People are a big concern," he said.
The energy industry is still hurting after massive layoffs during the oil bust. More than 500,000 petroleum-related jobs were said to be lost between 1982 and 2000 in the United States. In that period, a younger generation viewed the industry as a professional dead end, and enrollment in petroleum-related undergraduate programs skidded 85% from 1982 to 2003.
"We skipped an entire generation of workers," says Michael Killalea, vice president of the International Association of Drilling Contractors.
The consequence: today almost 40% of U.S. petroleum engineers are more than 50 years old, according to the Society of Petroleum Engineers (SPE). In 1997, only 30% were at the half-century mark. "It's a graying profession, and we're just not ready for the transition," said SPE spokesperson Margaret Watson.
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