# Presentation: 203833

## How Data Show Impact of Low Oil Prices in 1998

- January 10, 2000
- Energy Information Administration

**Notes:**
SUMMARY
The petroleum industry’s profits plummeted to a level not seen since 1986 as crude oil prices fell in 1998 to 25 year lows.  Prices have swung back to levels seen in 1996, but company responses tend to lag these price swings.  
Financial operating changes:
E&D expenditures fell considerably in 1999, with U.S. E&D taking more of the fall than foreign E&D.  Majors E&D expenditures fell less on a percentage basis than did the independents.
E&D expenditures are projected to begin increasing in 2000, but only the majors’ foreign E&D will return to the high levels seen in 1998.  U.S. oil E&D activities are not picking up as rapidly.
Drilling Response
Rig counts are more price sensitive in the short run than production and showed a huge decline since early 1998.  
Only twice in over 100 years have fewer oil wells been drilled than in 1998.
Consistent with slow recovery of U.S. E&D expenditures, oil rig counts are just beginning to increase.
Even with today’s high prices, production is not expected to recover to levels seen in 1996/97, but the rate of decline should slow next year as drilling activity gradually increases.
The recent decline in crude oil prices is fresh enough in companies’ minds to keep them from rushing back into the high-cost U.S. regions, unlike the U.S. natural gas sector where the long-term outlook remains promising.

## Return on Equity U.S. Energy Companies (1973-1998)

**Notes:**
With the 1998 drop in oil prices, the corporate profitability of U.S. majors in 1998 plunged to a level not seen since the oil price crash of 1986.  (The dip in 1992 was due to an accounting change.)

While lower natural gas prices, declining U.S. oil production, and reduced sales of natural gas contributed to the majors’ bottom-line problems, the primary cause was low oil prices, which hit a 25-year low in 1998. 

One bright spot was the majors’ U.S. downstream operations.  The majors were able to offset a narrowing of the margin between refined product prices and crude oil input costs in 1998 through strategies such as trimming operating costs and expanding the scope of petroleum marketing activities.

Internally generated cash flow was at the lowest level since 1986.

## Capital Expenditures and Value of M&A for U.S. Majors (1974-1998)

**Notes:**
Although oil prices hit a 25-year low, the majors’ capital expenditures in 1998, at $75 billion, were at their second highest level.
Mergers and acquisitions, mainly of oil and gas assets in early 1998, accounted for 57 percent of the growth in spending.
Oil and gas exploration and development projects were the primary investment targets.  The majors tended to push ahead with ongoing projects that have relatively long lead times.  Also, the search for new oil and gas fields continued as the majors increased their expenditures for exploration in all regions except Europe.
The majors’ continued upswing in E&D spending yielded 8 billion barrels of oil equivalent in added worldwide reserves in 1998 -- a 25-year record (probably the most since Prudhoe Bay).

However, the majors’ capital spending in 1998 exceeded their cash flow by 56 percent.
This disparity was highly unusual for this group, as their capital expenditures have generally been less than cash flow, averaging 14 percent less.
They closed the financing gap by increasing their debt loads, selling a record amount of assets, cutting dividends and stock repurchases, and drawing down cash balances by over $4 billion. These adjustments ran counter to the majors’ programs of debt reduction and increased payouts to shareholders evident in the 1990’s

## U.S. Majors’ Exploration & Development Expenditures

**Notes:**
In 1999, the majors cut their upstream expenditures despite the sharp turnaround in oil prices.  Based on the Salomon Smith Barney survey, the majors cut U.S. exploration and development expenditures (E&D) by 28 percent in 1999 and foreign E&D by 7 percent.
The cuts were primarily a response to balance sheet damage
They reflected cutbacks in planned projects made in the context of 1998’s oil price erosion.

For 2000, the majors indicate in the survey that they will increase U.S. spending by 7 percent and foreign spending by 9 percent, putting foreign E&D spending back on trend, but keeping U.S. spending well below prior high levels.
Planned foreign E&D for 2000 is back on trend, a tad above 1998 spending, suggesting that the 1999 cutbacks were mainly deferrals rather than project cancellations.
Planned U.S. E&D for 2000 is well below spending levels of 1997 and 1998, and may reflect longer term cutbacks in U.S. upstream commitments by the majors.

In summary, foreign development expenditures are less adversely affected than U.S. expenditures.

## U.S. Independents’ Exploration & Development Expenditures

**Notes:**
U.S.-based independents showed a similar, but more extreme, response to swings in oil prices and cash flow shortfalls.
The independents tend to have projects with shorter lead times than the majors, and their corporate organizations tend to be lean and nimble compared to the majors.
In 1999, the independents cut U.S. E&D by 41 percent and foreign E&D, which is far less important than U.S. E&D for most independents, by 38 percent.
Plans for 2000 indicate a turnaround: U.S. E&D up 20 percent and foreign E&D up 35 percent

Like the majors, the survey indicates that the independents’ U.S. E&D in 2000 will not come close to the spending levels of 1997 and 1998.
This latter development may not bode well for U.S. oil production.
Reduced drilling and asset writeoffs in 1998 had devastating effects on U.S. producers’ reserve replacement performance.

## U.S. Crude Oil Reserve Additions and Production Replacement Rate 

**Notes:**
The sharp decline in crude oil reserve additions in 1998 reflected the effects of the oil price collapse.
Extensions and discoveries were only half of the prior-year level.
Revisions and adjustments accounted for 71 percent of the fall off in U.S. crude oil reserve additions between 1997 and 1998.

Only 24 percent of crude oil production was replaced by proved reserve additions.  
The majors’ replacement rate was 61 percent.
The replacement rate for other U.S. producers was less than 10 percent overall.

## Weekly Oil Rig Count and Prices

- Source: Baker Hughes Rotary Rig Counts Web Site

**Notes:**
Drilling is more price sensitive in the short run than are exploration and development expenditures. Rotary rig counts lagged the oil price decline, but began to fall sharply in 1998, bottoming out in mid-1999. 
Drilling programs are relatively easy to cancel or delay.
Drilling contracts, particularly onshore, are flexible.
The level of U.S. drilling activity is dominated by many small independents.  For example in the 1990’s, the majors accounted for less than 25 percent of U.S. well completions.

Only twice in over 100 years have fewer oil wells been drilled than in 1998. 

Natural gas rotary rigs also declined in 1998 and 1999.
Although the natural gas price did not see the same relative decline as crude oil, it too fell.
The financial pressures on the petroleum companies affected their entire drilling programs -- including natural gas. 

With the resurgence in natural gas prices, natural gas rigs counts have recovered rapidly, unlike oil rigs.  

## U.S. Crude Oil Production

**Notes:**

The recent price decline resulted in a quick loss of U.S. production.  Even with the return to higher oil prices, production is not expected to increase back to levels seen in 1996 and 1997, but will continue to decline, albeit more slowly.  

Oil production does not respond rapidly to price changes. Price changes to impact exploration and development plans more than ongoing production initially.  

The high oil prices in 1996 helped to level out the earlier production declines in the U.S., along with technology-driven cost reductions and developments in the Gulf of Mexico.  But the 1997/1998 price drop put production back onto a steep decline trend.
From December 1997 to December 1998, U.S. production fell almost 500 thousand barrels per day (7.5%).
From December 1998 through the most recent October data, production has fallen an additional 165 thousand barrels per day.

Although current data do not yet show a change in trend, if prices remain high as forecast in the EIA base case, the decline should slow considerably during the year 2000 as shown in the graph.

## Coalbed Methane Gas Growing

**Notes:**
Although the main feature of U.S. resource development in 1998 was the poor performance in replacement oil production there was at least one upstream bright spot.

Production of natural gas from coalbed methane deposits more than tripled from 1991 to 1998 as coalbed methane proved reserves increased by 50 percent.

In 1998, production from coalbed methane deposits was up 10 percent from the prior year, while coalbed methane reserve additions replaced 160 percent of production.

The growth in production and reserves indicates that coalbed methane development is continuing even though only production from coalbed methane wells spudded before 1993 is eligible for Section 29 Federal tax credits.