Oil companies hold onto their wallets

Exploration and production companies could once be counted on to spend like drunken sailors when oil and gas prices were high, but in the current boom, they are holding onto their wallets like never before. Two key factors have led to the fiscal discipline in the exploration and production sector, say executives and industry experts: the memory of how free boom-time spending led to a sector collapse in 2001 and the growing shortage of high-yield prospects.
"In my history, I have never seen this industry so disciplined in terms of spending money," said Steven Farris, president and CEO of independent driller Apache. And that is in spite of natural gas prices in the range of $ 5 per thousand cf and oil near $ 30 a barrel. Ordinarily, drillers could be expected to raise their capital expenditure budgets drastically in such an environment.

There is a prevalent fear among investors and drillers alike, that the good times could stop rolling abruptly, as they did when prices fell sharply in 2001. "More than anything, people don't trust the volatility," Farris told.
Exploration and production companies appear to have learned their lesson from two years ago, when many in the sector overextended themselves with huge capital expenditure budgets and were caught short when commodity prices fell sharply. Investors savaged exploration and production stocks as a result.
"If they spend like they did in 2001, then the only people making money are oilfield service companies," RBC Capital Markets analyst Andrew Lees said.

That highlights an ugly side of a high-price cycle for exploration and production companies: oilfield service providers charge higher fees, which squeeze profit margins. Add to that the fact that all of the easy-to-find oil and gas in North America has been discovered, making it a "mature province" in oilpatch parlance.
"Even if producers want to throw money at it, there are no easy, quick-return prospects," said Irene Haas, an analyst with Houston investment bank Sanders Morris Harris.

Though the scarcity of good prospects would appear to keep prices high, it tends to work the opposite way. Since finding costs are higher across the board, wells have to yield more to be as profitable as they were in the past. Adding to the pressure is Wall Street's expectation that exploration and production companies deliver earnings or cash flow growth, which means production volumes have to grow.
But the higher costs have made producers more choosy about what wells they drill, especially since Wall Street also rates the sector on return on capital invested.

A bigger exploration budget demands bigger returns, so drillers have been forced to rein in their spending to keep up their rates of return, Lees said. "What they have been focusing on instead is having a right-sized capital budget and focusing on bigger-hit prospects internationally," Lees added. "Every single company in this space with any growth at all has an overseas component."
Haas said that trend is likely to remain as producers look for prospects that deliver the optimum mix of big finds and a good return on investment.
"To find new gas and oil, we have to go into areas that are not easy to get to. Literally, the producers are between a rock and hard place," Haas said.