Upstream investments at 232 of the largest global natural gas and oil producers jumped 21% to $492 billion from 2007 to 2008, but with this year’s cash flow and revenues below year-ago levels, many producers face “serious challenges” going forward, according to a study by IHS Herold Inc. and Harrison Lovegrove & Co. Ltd.

Strong commodity prices through the first half of 2008 helped producers set a record in development spending, which jumped nearly a quarter from 2007, the study said. However, the spending failed to lift worldwide finding and development reserve replacement rates, which fell to 88% of production, the authors of the 42nd annual 2009 Global Upstream Performance Review said. 2008 was the first year since 2004 in which production was not 100% replaced, the study noted.

The annual review is based on publicly available data filed with the Securities and Exchange Commission and related agencies worldwide.

Worldwide gas reserves rose 3% from 2007, but together, oil and gas reserves fell 0.4% by year-end 2008 because of a 4.4 billion-bbl decline in oil reserves, said the authors. According to the authors, gas production in 2008 accelerated almost 5% to 44.2 Tcf.

By the end of 2008, acquisition spending had declined by almost a third because the merger and acquisition (M&A) market “collapsed over the course of the last five months of the year,” said the authors. Meanwhile, unproved acquisition outlays more than doubled to $62.4 billion, surpassing proved outlays for the first time.

“Higher prices drove revenues 31% percent higher to $1.232 trillion,” said IHS Herold’s Robert Gillon, senior vice president. “But net income gained by a more modest 24%, held back by rapidly rising depreciation charges.” Depletion, depreciation and amortization were “driven higher by escalating finding and development costs, which soared 66% to $25.50/boe.”

The industry generated record cash flow of $580 billion from its operations, jumping 36% from 2007, because of high oil and gas prices that were sustained until late in the year, the study noted. Capital spending was up by almost $100 billion from 2007 levels. Dividends rose to a record level in 2008, exceeding $100 billion for the first time, but common share repurchases were down for the first time since 2004, falling around 23%.

“As revenue fell in the second half of the year and financing options closed, many companies reduced or ended stock buyback programs to conserve increasingly scarce cash,” the study said.

The study also found that year/year:

Negative revisions in U.S. gas and oil reserves numbers in 2008 caused replacement costs to triple and replacement rates to plunge last year, the study found. Unit profitability also fell for the third consecutive year despite robust price realizations. In Canada, the study showed that mineable bitumen reserve additions offset conventional and in-situ oilsands reserve declines. In contrast to the U.S. region, per-unit profits were higher as cost increases were more moderate than gains in realized prices.

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