Article gas high price

The pundits have raised warning signs, but first-half momentum should push regional drilling up 30% to the highest in 16 years. But if gas prices stay weak, next year will suffer

UNITED STATES

This year began with high expectations for increased E&P activity, and to date, there has been little disappointment. The number of drilling rigs active in the U.S. last January were 44% higher than a year ago, and this figure grew an additional 14% by mid-year.

Although average first-half 2001 (WTI) crude prices remain strong, and only about $1.80 below the 2000 average (which was the highest in 19 years), natural gas prices have dropped significantly from the irrational highs reached earlier this year. The gas-price drop has prompted the worry-warts to call for all sorts of gloom and doom for the remainder of the year. However, it's believed that most of the reasons for the gas-price decline are just as irrational as those behind the large run-up earlier, and that gas in the U.S. will finish the year strong, averaging $5/Mcf. As a result, exploration and development drilling will remain robust for the rest of 2001.

Forecast summary. The following forecast of U.S. drilling was formulated using results from two operator surveys (World Oil's comprehensive survey of major and independent operators' drilling plans and Schroder Salomon Smith Barney's survey of operator E&P expenditures) and historical drilling figures furnished by ODS-Petrodata Group (a OneOffshore Company), numerous state regulatory agencies and the American Petroleum Institute. These surveys and statistics, plus price projections for oil and gas, are discussed below. Highlights of World Oil's revised 2001 forecast include:

* The drilling of 19,331 wells in the U.S. during the second half, a 17% increase from the first six months.

* Full-year 2001 drilling will total 35,834 wells and 181 million ft of hole, up 19% and 22%, respectively, from last year.

* Gulf of Mexico drilling will improve 6% the second half, reaching 1,223, wells for 2001.

* The U.S. rig count will average 1,335 rigs during the second half, bringing the yearly average to 1,262 rigs.

All the fundamentals are in place for a strong finish to 2001. The main constraints, which include gas prices, equipment and personnel shortages and rising rig rates, were considered while preparing this forecast. While rig and personnel availability are tight, the drilling projections for the remainder of 2001 can be achieved with only a minor increase from the levels of rigs and staffing reached last month. And while there have been reports of operators releasing rigs in response to rising day rates, the operators answering World Oil's surveys collectively plan more drilling the second half. Mobile offshore rig releases and movements out of the Gulf of Mexico also have garnered much press recently; however, these rigs are not a primary contributor to development drilling, which accounts for 76% of the Gulf of Mexico wells operators say they will drill.

Prices. It appears that OPEC does not have a production-quota increase in mind at this time, thus the slight weakening in oil prices this year is likely to reverse, with prices strengthening through the rest of the summer. This scenario should hold, even though Iraq has agreed to resume UN-supervised exports. The U.S. Energy Information Administration sees total OPEC crude oil production averaging about 27.3 MMbpd in the third quarter, which is only 200,000 bpd above the second quarter OPEC average. In addition, the agency expects enough demand growth to absorb the implied increase in world output and reduce the extent to which inventories have risen above year-ago levels. Therefore, the spot price for WTI, which averaged $28.36 per barrel during first-half 2001, should reach $30 by September, and with further gains, average $30 for the full year.

Natural gas prices are much more perplexing. Cool weather, good industrial demand and the electricity crisis in California caused buyers to panic, driving gas prices to a record average of $9.76/Mcf in January 2001. But after the panic subsided and prices returned to rational levels, speculators, using preliminary and incomplete gas storage additions, fueled a stampede in the opposite direction. Although final production figures will not be available for three to five months to verify same, the "surplus" will likely end up being much smaller than speculators currently think. In fact, a prolonged heat spell, and attendant rise in electricity demand, could immediately turn surplus to shortage once more.

Looking forward, gas will likely stay below $4/Mcf during the third quarter, then rise toward $5/Mcf in the fourth quarter. Thus, overall 2001 gas price should average about $5/Mcf. Realistically, some operators will trim gas development activity because of current prices, but most indicate a longer term view and will maintain their search for gas.

Operator surveys. Despite a significant increase in drilling during first-half 2001, companies responding to World Oil's operator survey anticipate even more activity in the second half. The 20 companies with major drilling programs and 175 independents said they would raise overall drilling levels by 17% the last half Operators continue to focus on field development, which will account for 88% of second-half wells. Attention to gas targets will remain, as respondents plan to boost gas drilling by 30%.

While planning to increase drilling by 11%, the majors see even more emphasis on exploration, and say wildcat drilling will rise 64%. The independents are more bullish overall, with plans to raise drilling by 40%. On the other hand, independents say they will increase exploration by 35%.

In its mid-year survey of operators' E&P expenditures Schroder Salomon Smith Barney indicates that U.S. oil companies will boost spending by nearly 22% this year. This is the second sharpest year-to-year increase since the firm began the survey 19 years ago. Independents, who are historically quicker to modify their plans, will account for 76% of the increase over 2000. While the majors are less optimistic, 50% will raise second-half spending, while the remainder expect it to at least equal first half spending.

More specifically, the 177 independents responding plan to spend $19.6 billion in 2001, up 31% from the $15 billion they spent in 2000. The eleven major oil companies surveyed say their 2001 expenditures will rise 12% to $13.6 billion, vs. $12.1 billion in 2000.

Independents with significant spending increases include Anadarko Petroleum, Dominion E&P, Pioneer, EOG Resources, Enterprise Oil and Kerr McGee. Of the few independents with planned spending declines this year, the most significant are Bellwether, EEX, Newfield, Seneca Resources and Woodside Petroleum.

The majors' 2001 spending increase is much less than originally predicted last December, with the relative decline due almost entirely to Texaco and Chevron. Their decline appears to be a combination of increased emphasis on international markets and their pending merger. The remaining nine majors all plan increases, with the most significant coming from BP, ExxonMobil, Conoco and Occidental. BP alone represents 15% of the total U.S. spending increase this year.

CANADA

Robert Curran, Calgary, Canada

At the outset of 2001, there was an air of unbridled optimism in downtown Calgary. Flush with cash, producers spoke of massive production increases and the occasional mega-project. Halfway through the year, sustained high oil and natural gas prices, record-shattering financial results and a bullish industry outlook have combined to exceed all expectations.

Despite a recent onslaught of price warnings and concerns about the sustainability of current activity, the first half of 2001 established several new standards, including drilling levels, overall profits, export throughput and revenue, and merger and acquisition activity. But the record numbers have not been reflected in stock prices, which continue to trade at levels lower than expected.

Acquisitions and expenditures.

The result has been a slew of takeovers and mergers, highlighted by Conoco Inc.'s C$9.8-billion takeover of Gulf Canada Resources Limited. The deal, which includes C$3.1 billion in debt, comes almost 20 years after Conoco substantially reduced its Canadian position by selling its majority stake in Hudson's Bay Oil and Gas Co. Ltd. to Dome Petroleum.