# Presentation: 199284

## U.S. Independent Oil and Gas Producers, 1993 - 1998:  Survivors and Nonsurvivors

**April 2000**
**Energy Information Administration**
- Office of Energy Markets and End Use
- Washington, DC  20585

## Purpose

-     The U.S. oil and gas industry has undergone substantial changes in ownership structure since the oil price crash of 1986.
-     Changes over the 1986-1993 period were presented and analyzed in a 1995 Energy Information Administration (EIA) report entitled, O*il and Gas Development in the United States in the early 1990’s: An Expanded Role for Independent Producers* (“the 1995 report”).
-     This presentation updates the 1995 report through 1998 in response to:
-     -- Customer interest
-     -- Continued changes in industry structure
-     -- Five additional years of data availability.
-    The focus of this presentation is on contrasts between independent companies that were still in U.S. oil and gas production in 1998 (“survivors”) and independent companies that exited the industry between 1993 and 1998  (“nonsurvivors”).

## The vertically integrated majors’ role in U.S. oil & gas production continued to decline in the 1990’s while nonintegrated majors and independents increased their shares. 

- Note: BOE=barrels of oil equivalent. Natural gas converted at 0.178 barrels per thousand cubic feet.
- Sources: Majors: Energy Information Administration, Form EIA-28 (“Financial Reporting System”).
- Independents: EIA-28 totals subtracted from U.S. totals in Energy Information Administration, *U.S. Crude*
*Oil,Natural Gas, and Natural Gas Liquids Reserves* (less 15 percent for royalty interests).

**Notes:**
The majors are U.S.-based energy companies that are required to report to EIA’s Financial Reporting System (FRS) annually on Form EIA-28. 
An FRS company accounts for (on a net ownership basis) at least one percent of U.S. production or reserves of U.S. oil or natural gas or at least one percent of U.S. refinery capacity or refined product sales.
Vertically integrated companies are materially involved in all stages of the petroleum industry: oil and gas production, pipeline transport, refining, and marketing. In this presentation, “integrated majors” are FRS companies that were vertically integrated in 1998. 
“Nonintegrated majors” are FRS companies that were oil and gas producers in 1998 but not involved in refining or marketing.
Companies accounting for the balance of U.S. oil and gas production are termed “independents.”

## The integrated majors’ worldwide oil & gas production has been nearly constant in the 1990’s as U.S. cutbacks have been offset by production gains abroad. 

- Note: BOE=barrels of oil equivalent. Natural gas converted at 0.178 barrels per thousand cubic feet.
- Sources: Majors: Energy Information Administration, Form EIA-28 (“Financial Reporting System”).

**Notes:**
The integrated majors began shifting their upstream targets of investment from U.S. locales to overseas locales soon after the oil price crash of 1986.
The share of the integrated majors’ oil and gas production from foreign areas increased from about one-third in 1985 to nearly one-half in 1998.

## Among publicly-traded independents, survivors clearly grew and gained prominence. Privately-held independents, in contrast, registered a 15-percent decline in U.S. oil & gas production. 

- Note: BOE=barrels of oil equivalent. Natural gas converted at 0.178 barrels per thousand cubic feet.
- Source: Publicly-traded independents: Company filings of Securities and Exchange Commission Form 10-K.
- Privately-held independents: U.S. total oil and gas production (adjusted for royalty interests) less majors
- and publicly-traded independents.

**Notes:**
The independent oil and gas producers are divided into two categories: publicly-traded companies and privately-held companies.
Publicly-traded companies are those companies who file their annual reports and Form 10-K with the Securities and Exchange Commission (SEC) because their common shares are traded on U.S. exchanges. For the purposes of this presentation, this category is subdivided into companies that were producing U.S. oil and gas in 1993 and 1998 (“survivors”), companies that were producing U.S. oil and gas in 1993 but not in 1998 (“nonsurvivors”), and companies that were producing U.S. oil and gas in 1998 but not in 1993 (“entrants”).
Privately-held independents are not required to make public financial disclosures and account for the balance of U.S. oil and gas production (adjusted for royalty interests).
The decline in the privately-held companies’ share in the 1993-1998 period, from 31 percent to 25 percent, was a reversal of trend. The 1995 report showed that the comparable share was 26 percent in 1985. The privately-held U.S. oil and gas producers number in the thousands and are much smaller, on average, than the 400 or so publicly-traded oil and gas producers.

## Reserve holdings reflected a similar pattern. The big gainers were the independents that remained in production while nonintegrated majors showed modest growth. The integrated majors registered the largest drop in U.S. reserve position followed by the private independents.

- Note: BOE=barrels of oil equivalent. Natural gas converted at 0.178 barrels per thousand cubic feet. Sources: Majors: Energy Information Administration, Form EIA-28 (“Financial Reporting System”). Publicly-traded independents: Company filings of Securities and Exchange Commission Form 10-K. Privately-held independents: U.S. total oil and gas production (adjusted for royalty interests) less majors and publicly-traded independents.

**Majors**

**Independents**

**Notes:**
Proven U.S. oil and gas reserves are hydrocarbon deposits from which production is economic. Publicly-traded companies that produce oil and gas are required to disclose annually their proven reserves in their filings of SEC Form 10-K.

## Surviving and entrant publicly-traded independents and the nonintegrated majors, on balance, added to their U.S. reserve base through purchases of already discovered reserves. Integrated majors, nonsurviving publicly-traded independents, and privately-held independents were net sellers of their proven reserves.

- Note: BOE=barrels of oil equivalent. Natural gas converted at 0.178 barrels per thousand cubic feet. Sources: Majors: Energy Information Administration, Form EIA-28 (“Financial Reporting System”). Publicly-traded independents: Company filings of Securities and Exchange Commission Form 10-K. Privately-held independents: U.S. total oil and gas production (adjusted for royalty interests) less majors and publicly-traded independents.

**Notes:**
Reserve additions are gained through exploration and development efforts, primarily drilling, and include discoveries, extensions to existing fields, improved recovery, and (net) revisions to earlier reserve estimates. Oil and gas producers also add to their reserves through purchase of producing properties and also sell producing properties.
Surviving independents and nonintegrated majors managed to replace their production via the drill bit. However, surviving independents relied heavily on purchases to grow their reserve base.
The nonintegrated majors acquired about 2 billion BOE of reserves but were also heavy sellers of reserves so that their net purchases were small compared to their reserve additions gained through exploration and development.
The integrated majors and privately-held independents fell well short of replacing production and, on balance, were heavy sellers of reserves.

## Reserve replacement costs were not much different between survivors and nonsurvivors.

- Sources: Majors: Energy Information Administration, Form EIA-28 (“Financial Reporting System”). Publicly-traded independents: Company filings of Securities and Exchange Commission Form 10-K.

**Notes:**
Reserve replacement costs are an estimate of the costs of adding oil and gas reserves through reserve additions and purchases of proven reserves. Reserve replacement costs are measured here as the three-year weighted average of exploration and development expenditures (including acquisitions of unproved properties) and acquisition of proven properties (in 1998 dollars) divided by reserve additions and purchases of proven reserves of oil and gas on a BOE basis.
The 1995 report, covering the 1986-1993 period, found that reserve replacement costs were the key distinguishing characteristic between surviving independents and nonsurvivors.
That is, surviving producers tended to have noticeably lower costs of replacing reserves (including purchases of reserves) than did nonsurvivors.
 Further, there was little difference, on average, in U.S. reserve replacement costs between surviving independents and the majors.
By contrast, for the most recent five-year period, reserve replacement costs are close in value for surviving independents and nonsurvivors. Also in contrast to the earlier period, the majors’ reserve replacement costs were noticeably lower than those of the surviving independents by the end of the period. 

## However, the combined costs of extraction (lifting costs) and replacement of reserves increased the most for nonsurvivors.

- Sources: Majors: Energy Information Administration, Form EIA-28 (“Financial Reporting System”). Publicly-traded independents: Company filings of Securities and Exchange Commission Form 10-K.

**Notes:**
Lifting costs are the out-of-pocket expenses, including production taxes such as State severance taxes,of extracting oil and/or gas from proven reserves.
The sum of lifting costs and reserve replacement costs is a gauge of the costs of producing from and maintaining an oil and gas producer’s reserve base.
Figure 7 shows that U.S. lifting plus reserve replacement costs in 1994 were, on average, about $9 per BOE for all categories of producers.
Subsequently, costs rose most steeply for nonsurvivors, also rose for surviving independents but not by as much as for nonsurvivors, while the majors registered a decline followed by an uptick in 1998. 

## Nonsurvivors had the largest increases in both cost categories.

- Sources: Majors: Energy Information Administration, Form EIA-28 (“Financial Reporting System”). Publicly-traded independents: Company filings of Securities and Exchange Commission Form 10-K.

**Notes:**
Figure 8 shows the change in lifting costs and replacement costs separately for the three groups:
 The majors were able to reduce lifting costs and replacement costs.
 Surviving independents cut their lifting costs but not their reserve replacement costs.
 Nonsurvivors suffered from increased lifting costs and	registered the largest increase in replacement costs.

## Nonsurviving independent oil and gas producers began the period with a larger debt load.

- Source: PC Compustat, a service of Standard & Poor’s, Inc.

**Notes:**
The ratio of total debt to equity shows the relative size of debt in a company’s balance sheet.
By this measure, the nonsurvivors began the period with a debt load about twice that of the surviving independents.
However, companies with the highest debt loads among the nonsurvivors exited first, as suggested by the decline in the nonsurvivors’ debt/equity ratio over the period.
In contrast, the debt/equity ratio of survivors increased in the context of a surge in exploration and development spending in 1996 and 1997, when oil prices rose and peaked. In 1998, capital expenditures of the independents greatly exceeded their internal cash flow. Cash flow fell sharply in 1998 due to the collapse in oil prices in that year, leading to increased borrowing to bridge the spending-cash flow gap.

## As a result of their debt load, nonsurviving independents had a heavier interest burden.

- Source: PC Compustat, a service of Standard & Poor’s, Inc.

**Notes:**
At the outset of the 1993-1998 period, the companies that turned out to be nonsurvivors in the U.S. oil and gas industry had to allocate over 60 percent of their internal cash flow for interest expense.
In contrast, the share of cash flow going for interest expense for surviving U.S. oil and gas producers ranged from 15 to 30 percent over the period.

## The nonsurvivors’ cost disadvantage and heavier interest burden contributed to their lower profitability.

- Source: PC Compustat, a service of Standard & Poor’s, Inc.

**Notes:**
Return on equity (ROE), defined as net income as a percent of stockholders’ equity, is a commonly used measure of corporate profitability.
The nonsurvivors’ ROE was negative and well below that of surviving independents in the early years of the 1993-1998 period.
As the period unfolded, the least profitable companies exited from U.S. oil and gas production, closing the gap in profitability.
The plunge in ROE in 1998 was largely attributable to two developments. First, the collapse in oil prices sharply reduced revenues and income from oil production. Second, the value of many companies’ oil reserves, based on contemporary oil prices, was reduced below the value carried on their balance sheets in 1998. Accounting rules required a writedown of reserve values which also had to be reflected as a charge against income.

## Investors’ outlook reflected the nonsurvivors’ poor performance and low expectations of future performance. 

- Source: PC Compustat, a service of Standard & Poor’s, Inc.

**Notes:**
One indicator of investors’ evaluation of a company’s future profit prospects is the ratio of the market value of the company’s common shares to the book value of the company’s net assets (i.e., stockholders’ equity).
A company’s current share price reflects investors’ expectations of profitability at the time the shares are purchased; book value reflects the expected profitability of productive assets at the time the assets are purchased.
The market-to-book ratio was clearly lower for the nonsurviving U.S. oil and gas producers, indicating investors’ lower expectations of future performance of the companies that eventually exited U.S. oil and gas production.

## Summary

- The 1995 report indicated that over the 1985-1993 period:
- The key difference between surviving independents and nonsurvivors was the cost of replacing reserves
- Measures of financial performance and investor valuation were about the same for the two groups of companies
- The lower level of oil prices following their crash in 1986 tended to push less efficient producers to exit U.S. oil and gas production
- The update of the 1995 report for 1993-1998 revealed contrasting results:
- Little difference in reserve replacement costs between survivors and nonsurvivors was apparent, although differences in full-cycle costs were apparent by the end of the period
- Nonsurvivors had a much heavier debt load and interest expense burden at the beginning of the period than did surviving independents

**Notes:**
Summary

The 1995 report, which covered the 1985-1993 period, found that the cost of replacing oil and gas reserves was the most distinctive difference between independent oil and gas companies that remained in U.S. oil and gas production and companies that exited the industry.
Conventional measures of financial performance and investor valuation for most of the 1985-1993 period were little different between the two groups of companies.
These findings are consistent with the view that with the generally lower level of oil prices following the oil price crash of 1986, oil and gas producers sorted themselves out on the basis of how efficient they could be in replacing production and adding to their reserve bases. The least efficient producers sold, or otherwise disposed of, their U.S. oil and gas properties while the more efficient producers increased their role in U.S. oil and gas production.
Updating the findings of the 1995 report for the 1993-1998 period yielded some contrasting results. Reserve replacement costs were not much different between independent companies that remained in in U.S. oil and gas production in the late 1990’s and  companies that exited the industry. However, there was a role for costs. (cont.) 

## Summary (cont.)

- Independents that eventually exited U.S. oil and gas production evidenced lower profitability and investor valuation
- Poor balance sheets rather than reserve replacement cost differences were the drivers in 1993-1998.

**Notes:**
Summary (cont.)

Full-cycle costs (i.e., the cost of producing oil and gas plus the cost of replacing production) increased more for companies that eventually left the industry than for companies that remained in U.S. oil and gas production.
Contrasts between the two groups in measures of financial performance and investor valuations were stronger in the most recent period. The key difference appeared to be the much heavier debt loads of the companies that exited the industry. The heavier debt loads led to interest payments that claimed large shares of cash flow.
Higher interest expense and increasing production and reserve replacement costs were reflected in the lower profitability of the exiting companies. Also, the higher proportion of cash paid out by the nonsurvivors meant that less cash was available for reinvestment. Investors evidenced a diminished outlook for the prospects of nonsurviving independents compared with independents who remained in U.S. oil and gas production.