Oil Spending Drips Even as Profits Gush

The key numbers for Big Oil these days aren’t $45 or $55. They’re 1986 and 1998.

Although producers are reaping massive revenues because of soaring prices -- crude eclipsed $55 a barrel last month and gasoline is well above $2 a gallon in California -- the industry remains wary of spending on exploration and production.

The worry is that oil prices will drop sharply and perhaps even collapse as they did in 1986 and again in 1998. And no producer wants to be stuck with a string of expensive new drilling sites that can’t turn a profit.

“Companies are cautious,” said Charles Williamson, chairman of El Segundo-based Unocal Corp. “We’re not investing based on $45 oil, because our projects are in three-, five-, 10-year cycles -- and we don’t know what the oil prices will be then.”

Instead of betting all of their extra cash on drilling, oil companies are using much of it to reward investors and bolster their balance sheets. They are hiking dividends, buying back shares, paying down debt and beefing up pension plans.

ChevronTexaco Corp., for example, raised its quarterly dividend 10% in the third quarter and bought back $750 million of its stock. Those moves came as profit that quarter jumped 62% from a year earlier at the San Ramon, Calif.-based company. Irving, Texas-based Exxon Mobil Corp. raised its quarterly share repurchase program to $2.5 billion from $1.5 billion.

Stephen Chazen, chief financial officer of Occidental Petroleum Corp., recently told analysts that the Los Angeles-based company hoped “over the next year to find high-quality projects with good returns.” But if it doesn’t, he said, “we will return the money to shareholders.”

Investors are happy, but the industry’s moves aren’t making a big dent in one of the key problems behind lofty oil prices: tight supplies. The world’s limited supply of oil is struggling to keep pace with rising demand in the United States, Asia and other regions. And with spare capacity so slim, fears of production snags because of terrorism, political upheaval and bad weather have repeatedly pushed prices up. So has heavy speculation by traders.

Yet even if companies immediately started spending more heavily on finding and producing oil, it probably wouldn’t have an effect in the short term. That’s because major new oil projects -- many of them in difficult terrain -- don’t produce their first barrel of oil for years, sometimes even decades.

“If we’re developing a deep-water project, say, off the coast of West Africa, it may have another four or five years before it’s producing oil,” said David Pursell, a principal at Pickering Energy Partners, an investment bank in Houston.

The world’s six largest oil companies this year are expected to reach a record cash flow of $151 billion, a 40% jump from last year, according to John S. Herold Inc., an industry consulting firm in Norwalk, Conn. But their capital spending will rise only 19.6% to $75.4 billion, Herold estimates. And much of that gain won’t involve new exploration and production; it will reflect higher operating costs for existing projects and the companies’ investments in foreign oil alliances.

ConocoPhillips of Houston, for instance, recently announced an investment in Russian oil giant Lukoil valued at more than $2 billion. At Unocal, its 2005 capital budget “will look roughly like it does this year,” about $2 billion, Williamson said. “Obviously, we’ve got to drill more wells; you can’t just stay still,” he said. “But this industry is acutely aware of having financial discipline.”

It’s an awareness born of disaster. As prices soared in the 1970s, oil companies went on a spending binge. Exploration projects boomed, and the companies diversified into such far-flung areas as retailing and beef processing.

Then came the price collapse of the mid-1980s, with oil plunging as low as $10 a barrel. Profits evaporated, exploration spending dried up, energy stock prices tumbled, and several of the big oil companies merged to survive.

The scenario repeated itself in the late 1990s, when oil climbed back above $30 a barrel and then two years later plummeted to $10 a barrel. Ever since, “capital discipline” has been the watchword for oil executives.

“They have memories of being chastised by investors for destroying value,” said Herold Chairman Arthur Smith.

Oil executives remain in a tough spot today even though oil prices have climbed 52% this year. Crude for January delivery closed Wednesday at $49.44 a barrel on the New York Mercantile Exchange; commodities markets were closed Friday for the Thanksgiving weekend.

They have to find more oil because their existing sites are being depleted. But prosperous new fields are getting hard to find, or are off-limits because they are environmentally protected or run by national oil companies. Meanwhile, there is pressure from investors for companies to keep posting high earnings quarter after quarter -- which requires a close watch on spending -- and to return a big chunk of their extra wealth to stockholders.

Paul Roberts, author of the book “The End of Oil,” said he would prefer to see oil companies boost spending on alternative fuels in the face of dwindling supplies of conventional crude oil. Even so, Roberts said, he understood the companies’ dilemma.

“I would hate to be in their position, because they don’t think there’s any clear picture of how to invest” their latest windfall, Roberts said. “They’ve seen these cycles before.”

Refiners, too, are spending cautiously on new equipment because they expect prices to drop from current levels. Strict environmental laws have curbed new construction -- there hasn’t been a new U.S. refinery built from scratch in two decades -- though several refiners are expanding or modernizing current sites to produce more gasoline, heating oil and other fuels.

Exxon Mobil, for instance, is seeking approval to enlarge its giant Baytown, Texas, refinery to increase output by 3% to 575,000 barrels a day. ChevronTexaco this month said it was considering plans to increase the capacity of its Pascagoula, Miss., refinery by 25% to about 79,000 barrels a day.

Total U.S. refining capacity “should rise annually only by 0.6% during the 2005-07 pe- riod, significantly less than the 0.9% yearly increase witnessed in 1998-2004,” analyst Jacques Rousseau of Friedman Billings Ramsey & Co. said in a recent note to clients.

To be sure, the industry isn’t running in place. It is spending more than $60 billion a year scouring the world for more oil, and that’s keeping providers of drilling rigs and other oil field services busy.

“We forecast continued growth in the worldwide rig count to 2,595 rigs in 2005, up 8% from 2004,” analyst Mark Urness of Merrill Lynch & Co. said in a recent report.

Still, that’s less than half the peak number of rigs operating in the early 1980s, and spending for oil services also is expected to keep rising only gradually despite the surge in crude prices.

“We have the same problems the operators have,” said Dennis Smith, director of corporate development at Nabors Industries Ltd., a leading oil services concern. Oil exploration and production companies “are very sensitive” to the past boom-and-bust cycles, “and they’re being more measured” about spending, he said.

The oil companies’ search for petroleum spans the globe. Unocal is operating in the Gulf of Mexico, Indonesia, Thailand and Bangladesh. Occidental -- whose oil spending is expected to rise 13% next year to about $1.8 billion -- has sites in Ecuador, Colombia, Qatar and Yemen.

ChevronTexaco this year has announced discoveries in the Gulf of Mexico, Australia, Venezuela, Nigeria and the Atlantic Ocean off the coast of Angola. The company also is boosting its total capital budget next year by 15% to about $8.5 billion. But that’s still well below the $12-billion level it reached in 2001.

Each year’s spending is “guided by long-term corporate strategies and business plans, and not by short-term market conditions” such as this year’s soaring oil prices, said ChevronTexaco spokesman Stan Luckoski.

Analysts said there were some potential oil sources that the major companies would pursue regardless of their outlook for future market prices, simply because those fields have such rich long-term prospects.

One is the Arctic National Wildlife Refuge, a 19-million-acre region in northeast Alaska. The oil industry, environmentalists and politicians have fought for years over whether drilling should be allowed there.

Now, with Republicans having added to their majority in Congress, the Bush administration is expected to push again to open the refuge to drilling. If it prevails, “the oil companies will be standing in line to get leases,” Smith of Herold said.

The government estimates that there are 6 billion to 16 billion barrels of oil beneath the refuge’s tundra, though opponents argue that only about 3.2 billion can be recovered economically.

Another potential source is Libya, which has about 36 billion barrels of proved oil reserves, more than Mexico and Nigeria and about 3% of the world’s total, according to the U.S. Energy Department.

This year, President Bush eased sanctions that have kept U.S. oil producers out of the North African country for 18 years. Occidental and ChevronTexaco are among the companies exploring ways to resume operations there, and another meeting of U.S. oil firms and Libyan officials is scheduled in Tripoli in early December.

“Whether oil is $25 or $30 or $40, Libya is an extremely attractive spot, so I think it’s pretty independent of price,” Occidental’s Chazen said in an interview.

Overall, though, the oil companies will maintain their guarded stance toward spending on new production unless they become convinced that today’s prices are here to stay, Pursell of Pickering Energy Partners said.

“They’re making long-term bets here,” he said. “But if we’re having this discussion next year, and oil is still $50 or $55 a barrel, you will see them drill for more oil. You can buy back stock or raise the dividend only so much.”