Upstream capital spending rose 13.7% worldwide in 2001, with the largest increase in Canada, according to a new report by John S. Herold Inc. Meanwhile, U.S. spending dropped $2 billion last year to $43 billion, with a 50% drop in mergers and acquisitions (M&A). Analysts said that drop in M&A may signal a greater focus and more spending on North American exploration and production (E&P) and less worldwide.

The 2002 Global Upstream Performance Review, which tracks performance for producers across the world for the prior year, was finalized by analysts Nicholas D. Cacchione, Aliza Fan, Arthur Smith and Aaron Johnson. The 136-page report noted that the worldwide spending increase in 2001 to $157.5 billion came “on the strength of a 30% increase in finding and development spending to $121.3 billion.”

Going forward, analysts noted that “from a financial and stock market perspective, the oil market so far this year has Herold and most in the industry scratching our heads.” For oil and gas producers, “2002 has been a year of dichotomies,” with robust prices. However, “investor sentiment hasn’t matched the commodity markets. Natural gas prices have surged by 70% and oil prices are up 38% since the beginning of this year, but shares of integrated oils are down nearly 10% and E&Ps have managed only a 3.5% gain.”

From a broad perspective, “there appears to be growing concern that the U.S. economy will fall into a severe deflationary environment, similar to the currently ailing Japanese economy.” Oil companies would be especially hurt, said analysts, “whose earnings are especially tied to commodity prices.” Also, “on the natural gas side, there is skepticism about relatively robust natural gas prices with historically high natural gas storage levels. At the same time, long-term optimism seems to prevail over natural gas as the fuel of choice.”

In the overview for 2001, Herold reported that Canada, where the largest spending hike occurred — $12 billion more was spent there in 2000 — the jump was evenly split between acquisitions and drill-bit spending. “Canada showed the only sizeable increase in proved acquisition spending, doubling to $12.3 billion and elevating proved acquisition costs 11% to $6.09/boe,” according to Herold’s report. The analysts also found that the increase in Canadian spending came on the strength of four U.S.-based companies.

Meanwhile, worldwide reserve replacement costs (RRC) rose almost 36% to $5.31/boe following a 600% increase in finding and development costs (FDC) to $6.33/boe. Proved acquisition costs dropped 10% to $3.45/boe. “Regionally, large increases in RRCs to uncompetitive levels were seen in the U.S. ($8.41/boe) and Canada ($8.44/boe) during 2001.” Other large increases also were found in Africa/Middle East and South America, “but they remained at enviable levels.”

Foreign producers with assets in the former Soviet Union dominated the three-year RRC/FDC numbers, but El Paso Energy Partners LP (EPN) led the three-year FDC list at 59 cents/boe. In 2001, leaders in RRC included three U.S.-based companies, EPN, tied for first place at 71 cents/boe; Ultra Petroleum Corp. in fourth place at $1.21/boe; and CMS Energy Corp. in fifth place at $1.30/boe.

Herold, which tracks both the frontier and mature producing regions of the world, said that historically, the frontier regions have exhibited “a huge cost advantage over the mature areas. However, over the past two years, capital spending has shifted back from the frontier areas and toward North America. Spending in the U.S. has more than doubled since 1999 and has nearly tripled in Canada over the same time period. This intense focus north of the 49th parallel has pushed up RRC/FDC in Canada to levels rivaling the U.S. and Europe.”

Worldwide, Herold found that oil and natural gas reserve replacement rates (RRR) dropped to 173% of production from all sources, net of sales, down from 203% in 2000 and the five-year average of 187%. Replacement rates through the drill bit fell to their lowest level in five years, 118%, with the biggest drops in South America and the Asia Pacific region in four out of the past five years.

In the overview of RRR, the study found that with higher costs, “Canada ranks last in recycle ratio performance, even below the U.S. and Europe. The influx of capital north of the border, however, has kept RRR for Canada at or near the top of the chart.” Analysts said the question to be answered is, “can North America continue to attract a disproportionate share of capital going forward, given the investment results?”

In 2001, spending increases were found in the larger U.S.-based producers, which spent $7.5 billion; U.S. integrated oil companies, $6 billion; overseas integrated oils, $5.7 billion; and the U.S. power and pipeline companies, $4.7 billion. Offsetting the increases, however, was a 20% decline in spending by international integrated oil companies. “Every group had higher finding and development spending, ranging from a 13% increase by the international integrated oils ($35.1 billion) to a more than 80% jump by the large U.S. E&Ps ($7.2 billion) and U.S. integrated oils ($10.9 billion).

Finding and development spending was up 30% worldwide to $121.3 billion, and drill bit spending was up in every region, with the United States in the lead at $11 billion, followed by Canada at $5.7 billion. Royal Dutch Shell Group was the largest upstream spender in 2001, at $8.9 billion, slightly ahead of the former leader BP, at $8.6 billion. “Each company used a preponderance of its capital spending for development activities,” said analysts. Rounding out the top five were ENI, $8.4 billion; Conoco Inc. at $8.2 billion; and ExxonMobil, $7.9 billion.

The United States and Asia Pacific “were the two most profitable regions in 2001, at $6.64/boe and $6.61/boe, respectively.” In the United States, profits were pushed by an actual 32 cents/boe hike in realized prices to $23.12/boe, which “helped limit the decline in net income to $1.36/boe from $8/boe in 2000.”

Gas reserves increased at a 6% rate in 2001 to 627 Tcf, while developed reserves gained 4.4% to 386.6 Tcf. “This knocked down the worldwide gas reserve base to below 62% developed from 63% developed in 1999,” said analysts. U.S. gas reserves jumped 9.4 Tcf to 119.6 Tcf, while developed reserves only gained about half of that amount. Domestic gas production was up 8% in 2001 to 11.8 Tcf. In Canada, developed reserves were up more than 20% to 34.5 TCF, while undeveloped also grew 20% to 28.4 Tcf. Gas production in Canada was up 19% to 3.5 Tcf in 2001.

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