Tuesday, November 04, 2008

Lower gas price means less drilling for new oil

Let me repeat that:
Lower gas price means less drilling for new oil.

The price of gas is directly tied to the price of oil.
When the market price of oil goes down, so does the cost of gas.

Unfortunately, when there is a poor market for oil, there is less reason for oil companies to drill for two reasons.
First, increasing the supply will further erode the price.
Second, the lower the price, the lower the return.


Think about it.
Keep on thinking about it as you peruse the following.

Prices may slow oil flow


The Wichita Eagle, Sun, Nov. 02, 2008

As crude prices fall, producers likely to relax exploration

While falling oil prices might thrill the nation's drivers as they fill up with gas, the plunge has put the oil industry on edge.

And that very much includes Kansas, where oil and natural gas are a $1 billion force.

The record-high prices that saw crude oil peak at $147 a barrel in early July drove exploration in the third quarter.

Through Sept. 30 this year, Kansas saw 125 new oil and gas discoveries for a 47 percent increase over the same period in 2007, according to the Kansas Geological Society.

But that has become a distant memory, particularly after the price dipped this past week to a 17-month low of $62.73 on the futures market. By Friday's close, the spot price had climbed to $67.81.

Kansas crude, which is usually about $10 less than the international price, was at $57.25 a barrel Friday.

So where does that leave those who turn the crank on the state's oil industry, whether it be in exploration, service, delivery or manufacturing?

Start with the producers, because the rest of the industry spins off what they do.

"The more exposed a producer is to credit," said Michelle Foss, chief energy economist for the University of Texas' Center for Energy Economics, "the more difficult it's going to be for that producer to keep drilling."

Exploration plans for the area's producers vary widely.

"The large percentage are already starting to cut back," said Wink Hartman, owner and president of Hartman Oil.

His company is involved in the full range of the oil industry, including exploration, drilling, servicing and trucking.

"So far we've not seen a noticeable decrease," Hartman said.

But he said that is likely to change during the fourth quarter and the first quarter of next year.

Hartman said his company has plans to drill 28 new wells through March 2009.

"I seriously doubt we will do that much," he said.

At Sandhill Well Service, exploration geologist Tyler Sanders said his company has already pulled back.

"We've put some projects on hold because of the price," Sanders said. "You sure can't predict anything anymore. The $140 oil was way out of whack; now these 50s are too low.

"It makes budgeting impossible."

'A temporary blip'

Jay Ablah, president of Noble Petroleum, is at the other end of the spectrum.

He said his company plans to drill 20 new wells in 2009, which is more than he has done in any given year over the past decade.

"The current situation is a temporary blip," Ablah said. "When the market starts to repair, oil prices will probably creep back up.

"So we're going to be pretty bullish."

It's important to remember that new wells drilled today won't produce for two to three years. So the payoff comes from the price of oil down the line, not where it is today.

Ablah said the companies altering their drilling plans now are doing it based on what their income structure is now.

"If they don't have a lot of capital that they're setting on and their drilling programs are directly related to the run check they're getting each month," he said, "they're having to cut back because they don't have the income to continue forward."

Other producers say they aren't reaching out to do more than what they're already contractually obligated to do.

"Until things settle out," Sandhill's Sanders said, "I don't think it's prudent to go out and spend money right now."

Steel costs

Scott Ritchie, president of Ritchie Exploration, said he plans to "build on the success in the areas we've had rather than venture out with wildcats."

He added that the industry will be greatly affected if the outcome of this week's national election results in a windfall tax.

"If they put a windfall tax on," Ritchie said, "we're going to pay a significant price because there is no windfall."

Input costs, particularly in steel, have taken a significant bite out of the profit margins.

An average well in western Kansas has about $200,000 tied up in steel, said Dave Dayvault, chairman of the Kansas Independent Oil and Gas Association.

The exploration explosion this summer was a factor in creating a 40 percent increase in the price of steel over past year by September, Dayvault said.

Since then he said the price has dropped 15 percent, still leaving a considerable increase.

Hartman's figures, however, show a 50 percent increase for all steel products used on a well.

The biggest increase for steel is in five-inch casing, which has seen a 270 percent increase from last year and now is at $23 a foot.

Hartman said the cost of drilling a 5,000-foot, new discovery well two years ago was $285,000 to $300,000. Today, he said it's $500,000.

"I'm drilling them every day," he said, "so I see the bills."

Leasing costs

The cost of leasing land has doubled to tripled over the past two years. Western Kansas land is leasing for $25 to $35 an acre for a two- to three-year paid-up lease, while southeast Kansas is at $50 to $150 an acre.

A single Kansas oil and gas lease generally ranges from 80 to 640 acres.

"It's all about how hot the area is," Foss, the economist, said of the leasing price.

It's been red hot in parts of Texas and northeast Louisiana where drilling for natural gas has driven leasing costs to as high as $30,000 per acre.

But even that exploration is tailing off as the price for natural gas dipped from almost $14 this summer to well under $7 this fall, Foss said.

Backing off?

Regardless of the numbers, the service companies and manufacturers will know when the wind shifts.

So far, the impact hasn't been felt.

"Right at the moment, we're shipping as scheduled," said Willie Stultz, who oversees the inside sales for Coffeyville-based Jensen Manufacturing. The company makes pumping units.

"We have gone down a little since September," Stultz said, "and it looks like we'll be down for the end of '08 and start of '09."

Bob Bass, a Wichita-based, five-state sales representative for National Oilwell, said the third quarter was one of the best he's had.

"What I'm worried about is the third quarter of 2009," he said.

He said most of the big oil companies used the large profits from earlier in the year to rework old wells.

"But most of that is done now," Bass said. "The producers aren't going to quit drilling, but they're going to back off."

For how long?

Again, it depends to a large extent on how much leverage a company is carrying. And on either the price of oil or one's willingness to assume the price will be good by the time a well actually begins to produce.

Determining when it's no longer profitable to drill is a slippery question because everyone's cost structure is different.

Such variables as the depth of the well and the kind of oil are factors.

Plus, said Hartman, "It's all equal to the activity a company takes on. If your company is still out leasing land, shooting 3D seismic, drilling new well prospects, then this price is going to make it very tough to continue that activity.

"But if you sit back and try to take care of the production you presently have and keep it up and running, you can get by at this price. If you go to neutral, you'll probably survive."

Many Kansas companies also are bearing the financial burden left in the wake of SemGroup, a Tulsa-based purchaser, filing for bankruptcy in July. The state's producers, which had about 20 percent of their market tied up with SemGroup, were left holding the bag for almost $140 million.

As for how long the slump in oil prices will be, Foss said, "I don't think it's going to be very long. I keep thinking this will be a two-year period for lower prices."

The recent strengthening of the dollar and increasing energy demand from big economies such as China factor into a return to higher oil prices, she said.

How high? Ablah isn't looking past 2009.

"We see next year as having a really fair oil price, somewhere between $75 and $80," he said. "I think ultimately that's where we're going to land."

Here's a link to RIGZONE, an industry newsletter.
Check out where the action is in drilling. Look for interests in America. Look for offshore contracts.
Yeah, keep looking...

Ecuador Signs Status-Changing Oil Deal with Petrobras
79 Blocks Up for Bids in Norwegian Shelf Licensing Round
Conoco to Make Final Decision on Abu Dhabi Sour Gas Project in '09
Global Oil Giants to Expand Investment in Indonesia
Beach Strikes Gas at Brownlow-1 in Cooper Basin [Australia]
Total Makes Discovery in Block B Offshore Brunei
Sasol Teams Up with Petronas for Exploration Offshore Mozambique

I could go on, but you get the idea. This is not cherry-picking. I got that from yesterday's news. This is low-hanging fruit for anyone who doing his homework.

Here's something interesting I found at Wikinvest. I don't know anything about this source but it strikes me as a product of keyboard experts who never get their hands dirty. But they do have time to do a lot of reading and study. Lots of successful investors never get a sunburn or blisters on their hands. Take it for what it's worth.

As would be expected, oil exploration companies prospect for oil in the lowest risk / highest return environments first. These are typically onshore sites in politically stable countries. Riskier exploration prospects are offered in off-shore facilities -- exploring off-shore is also more expensive, requiring a larger discovery in order to break-even. The riskiest of all exploration plays involves "non-conventional" sources of oil, such as oil shale or the oil sands.

Key drivers of oil exploration

Price of oil - The backdrop to all conversations about oil exploration is both the price, and the current worldwide proven reserves, of oil. Taken together, these determine whether a specific exploration project will be economically attractive. In particular, the higher the price of oil, the more expensive it can be to draw oil out of the ground and still make a profit. This makes smaller fields, more remote fields, and oil that require more processing all the more viable.

Technology - As one might imagine, the availability of computers and advances in seismic technology have drastically improved the process of oil exploration, which was once little more than drilling a well and crossing your fingers. Advances have pushed the envelope of what is feasible, both in terms of finding where oil is and figuring out how to extract it once a company has identified where it is. General Electric Company (GE), for example, offers "Intelligent Drilling" technology, while a variety of engineering and seismic services firms offer the latest in technology to find oil (e.g., 3D seismic mapping).

Availability of oil field services - The availability of equipment and qualified professionals to service it represents a genuine bottleneck in oil exploration. The price of "oilfield services," which includes all the ancillary requirements for drilling and operating a well, rose 20% in 2006. Lack of availability of drill rigs (for drilling oil), skilled petroleum services professionals, seismic trucks, etc., can be a constraint in oil exploration. Note especially the increase in drill rig rental rates experienced around the world (chart on left).

In its Q4/2007 Earnings Call, Andrew Gould of Schlumberger pointed out that, worldwide, 93% of jackups, 97% of semi-submersibles, and 100% of drillships are currently being utilized, with very few new offshore rigs coming online in 2008. This makes significant offshore growth in 2008 relatively unlikely, as capital is already being used almost to capacity. This lack of capital to meet demand will probably drive up oilfield services rates significantly.

Weather - Difficult weather, especially hurricanes and tropical storms, can create a challenging environment offer a double whammy for oil & gas companies. Not only do they disrupt current supply chains (making tanker deliveries difficult, for example, or disrupting refining processes), but also they may disrupt or disable offshore drill rigs. This disruption ultimately feeds through to the oil field services pricing, as discussed above. And, of course, leads to further difficult conversations about the impact of climate change on extreme weather patterns....

Here's a link to another industry newsletter specializing in offshore drilling. The seem pretty pumped up, to coin a phrase, about the Middle East and Australia. I didn't notice a lot of excitement about any place close to home. But why should there be?
Someone once asked a famous bank robber why he robbed banks. His immortal answer was "That's where the money is."

I think I've made the point.
All I can say in conclusion is "D'oh."

Go ahead. Let's hear it again this election day:

Before I quit, here's one more article from a couple of days ago by Elizabeth Douglass.

African children smile for the camera, a youngster sips pink medicine from a spoon and a doctor explains his part in a venture to fight malaria, the No. 1 killer on the continent. It's an effort, he says, that will help save hundreds of thousands of lives.

The images look like something out of a health documentary, but it's a commercial for oil giant Exxon Mobil, for which the doctor is medical-projects director.

Exxon's other new ads talk about efforts such as its breakthrough technology for hybrid-electric car batteries. Chevron is showcasing its geothermal operations. Of the energy challenge, one ad says, "This isn't just about oil companies. This is about you and me."

The world's best-known oil companies are pouring on the charm as they get ready to parade another round of fat profits before a public that feels suddenly poorer. The spotlight will shine on Exxon today and Chevron on Friday.

Such advertising makes sense after a summer with oil at nearly $150 a barrel and a fall likely to bring renewed scrutiny of the companies' investments and tax breaks.

But when they spend their money, it's less about you and me than about their shareholders. In many respects, industry experts note, what's good for Big Oil's bottom line isn't necessarily good for Joe Q. Jetta.

"That's a game that oil companies have been playing for a while, but they've been pumping more money into it lately," said Sheldon Rampton, research director at the Center for Media and Democracy. "They're hoping to mitigate their bad reputation rather than become beloved."

A few examples in which shareholders have trumped consumers:

• With world oil production falling behind demand, major oil companies are spending a larger share of their record profits on stock buybacks and dividends rather than increasing exploration.

Post-storm shortages

• In July, when refiners saw profits squeezed by high oil prices and lower fuel demand, they throttled back production. When hurricanes hit the Gulf Coast, as much as 14 percent of the nation's refining capacity was offline and gasoline inventories were unusually low. Drivers quickly felt the effects.

• As high diesel prices help put truckers on the road to bankruptcy, refiners have been sending diesel to Europe to fetch a better price.

In nearly every industry, shareholder returns regularly win out over the needs of consumers, who also might be shareholders. Energy companies are unusual, though, because the planet hasn't yet figured out how to operate without their products.

And unlike regulated utilities, which have a legal duty to consider the needs of ratepayers, oil companies have little direct connection to the customers who frequent their branded gas stations.

Most Shells, Chevrons and the like long ago were sold off to dealers and wholesalers.

"It's a tough, tough business, and that's why they've decided to get out of it," said John Felmy, chief economist at the American Petroleum Institute, the industry's lobbying group. But, he added, "we do care about consumers. If you don't care about consumers, you're not going to stay in business."

That allegiance to consumers is sure to be tested in the next year, as Congress and the public weigh major energy proposals, said Amy Myers Jaffe, energy fellow at Rice University's James A. Baker III Institute for Public Policy.

"The question is, would consumers be better off if they spent more money on exploration and less money buying back stock? In my opinion, the answer to that question is yes," Jaffe said.

In 1993, the five biggest publicly traded oil companies — Exxon Mobil, Royal Dutch Shell, BP, Chevron and ConocoPhillips — spent 39 percent of their operating cash flow on development projects, 14 percent on exploration and only 1 percent on buying back their own stock.

In 2007, they spent 34 percent on development, 6 percent on exploration and 34 percent on stock buybacks, according to a study co-written by Jaffe.

In a capitalist market, though, "you could say that it's not their job to be doing things in the public's best interest," Jaffe said.

Domestic oil exploration illustrates the point.

Congress recently voted to ease long-standing bans on new offshore oil drilling in certain regions.

Whether the companies pursue new drilling will depend not on the needs of consumers but on profit considerations such as the price of oil, the cost of the project and estimates of future demand.

When oil pushed toward $150 a barrel, it was hard to imagine any company having second thoughts about new drilling. But oil prices have slumped below $70 a barrel.

This summer's soaring fuel prices and post-hurricane shortages underscored the fragility of the nation's supplies.

Even though fuel production runs chronically short of demand, rising construction costs, sinking demand, greater use of renewable fuels and worsening credit markets have tempered enthusiasm for investments that would pump up output.

Recently, Canada's Connacher Oil & Gas shelved plans to more than triple production at its Montana refinery. The project "would have increased diesel supplies in the Northern Rockies and in some Western provinces that at times have been chronically short of diesel," the Oil Price Information Service said in a subscriber note.

Valero Energy, the largest U.S. fuel maker, is one of the few refiners planning big investments. But like its rivals, it keeps its focus on the bottom line.

The company noted that high gasoline stocks in the spring cut into profit, but the returns on diesel have been "terrific all year," Chief Executive Bill Klesse told analysts last month.

"Valero has exported a lot of diesel fuel, both to Europe as well as to South America, even to Australia," Klesse said. "We were making good money."

Industry economist Felmy, said some of what refiners are exporting isn't usable in the U.S. because of clean-air requirements.

"If you have the ability to be able to reduce your costs by exporting a product, just as we export anything in the United States, it makes economic sense," he said.

Copyright © 2008 The Seattle Times Company

[Emphasis added by this blogger]

1 comment:

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