Industry Needs Stable Funding

Wednesday, October 14, 2009

In reporting on the May Offshore Technology Conference in Houston, the Oil & Gas Journal said that "Oil and gas companies are becoming more adept at maintaining long-term business strategy in the face of short-term uncertainty stemming from oil price cycles." In a session on "Coping with price volatility: how will it affect major capital projects," executives discussed cost-cutting measures that include lowering capital budgets and renegotiating contracts.

The responses were hardly revolutionary or even evolutionary. Adjusting budgets is the time honored response to fluctuating oil prices. Unfortunately, the knee-jerk, cash-flow driven reaction is dead wrong. What it amounts to is buying high and selling low.
As profits rise, driven by high oil prices, companies increase spending and operating costs rise driven by restrictions on goods and services. When prices drop, budgets are slashed and oil field activities drop. The recent decline in drilling activity has occurred much faster than in previous down cycles. The herd mentality prevails and oil and gas companies line up to announce reductions.

Where are the contrarians? We believe that the best approach in dealing with the highly volatile oil market is to maintain constant real dollar budgets. This level spending will enable companies to focus on the long-term and take advantage of opportunities during business cycles.

From a strategic position, upstream companies should focus on development during up cycles and exploration in down times. When profits are high, build a cash reserve that can be used to fund projects when revenues drop. For downstream companies, low prices and low demand periods are opportunities to invest in capital projects to add capacity and improve efficiency.

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