The Observer: Are multinationals to blame? (ShellNews.net)

Oliver Morgan examines claims that underinvestment by oil companies is helping push prices to record highs  

Sunday August 15, 2004

Sky-high oil prices are threatening to send the global economy into a spin, but to what extent are the big oil multinationals to blame for the crisis? Much has been made about disruption to supplies from Iraq, booming demand from China and the fact that world's appetite for oil is close to outstripping what the producing nations can produce.

The top 10 independent oil companies account for 20 per cent of global production, and they are raking in cash from the high oil price, and giving it back to shareholders through share buybacks and chunky dividends.

Jon Rigby, oil analyst at Commerzbank, says this is because capital expenditure 'is not being flexed. That is why cash is coming back to shareholders.' But he also suggests that such spending has not been 'flexed' throughout the current oil price cycle, which saw prices averaging a rock bottom $12.72 in London and $14.39 in New York in 1998.

So are the companies partly to blame for the current surge, which could see prices nearly treble the 1998 average this year, because they failed to develop new supplies quickly enough?

Clearly, expecting them to balance world demand is unrealistic - they do not operate as a cartel, restricting supply to manipulate price, in the way Opec does: they sell all their output. Yet could they have invested earlier to ensure that greater capacity was available now?

Rigby says: 'When the price was low, they were probably underinvesting.'

Indeed, the raw figures for the for the top 10 companies compiled by oil industry consultant Wood Mackenzie show a drop from $45.9 billion in 1998 to $36bn in 1999. The total did not return to 1998 levels until 2001, before accelerating last year to $57.6bn.

However, Derek Butter of Wood Mackenzie says: 'Companies are now spending at record levels. The reasons for the high price are not simply on the supply side; it is also a consequence of surging demand, coupled with supply disruptions, particularly in Iraq and Nigeria, due to civil unrest.'

The firms themselves emphasise that capital spending is dictated by long-term considerations, not price volatility.

But most have recently revised upwards their expectations of the long- term oil price, while City analysts say the size of their investment is inevitably affected by cash generation and the market price.

Rigby says: 'Capital expenditure is not going up in cyclical terms. There is a view in the market now that the level of capacity comfort above demand is due to the low spending by both nationalised oil companies (such as Saudi Aramco) and independent companies.'

Adjusting the raw spending figures by linking them to production gives a clearer idea of the trend throughout the cycle, as firms pump oil more when the price is higher. So in 1998, the ratio of expenditure to production was 3.4 times. It fell to 2.6 the following year, and did not reach 1998 levels again until 2003.'

Rigby says: 'You find that the oil companies reacted very quickly on the downside, and have been much slower to come back up to mid-cycle levels.'

Butter has a caveat: while there is a link between spending and production, it is a lagging one, and the production figures from the top 10 companies have been boosted by mergers and takeovers.

Nevertheless, the trend may be prudent. BP for example, spent freely in the Eighties on exploration and production, as did Shell in the Nineties, but with unhappy returns. And in the short term this may have contributed to today's cash bonanza and the highlighting of oil companies as top picks by equity market strategists.

However, in the longer term, compa nies maintain their value by finding more oil to pump (major finds have declined and replacement of reserves has been slipping), while energy consumers hope they will keep finding it to keep prices down.'

Different companies have different records. Those of the UK giants, BP and Shell, are mixed. BP's performance is obscured by the huge mergers with Amoco and Arco of the US that transformed its scale. Shell had a major overhaul in 1998, partly spurred by the lower oil price, that saw it impose harsh capital discipline. One analyst says: 'At Shell this definitely resulted in underspend.'

Consolidation, such as BP's US tie-ups, Exxon link with Mobil, Chevron's with Texaco, and the combining of Total, Fina and Elf, have also marginally affected total capital spending, as budgets have been trimmed as part of the merger process.

But exploration budgets, rather than those for developing discoveries, have been hit hardest. Total exploration spending for the 10 in 1998 was $11.3bn. Last year it was $8bn.

The companies point to a number of reasons for this. BP, for example says that following poor performance in the Eighties chasing small finds in the North Sea, chief executive Lord Browne focused on large 'elephant' finds where costs were lower. The problem has been the decline of such finds. One company official says: 'Accessing reserves gets more difficult, simply because there is not the number of big fields.'

Butter adds: 'New field exploration results in the past few years have not been particularly good. There has not been the opening of major new provinces which we saw in the mid-Nineties when the independents's exploration success in deep water Angola and Nigeria was bolstered by a resurgence of exploration success in the US Gulf of Mexico and access to explore in Kazakhstan.'

Under these circumstances the majors believe cash is better returned to shareholders.

Meanwhile, development spending has shot up from $34.6bn to $49.5, as companies have raced to get finds in areas that were open to exploration in the Nineties ready to operate.

Butter expects development spending in these areas to go on rising in the next two years, driving production growth of between 2 and 3 per cent until 2008.

But in the longer term, the increased production in these areas is likely only to balance out declines in others - particularly in the North Sea, where it peaked five years ago, and in the 'lower 48' US states, he says.

One area of growth would be in areas now operated by nationalised oil companies, often in Opec countries. Indeed, Opec, particularly the Middle East where costs are relatively low, is expected to be the main source of new future supply. Oil companies covet access to these areas. If they get it, investment may rise. If not, the faltering investment, particularly in exploration, that has emerged since 1998 may become permanent.

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