Spurred by rising energy demand, majors and independents alike ramped up ambitious exploration and production (E&P) growth plans in the mid-1990s, but in the end, virtually none have yet cleared their upstream “highbars,” according to a new study co-authored by consultants John S. Herold Inc. and London-based Harrison Lovegrove & Co.

The end result, according to Herold’s 36th annual “2003 Global Upstream Performance Review,” is that most E&Ps, from super majors BP to independents, now refrain from issuing production targets.

“The lesson of the past 30 years is that the world’s petroleum resource base can support growth in production, but not at the heady pace promised a few years ago,” said the authors. “Reserve growth has been only 2.6% per annum since 1998, with gas additions much stronger than for crude oil. Efforts to aggressively ramp up spending are almost immediately followed by soaring finding costs. The piper must be paid as returns on incremental capital shrivel to uneconomic levels.”

Variable costs also are rising, but only partly because of the gradual depletion of legacy assets, said the authors. “Efforts to boost production led to intensive exploitation of older fields with inherently high lifting costs. In addition, the long period of limited investment has resulted in an aging infrastructure in many regions. Attempts to move expanded volumes of production through outdated facilities have taken a toll on unit costs.”

However, the study found that value creation is becoming more important than increased volume to many E&Ps. “This is welcome news, since oil companies can deliver substantial appreciation to the shareholders when they concentrate on improvement in value per share. Alas, too often the oils have been very disappointing holdings when they attempt to metamorphose into growth vehicles.”

The Herold study noted that capital availability has not been an issue since 1999 because world oil prices have “hovered at levels not seen in 20 years, while North American natural gas prices have soared as domestic demand challenged conventional supplies.” The strong wellhead prices “stimulated a rush” to E&P activity by the independents, but the “2000 spending binge” overwhelmed the service industry and resulted in a strong hike in oilfield costs.

“North America, an island so far as natural gas is concerned, and the primary operating region for the independents, has been more severely impacted than other areas.” The damage has caused other problems, noted the authors. “While total industry outlays slipped in 2002, the budget axe fell solely on North American operations — every other region saw increased capital investments.”

Capital, said the authors, now is being directed toward regions where reserves can be discovered, purchased and developed economically, “as opposed to projects where incremental volumes can be brought on most quickly.” The study noted that the “abundant infrastructure” in North America allows “almost immediate production from new wells,” but the “funds are going elsewhere, implying that the better returns available in other parts of the world offer more appeal than near-term production gains.”

Until U.S. and Canadian returns become as attractive as other parts of the world, the study said that the “direction of capital flows should be expected to disfavor” those regions. The industry, however, has an “incentive to monetize assets in this high-cost area, through the active divestiture market or otherwise, and divert the funds elsewhere.” A willingness to actively manage an upstream portfolio is the “litmus test of whether a company is properly concerned with value creation.”

Since 2000, upstream capital investment has declined more than 20% in the United States and by nearly 10% in Canada, according to the study. “Meanwhile, double-digit increases were registered in Africa and the Middle East, Asia-Pacific, Europe and South and Central America.”

The “21st century upstream winners will be those enterprises that create a portfolio of properties from which a core producing area can be established,” said the study. “We define a core producing area as one that delivers strong production economies, excellent reinvestment options and a long-term window for activity.” Not surprisingly, North America is low on the list, with acquisition markets in Europe, the Asia-Pacific and South and Central America drawing more spending.

The objective of the review is to establish relative performance among 201 energy participants based on key performance measures, as well as identifying critical factors and trends that impact overall performance. To read the abridged edition of the report, or for information on how to obtain the full report, visit the web site at www.herold.com.

©Copyright 2003 Intelligence Press Inc. All rights reserved. The preceding news report may not be republished or redistributed, in whole or in part, in any form, without prior written consent of Intelligence Press, Inc.