Upstream Spending Favors Exploration and Development

Annual reports by oil and natural gas companies show that spending on exploration and development activities increased by 5 per cent ($18 billion) in 2013, while spending on property acquisition continued to decline by $17 billion. Total upstream spending was relatively flat after a period of strong growth (averaging 11 per cent per year) from 2000 to 2012, reports the US Energy Information Administration (EIA).

In the past two years, flat oil prices and rising costs have contributed to declining cash flow for this group of companies. Continued declines in cash flow, particularly in the face of rising debt levels, could challenge future exploration and development. However, reduced spending levels could be offset by rising drilling and production efficiency.

EIA reviewed data from 42 recently released financial statements for public oil and natural gas companies. The reports, required by the U.S. Securities and Exchange Commission, show that the slight increase in spending was driven by expenditures to develop fields acquired in previous years. Expenditures to buy new property fell in 2013, and spending on production activities was flat.

Companies report expenditures related to oil and natural gas production activities in three categories: property acquisition, exploration and development, and production, collectively referred to as the upstream. Property acquisition includes costs incurred to purchase proved and unproved reserves. Exploration and development includes expenditures related to searching for and developing the facilities and infrastructure to produce reserves. Production includes costs associated with extracting oil and natural gas from the ground once the field has been developed.

Composition of the 0.4 per cent increase in upstream spending in 2013 included the following: exploration and development expenditures rose 5 per cent ($18 billion) in 2013, while production expenditures grew by just 0.6 per cent ($1.4 billion) and acquisition expenditures decreased 33 per cent ($17 billion). Acquisition expenditures can fluctuate, spiking when there are large mergers and acquisitions. After a large increase in 2010, driven by ExxonMobil's acquisition of XTO, an independent oil and gas producer, acquisition expenditures have declined steadily and in 2013 were the lowest since 2009.

For this analysis, EIA considered 42 U.S. and international oil and gas companies that have reported data on upstream expenditures since 2000. The companies range in size of production and include publicly traded as well as state-owned enterprises, including large producers such as ExxonMobil and Petrobras, and smaller ones such as Encana Corporation and Talisman Energy. The 42 companies made up approximately 39 per cent of non-OPEC production in 2013, and had a combined market capitalization of more than $2.4 trillion.

Generally rising oil prices from 2000 through 2011 contributed to large increases in the companies' cash flow from operations and provided the funds needed to increase upstream expenditures. As crude oil prices increased, projects that had been uneconomic became feasible. Companies significantly expanded operations related to tight oil production in the United States and oil sands production in Canada. With many companies expanding oil and gas production activities at the same time, costs for equipment and personnel also increased, further pushing up expenditures. Costs for raw materials increased as most commodities experienced a general price rise from 2002 through 2008, although commodity prices have come down since 2012. After the 2008-09 economic downturn, property acquisition expenditures slowed first, as spending shifted to exploration, development, and production.

Although oil prices remained relatively flat in 2012 and 2013, rising costs contributed to a decline in cash flow from operations. Nonetheless, cash spent on investing activities, which tends to lag changes in cash flow, increased slightly in 2013 as companies increased debt to maintain investment, taking advantage of interest rates that have been low since 2009. Companies have increased debt every year since 2006, with long-term debt increasing 9 per cent and 11 per cent in 2012 and 2013, respectively.

With a larger share of cash flow from operations directed to investing activities, companies have made less money available for financing activities, including dividends paid to shareholders, share repurchases, and changes in debt. Dividends increased 1 per cent in 2013, but the dollar amount was more than twice as high as the amount paid in 2000. Repurchase of outstanding shares decreased for the second year in a row in 2013 and was well below the 2006 peak, but remained a substantial use of cash.