Record Prices Spur E&P Spending Frenzy

There has been a huge increase in exploration and production "overspending" in the U.S. and Canada this year because of enormous gas price increases, and that probably will continue into 2001, said Salomon Smith Barney (SSB) E&P analysts in their 19th annual worldwide E&P spending survey.

Six months ago, producers told SSB their North American E&P spending would grow by about 25% this year. That number has nearly doubled to a 40.5% increase compared to spending in 1999. In Canada, E&P spending is up more than 50% over last year.

Spending is expected to slow down considerably in 2001. SSB analysts Geoff B Kieburtz and Mark S. Urness predict a 19.1% increase next year in North America based on their survey results. However, it still will be the second-highest growth in more than 15 years. There is expected to be a 19.3% expansion in the United States and an 18.8% expansion in Canada. The U.S. rig count is forecast to climb 31% next year to an average of 1,200 rigs, and the Canadian rig count is forecast to increase by 14% to 390 units, SSB said in its latest rig forecast.

Furthermore, "the persistence of robust natural gas prices at levels well above what respondents are using for planning preserves the potential for spending to exceed the forecast," SSB said. "Commodity price assumptions, although higher, remain well below current futures prices. The average natural gas price assumption used by respondents for short-term North American planning purposes has continued to climb and is now at $3.86/Mcf for Henry Hub and $3.42/Mcf for longer-range planning. Despite the significant increase in the planning assumptions, they remain well below the 12-month Nymex futures strip," the analysts noted.

For planning purposes, the average of respondents' oil price assumptions jumped above $25/bbl for the near term and rose to nearly $23/bbl for the longer term. Among the largest oil companies, long-term oil price expectations remain below $18.50/bbl.

Worldwide E&P spending is expected to grow next year by the largest amount in more than two decades," SSB analysts said. Outside North America, spending is forecast to grow 20.1% in 2001 after a sluggish 8.2% increase in 2000.

The survey, which relied on responses from 234 worldwide oil and gas companies, "reinforces our view that the oil service industry is in transition from recovery to a period of sustained growth," Kieburtz and Urness said. "Following a robust 18.5% increase in 2000 led by North America, E&P spending is forecast to grow by 19.7% in 2001 and to broaden into international markets." Worldwide E&P expenditures by the 234 companies in the survey are expected to increase by almost $20 billion to $113.5 billion in 2001. Of the planned spending for 2001, about 62% likely will be directed outside North America, 11% in Canada, and 27% in the United States.

In the United States, the 154 independent producers surveyed plan a 20.4% increase in 2001 expenditures, to $16.9 billion from $14.1 billion in 2000. Spending by this group is expected to rise by 48.4% in 2000 versus 1999, a much larger increase than the 15.3% growth forecast in SSB's December 1999 survey and even the 30.3% growth in its June 2000 forecast.

"Further illustrating the U.S. gas drilling frenzy, the 11 firms designated as major oil companies plan to increase U.S. spending by 17.9%, after a 23.8% increase during 2000," SSB said. The majors planning the largest U.S. spending increases are Occidental Petroleum and BP, while three companies --- Texaco, Total Fina Elf, and USX-Marathon --- expect spending to be about flat with 2000. Aggregate U.S. spending is forecast to rise 19.3% in 2001, to $29.7 billion from $25 billion, compared to a 36.6% increase in 2000 from extremely depressed levels. Of the 165 respondents planning U.S. spending, just 22, or 13%, anticipate lower year-over-year spending, SSB said. Despite this fact, however, just 19% expect to outspend cash flow in 2001, compared to the past 10 years' average of 45%. "This paints a picture of extremely healthy E&P cash flows and tightness in worldwide oilfield service and equipment markets."

In Canada, 77 companies plan an 18.8% increase in 2001 E&P expenditures, to $13.1 billion from $11 billion. Canadian spending is now forecast to have risen by 50.1% in 2000, nearly twice the 30.6% rate estimated in SSB's midyear survey. The 2001 spending growth plans appear to be broad-based, with just 11 respondents, or 14%, planning spending declines and a further 11 increasing budgets by more than $100 million. Among the largest planned increases are at Gulf Canada, Anadarko Petroleum, Imperial Oil, Husky Oil, Canadian 88, and Exxon Mobil, SSB said.

Despite the worldwide spending increases, however, a "scarcity of attractive drilling prospects has become a significant industrywide problem, particularly in North America," SSB said.

"Finally, with the sharp increase in North American gas drilling --- indeed, approximately 80% of domestic rigs drilling are seeking natural gas, up from 60% in late 1997 and 40% in 1991 --- the availability of attractive shallow drilling prospects appears to be drying up. Due to high depletion rates and a scarcity of qualified geologists, geophysicists, and petroleum engineers, this could become a serious problem in coming years, in our opinion."

For a copy of the spending report, contact Salomon Smith Barney at (212) 816-3139.

Rocco Canonica

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