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Citigroup: Overspending Initial E&P Plans Should Slow in '07

Producers exceeded their initial exploration and production (E&P) spending plans this year in every region of the United States, resulting in a 38% jump in spending compared to levels in 2005, according to a survey by Citigroup analyst Geoff Kieburtz. Producers also overspent in Canada (15.6% growth) and overseas (24.2% growth), resulting in about 26.4% total spending growth compared to an initial expectation of 14.1% growth.

It was the seventh consecutive year of overspending, according to the Citigroup survey. Over that period initial plans have incorporated an average growth of 8.3% and actual spending increases have averaged 15.8%. But Kieburtz is predicting that exuberance will diminish in 2007. Natural gas and oil prices are less likely to exceed expectations in 2007 by the same magnitude as they have in recent years, Kieburtz said, with a particular emphasis on North American natural gas.

"Uncertainties in the natural gas markets reduce our confidence in the forecast for activity in North America, but the risks appear to be balanced around the current estimate," said Kieburtz. "We believe there is a bias to the upside in spending outside North America."

Not only are producers expected to overspend less than in prior years, they also are predicting far less growth in spending in 2007. Citigroup's 25th annual spending survey includes responses from 237 oil and gas companies with projected expenditures of $282.6 billion in 2007 compared to $264 billion in 2006 -- a 7% increase worldwide. North American spending is expected to be up only about 2.1% to $98.5 billion, comprised of a 5.7% increase in the U.S. to $71.8 billion and a decrease of 6.6% in Canada to $26.7 billion. Outside North America current plans for spending $184.2 billion represent a 9.9% increase over 2006 expenditures. "We believe the upward bias in 2007 is diminished for North America, but remains significant for international and deepwater activity," said Kieburtz.

He also said a "new phase" is beginning to emerge in the spending cycle. A dichotomy has developed in producer attitudes toward rising drilling costs. Some operators have decided to cut spending deeply in an effort to precipitate price reductions in the drilling service sector. This approach has been particularly common in Canada, where service cost increases have been seen by several large producers as excessive. In contrast, several large operators have expressed the view that rising service costs are merely catching up with several years of rising oil and gas prices and that project economics remain compelling.

Kieburtz said spending plans remain "reasonably insensitive to fluctuations in oil and gas prices but base case assumptions are rising." Over the past year the average oil price assumption used for planning has increase to $57.05/bbl from $49.51, while futures prices have risen to $65.54 from $63.00. Kieburtz said the acceleration of oil price assumptions likely moderates the upside bias to spending plans. He also said a 10% revision to spending plans would be triggered if oil prices rose by $13 above the base case price assumption or fell $12 below it. "This suggests the current plans are reasonably insensitive to oil prices until they fall to $45/bbl."

The base case assumption for natural gas prices in 2007 has declined to $7 from $8 in the survey a year ago. The futures strip also has fallen to around $8 from $12 at the same time last year. "The sensitivity of spending plants to gas price fluctuations has increase slightly in both directions," said Kieburtz. "Current plans appear intact down to natural gas prices near $5 but would be increased if gas prices averaged above $8.50."

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