Summary
The Rigzone Newsletter on June 19 quoted Kristen Hays of the Houston Chronicle who reported that the oil and gas industry’s costs of finding resources increased 35% in 2008. An Ernst & Young report showed the three-year average cost was $27.22/bbl. However in 2008, that rose to $51.96/bbl. The study examined U.S. exploration and production results for 40 companies. Included were majors and both large and small independents. Collectively these companies hold 70% of U.S.oil reserves. Still crude oil reserves fell 7% largely because regulatory rules required companies to book reserves on the last day of the year. On December 31, the threshold price for crude oil was $44.60/bbl compared to $95 at year-end 2007. Thus oil companies had to write off 15 billion barrels of oil and 6.7 trillion cubic feet of gas. These volumes required prices higher than $44.60 to be considered economic. The rules have now changed. For 2009, companies can book reserves based on average annual prices.
Analysis
The most recent estimates of cost declines in early 2009, (CERA) point toward an 8% fall with expectations of further reductions. Thus the majors, most of which kept their capital and exploratory budgets steady can look forward to improved finding and development costs for the year. Independents, many of them leveraged, are not so fortunate. For the most part, they must keep their eyes on the balance sheet and reduce total spending to the amount of cash flow expected. This means little or no increased production. The goal will be to keep production at the same level as in 2008. Of course they too benefit from lower costs. Some of the better capitalized ones may even be able to modestly increase exploratory budgets in the fourth quarter. Pioneer Resources (PXD) has already indicated that it will review its position in the fall with the intention of spending more. This rests on the assumption that crude oil prices will remain at around $70/bbl. As for natural gas, only the better shale gas areas such as the Eagle Ford, the Haynesville and the Marcellus expect increased activity. Most of that will be delineation drilling. Many of the shale gas drillers expect the natural gas price structure to strengthen in the fourth quarter. They base this on the high decline rates of existing wells plus continued lay down of shale gas drilling rigs. Still the specter of increased competition from liquefied natural gas (LNG) remains a threat. The most recent Purvin & Gertz netbacks (Oil & Gas Journal of June 22 ) show that import prices into the U.S. are still much lower than the recent Henry Hub prices of around $4.05/million btu. So uncertainty still hovers over both crude oil and natural gas prices. But at least costs are still coming down and that will improve balance sheets and may even allow oil companies to rebook some of the 2008 written off oil reserves. Rebooking natural gas reserves is far more speculative as of right now. Until the consequences of low LNG prices can be resolved which is unlikely before the end of 2010, natural gas reserves will stay where they are or possibly decline further. For investors, the situation today is that major oil companies will hold value and continue to pay dividends. Independents will have to strengthen balance sheets before much additional price appreciation occurs. For investors looking out five years from now, some of the independents are attractive speculations. Any evaluation of oil company stocks requires steady focus on the state of the international recession. Most observers think recovery will come son. But some pessimists see more problems ahead. Nouriel Roubini is one of these. So is Marc Faber.
