Thursday, August 21, 2008

The Folly of Offshore Oil Drilling

The idea that the oil companies need to get permission to drill offshore is ridiculous. The majors are more intent in using their funds to buy back their stocks to raise the share price to help boost their bonuses. Here are my notes from an interesting study from the James A. Baker III Institute for Public Policy.

Jaffe, Amy Myers and Ronald Soligo. 2007. "The International Oil Companies." Working Paper #20. Study on the Role of National Oil Companies in International Energy Markets. James A. Baker III Institute for Public Policy, Rice University.
http://www.bakerinstitute.org/publications/NOC_IOCs_Jaffe-Soligo.pdf




The idea that the oil companies need to get permission to drill offshore is ridiculous. The majors are more intent in using their funds to buy back their stocks to raise the share price to help boost their bonuses. Here are my notes from an interesting study from the James A. Baker III Institute for Public Policy.

Jaffe, Amy Myers and Ronald Soligo. 2007. "The International Oil Companies." Working Paper #20. Study on the Role of National Oil Companies in International Energy Markets. James A. Baker III Institute for Public Policy, Rice University.
http://www.bakerinstitute.org/publications/NOC_IOCs_Jaffe-Soligo.pdf

This study looks at the outlays of the big five or companies, BP, Chevron, Conoco Phillips, Exxon Mobil, and Royal Dutch Shell, which had $120.8 billion in profits in 2006 with 9.7 million barrels a day of oil production. The next 20 largest firms had 31.2 billion in profits with 2.1 million barrels per day of production. In terms of operating cash flow, the big five registered $155 billion in 2006, compared to only 50 billion for the next 20 largest American oil firms.

"Cash flow is a better measure of the discretionary resources available to firms than profits. For the Big Five IOCs, operating cash flow, shown in Figure 2, was slightly more than two and a half times higher in 2006 than the average levels prevailing in the 1996-99 period, rising from roughly $60 billion in the late 1990s to $154.9 billion in 2005."

"But while prices, profits, and cash flow have risen dramatically, investment in exploration has not -- especially by the largest IOCs."

They look at outlays of the Big Five firms among the following categories: share buybacks, reserve acquisitions from other firms, exploration expenditures, development outlays, and dividend payments.

"Development expenditures reflect investments in fields that have already been discovered and are the easiest (most cost-effective) way to boost output in the short run. Nonetheless, it is investment in the exploration of new fields that will assure the long-term viability of these firms."

"Share buybacks (equity repurchases) have absorbed a growing share of these outlays, rising from only 1% in 1993 to 37.1% in 2006, while expenditures on exploration account for a decreasing proportion, declining from 13.8% in 1993 to only 5.8% in 2006. It is interesting to note that, despite an almost 50% increase in exploration expenditures from 2005 to 2006, these expenditures as a share of the total increased from 5.3% to only 5.8%."
"The data for the "next 20" firms reveals a pattern of expenditures that is quite different from that of the Big Five. Outlays for exploration have increased significantly in absolute terms, although not as a share of total outlays. Dividends account for a much smaller proportion of outlays while acquiring reserves from other firms is larger. Development expenditures have increased more than three-fold since 1999. However, as a percentage of these outlays, development expenditure has increased from 33.5 % to 47.3%."

"smaller firms are more aggressive in spending for reserves additions than the Big Five-through growing exploration outlays and through acquisitions from other firms."

"The gap [in absolute dollar terms" between the exploration expenditures of the Big Five and the smaller companies has closed, with the next top 20 firms now spending in absolute amounts roughly the same as the Big Five. This is especially telling when one considers the huge differences in operating cash flow between the two groups, where the Big Five registered $155 billion in 2006 against only $50 billion in operating cash flow for these next 20 oil independents."

"The Big Five are gradually depleting their reserves with an average replacement ratio of only 82% in the period since 1999, as compared with 147% for the next 20.8."

"To some extent the decline for the Big Five is attributable to the downward restatement of reserves, especially by Royal Dutch Shell."

"The oil production of the five largest oil companies has declined since the mid-1990s. Oil production for the five largest oil companies fell from 10.25 million b/d in 1996 to 9.45 million b/d in 2005 before rebounding to 9.7 million b/d in 2006. By contrast, for the next 20 U.S. independent oil firms, their oil production has risen since 1996, from 1.55 million b/d in 1996 to about 2.13 million b/d in 2005 and 2006."

"Increasingly, the IOCs have become more like general contractors, coordinating the operation of a number of suppliers who themselves are the ones who undertake seismic work, analyze data, provide drilling rigs and crews and a host of oil field services. The larger IOCs also serve the function of bankers, providing the vast amount of financial resources required to mount greenfield projects in increasingly unfavorable and difficult environments. They also provide the management, organizational skills, and oversight that these large projects require."

"The question is whether NOCs will find this role increasingly useful or whether they believe that such operational planning functions can either be performed by themselves or be farmed out to a service company under a fee-for-service structure. The fact that IOCs have had a poor record in recent years avoiding giant cost overruns on mega projects in Kazakhstan, the Sakhalin Islands, and the Middle East means that NOCs might be skeptical of the benefits being offered by IOCs. Moreover, investors are also questioning whether there is a continued role for the largest firms in a world where the average size of new finds is declining. Smaller E&P firms have lower costs than the large bureaucratic IOCs. They might have an advantage in finding and developing the remaining reserves that are available to private firms. Stock markets reflect these perceptions, with the shares of NOCs and American independents generally performing better than IOC shares."


4 comments:

Anonymous said...

So, are the big five liquidating? I'm not sure if I understand the effect of all these buybacks.

Michael Perelman said...

Management buys stocks. Stock prices go up. Bonuses depend on stock prices.

juan said...

2004 Middle East Economic Survey article by Paul Stevens:

[clip]

It is generally agreed that a great deal of money needs to be invested in exploration, development and production to sustain an increase in crude oil supplies... However, in recent years this has failed to materialize and indeed in this decade, according to Deutsche Bank, the major companies have cut their exploration budgets by 27%.

The explanation for the potential lack of investment lies in the dominance of value-based management theories as the driving force of financial strategy in the major oil companies. This view of corporate finance began to gain credence in the 1990s. Its basis is simple, although the logic is based upon quite complex concepts such as the capital asset pricing model and later variations. If the company cannot provide a rate of return at least equal to the general stock market and to its appropriate sector, it should return funds to the shareholders rather than investing them itself. This is achieved either through higher dividends or share buy-backs pushing up the share price.

As the companies in a mature industry such as oil struggle to maintain shareholder value, this is precisely what they are doing. ...

This problem of funds leaching out of the industry is compounded because returning funds to shareholders is becoming a key source of competition between the major oil companies to keep their shareholders happy. ...

(Stevens, The Future Price Of Crude Oil, Middle East Economic Survey, 13-September-2004)

There are as well a number of pages dealing with this from the perspective of IOC and NOC differences in, if I recall, 'Oil in the 21st Century' by Mabro.

'Financialization' of the International Oil Cos might have made them less than excited about drilling the OCS and/or ANWR though I'd guess that would not be the case for those smaller firms in the Baker Institute study. Or was that one of your points?

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