IHS Herold: Total E&P spending to rise in 2010; oil service costs likely to escalate

Unconventional shale gas plays and oil production are focus of companies seeking to generate production growth, while capital will shift from offshore to onshore US

Spending on exploration and production, excluding acquisitions, is expected to rise by 8% to $353 billion in 2010 among more than 110 of the largest publicly traded oil and gas companies, according to the IHS Herold 2010 Global Upstream Capital Spending Report. An initial IHS Herold study of 65 companies issued in February had predicted a 7% increase.

“This is a nice turnaround from the 22% decline in upstream spending in 2009, when the global recession and tight credit markets made companies rein in upstream spending,” said Aliza Fan Dutt, senior equity analyst at IHS Herold. “The market conditions have improved, which is reassuring, and WTI (West Texas Intermediate) prices have hovered between $70 and $80 per barrel during the past few months. Steadier oil prices, combined with continued uncertainty over the near-term outlook for natural gas prices, are driving some E&P’s to shift their focus from gas to oil,” she said.

“However, this shift comes with a caveat,” she added, “since following the explosion and oil spill in the Gulf of Mexico, there is growing uncertainty in the industry over possible changes in government regulations and taxation relative to oil and gas drilling. As a result, we expect some shifts in E&P spending from deepwater to onshore US and, to a lesser extent, overseas plays, due to increased risks associated with drilling in the deepwater Gulf of Mexico. In addition, the uncertainty over the causes of the Deepwater Horizon oil blast and government restrictions on deepwater drilling will dampen activity in the US offshore waters.”

While the potential long-term impact of the Deepwater Horizon incident on E&P capital spending will not be known for some time, Dutt said, “regulatory and safety requirements will be heavily scrutinized, which will likely translate to higher oil service costs. These higher operating costs, and, hence, increased capital spending, will likely occur gradually, though, over an extended period of time.”

Despite increased costs and related capital spending, Dutt said some good might result from this tragedy in the form of increased transparency, and the implementation of tougher safety measures and emergency response provisions within the oil industry.

Shift to liquids production
Despite the situation in the Gulf, the report says that most E&Ps are touting their exposure to liquids production. Many natural gas-focused producers are shifting to oil drilling or are highlighting their exposure to liquids-rich unconventional gas. “Conventional gas development is being severely cut back,” Dutt said, “while prolific shale gas plays such as the Marcellus and Haynesville continue to drive spending among many E&P companies.”

Decreased spending in the last couple of years meant a decline in demand for equipment, which translated into oil field service costs that are now about 15% to 20% below the peak prices and demand of 2007-2008. Lower oil service costs should help oil and gas companies stretch their dollars even further, although, with increased upstream spending this year, rig prices could increase, which means producers must spend more as this year progresses in order to keep up with reserve replacement rates, the report noted.

Capital spending rebounds in 2010
According to the report, the combined Integrated Oils Peer Groups cut capital spending by 14% in 2009, due in large part to big cuts by the North American integrated oil companies. However, spending by the integrated oil companies is expected to rebound 5% in 2010. And after being slashed nearly 40% in 2009, capital spending by E&P companies is slated to jump 21% in response to higher oil prices and the need to increase production. An improved credit market has helped small US E&Ps increase capital spending, and the largest North American E&Ps are looking to boost spending by a healthy 24%.

More economical gas shale plays and liquids continue to be red-hot, driving much of this year’s upstream spending for this group. Particularly attractive are shale plays that yield significant oil and liquids, such as the Eagle Ford shale play in south Texas.

Slammed by the nearly non-existent credit market last year, small US E&Ps slashed capital spending by 61% in 2009. “What a difference a year makes,” Dutt said. “The improved economy has opened up new sources of capital, which should result in a 62% increase in spending for these small companies, which is the most dramatic rise in spending among all peer groups.”

Global integrated oil companies, representing about 28% of the total spending among companies in the IHS Herold study, are expected to cut capital spending by a modest 2% in 2010. However, the integrated companies outside North America are expected to increase capital expenditures by 12% in 2010 on stronger spending in Russia, Latin America and Asia. Offshore development will fuel a 23% increase in spending at Petrobras.

After falling by 26% in 2009, upstream spending among the US integrated oils is slated to rise 13%, primarily due to brightening prospects in the North American upstream. Hess plans to boost spending by 26% in 2010, much of which will be committed to the Bakken shale play.

Capital budget rationalization from the Suncor/Petro-Canada merger is the primary reason for the expected 8% drop in upstream spending among the Canadian integrated companies. The Canadian E&P Trusts should boost capital spending by 44% this year, a reversal of the 5% decline last year. All companies in this peer group are expected to increase spending.

The only peer group to boost spending in 2009, companies in the E&Ps Outside of North America Group, should increase capital spending by nine percent in 2010. Spending by CNOOC remains strong as it explores in new areas, such as the Philippines and Vietnam.

While E&Ps are enjoying a healthy increase in spending this year, depressed natural gas prices affected the US Pipelines, Power and Diversified Group, said the report, which is expected to reduce its spending by 8%. On a positive note, this is less severe than the 27% decline in spending the group experienced in 2009.

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