The past year and a half has seen significant volatility in commodity prices and financial markets. The crude oil price soared from about $100 a barrel in the beginning of 2008 to more than $147 a barrel in July that year, before plummeting to less than $40 in the beginning of 2009 and averaging about $57 a barrel in the year to date.

This volatility has made long-term strategic planning far more difficult for offshore oil and gas exploration and production companies.

In 2008 when commodity prices were at an all-time high, oil and gas companies made significant revenues but the deployment of cash varied substantially among organisations. Large oil companies used their cash towards dividends, share buy-backs, debt repayments and capital expenditures while the smaller companies used external borrowing in either debt form or equity to supplement internal cash flows to fund growth.

The capital expenditure of oil and gas companies after the surge in 2007-08 has witnessed a significant decrease in 2009. However, in 2010 capex activity is expected to rise, driven mainly by large national oil companies (NOCs).

With oil prices starting to stabilise at $65-75/bbl and as economic intervention by governments across the globe takes effect, oil and gas companies are expected to increase investments in 2010. However their plans are largely dependent on commodity prices, commodities’ demand-supply and reduced costs of oil services.

E&P takes a dive

Based on our analysis of the top 100 listed companies (based on oil and gas reserves), capital expenditure for these companies during 2007 and 2008 advanced 22% and 29.2% respectively, driven by increased exploration and drilling activities, and mergers and acquisitions. From $477.24bn in 2007 spending rose to $616.77bn in 2008, which was higher than expected.

This was because ongoing projects and long-term contracts did not give companies opportunity to adjust to deteriorating market conditions in the second half of 2008. There was also a time lag between the fall in commodity prices and a corresponding drop in the prices of oil services.

“The capital expenditure of oil and gas companies after the surge in 2007-08 has witnessed a significant decrease in 2009.”

Bucking the uptrend, total investment in the oil and gas sector is projected to drop 16.6% year-to-year to $514.3bn in 2009 as a result of a tight financial and economic environment and a drop in oil prices. Companies are struggling to make definitive plans in this uncertain and volatile environment.

Several businesses have announced delays in their normal budgeting process and a number of companies have already reduced budgets from their previous estimates.

If the commodity and capital markets remain weak, GlobalData expects that additional cuts will be necessary to realign companies’ spending plans in line with their internal cash flows and based on the availability of external finance. Rising inventories, unstable demand and anticipation of lower prices for oil services have forced companies to postpone new projects and renegotiate existing ones.

Even the depreciating currency of Russia has affected spending plans.

So what has made the industry so hesitant? Oil and gas companies that registered windfall gains in 2008 as a result of high crude oil prices were not able to rapidly bring down costs as the commodity prices dropped and, as a result, profit margins started to contract.

Companies are trying to bring down their costs and hence are conservative about capital investments in the near term, though long-term fundamentals for the industry remain strong.

Smaller companies are the most affected by the economic downturn. Being cautious, they have lowered their production as a result of volatile crude prices, reduced availability of capital and tougher credit terms.

“Bucking the uptrend, total investment in the oil and gas sector is projected to drop 16.6% year-to-year.”

This could potentially lead to a supply crunch when the economy rebounds. Small-cap oil and gas companies also face a challenge in terms of limited operating cash flow. These companies relied more on external debt to fund their growth.

However, well-capitalised companies may view the downturn as an opportunity to position themselves for an upturn.

Capital expenditure plans for 2009 are noticeably different in terms of the scope and strategy adopted by large companies. Even ambitious investment plans are accompanied by cost-cutting measures.

Uncommitted investment plans are also being reviewed and revised in expectation of a better deal in terms of lower raw material prices and service rates. Furthermore, companies are reluctant to invest in mature basins, which typically have high costs, or in regions with high geopolitical risk or unstable fiscal regimes.

Majors play it safe

Almost all the big international oil companies have reduced their capital expenditures for 2009. Investments from the super-majors and majors, which together contribute 49.9% to total capex, are estimated to decrease 14.1% and 37.1% to $187.6bn and $69.3bn respectively in 2009 compared to 2008.

Large, medium and small-cap companies, which together contribute about 9.4% to the total oil and gas capex, were significantly affected by high costs and the credit crunch, and their investments are expected to decline by 31.6%, 57.8% and 43.1% respectively in 2009 compared to the previous year.

National oil companies (NOCs) have continued to spend despite the economic downturn. The total oil and gas capex of NOCs is expected to witness a growth of 6.1% to more than $209.3bn. Most NOCs have the necessary financial strength to fund their capital-intensive projects, even in the adverse financial and economic environment.

An overall view of 2010

GlobalData forecasts a 4.9% growth in oil and gas sector capital expenditure in 2010, and expects the total capex of the leading listed oil and gas companies to exceed $539.7bn, driven mainly by the investments of NOCs. The total capital expenditure by the listed NOCs (for which data is publicly available) is expected to register 9.3% growth and exceed $228.7bn in 2010. PetroChina and Petrobras, together contributing about 35.8% to total oil and gas capex in 2010, are expected to increase their spending by 38% and 16% respectively compared to 2009. OAO Gazprom, PDVSA and PEMEX are also expected to spend significantly in 2010.

“GlobalData forecasts a 4.9% growth in oil and gas sector capital expenditure in 2010.”

Capital expenditure from the super-majors and majors is estimated to increase by 0.6% and 4.1% to exceed $188.6bn and $72.1bn respectively. These companies will look towards using their resources efficiently even as they continue to expand their operations.

Large, mid and small-cap companies are collectively expected to contribute $50.4bn to total oil and gas capex in 2010.

GlobalData’s 2010 capex estimates rely on the largest NOCs keeping up with their aggressive capex plans. We have assumed stable commodity prices, and a better global economic and financial environment, in 2010.

The other factors that can potentially impact our forecasts include exchange rates, global supply and demand for oil and gas, plus raw material and service costs.

The negative impact of the economic downturn can be witnessed in the form of lower investments in 2009. However, we expect that NOCs with strong balance sheets and support of their national government will drive growth in capital expenditure in 2010.

Driven by the objective of meeting their nation’s energy requirements, NOCs are also expected to maintain or increase their spending in the near term. Thus, after certain economic hiccups, there are reasons to believe that the long-term perspective of capital investments remains positive for the oil and gas sector.

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