As another cycle approaches, how will oil prices, capital expenditures, stocks and labor levels affect the industry?
It's no secret that markets are ruthless. During the past decade, oil prices and drilling activity have crashed twice.
Two clear patterns emerge from these cycles. First, the upstream industry is dominated by a herd mentality. Despite bust markets offering less expensive stocks, rigs and labor, drilling levels never rise; they fall. Second, the industry is regulated as if it were a tap. Despite experience reminding us that cycles do not last forever, the faucet is loosened or tightened, and the flow that follows always compounds the boom or bust.
Recently though, even tight controls on the supply of crude haven't boosted drilling activity. Since mid-1999, basket crude prices have stayed above US $20/bbl. Although oil prices have almost doubled since 1998, exploration spending is roughly the same (Figure 1). This has meant fewer active rigs and less drilling. Beneath the budgets, technological forces are at play. Fewer wells are being drilled, but production is up due to better techniques. These range from predrill packages that incorporate subsalt imaging to directional drilling techniques that can access and enable multiple reservoir completions.
Returning to crude oil, due to cohesion within Opec and tension in the Middle East and Latin America, prices are likely to remain strong. And the US Department of Energy calculates supply will fall short 550,000 b/d of oil through to 2003. Adding to this view, Dan Pickering, Simmons & Co. International's head of energy markets research, said, "A recovering global economy should increase demand for oil and gas by 1% to 2% during 2003, while North American natural gas prices should average $3.25/Mcf to $3.50/Mcf as demand improves and inventory levels decline. Drilling activity should improve slowly in international areas, with West Africa, Mexico, Asia and the Caspian/FSU/Russia being the strongest markets. North American markets will be primarily gas-driven and should see a relatively strong 15% to 20% increase during 2003. But the inherent caveat is the health of the US and worldwide economy."
Perhaps fears of an economic slowdown have dealt global drilling activity a duff card as operators delay extensive drilling campaigns. On the other hand, operators are racing for deepwater drilling permits. This is better news because deepwater projects can't easily be turned on and off. Characterized by intensive engineering, heavy investment and an average of 4 years before production comes onstream, these projects require long-term thinking. In sharp contrast, US onshore and shelf activity roller-coasters with gas prices. But thankfully, the global impact of a depressed US drilling market is limited. African, Brazilian and Caspian Sea projects have increased activity while the US market was down.
From an investor's perspective, supermajor stocks tell one story. ExxonMobil, BP, Royal Dutch and ChevronTexaco (Figure 2) have enjoyed an increase in absolute values. Independents and service-company stocks tell another, more volatile story. Anadarko, Burlington, Baker Hughes, Halliburton, Schlumberger, Smith and Weatherford have experienced only small gains with tremendous fluctuations in unison with cycle movements. In the meantime, mergers and acquisitions remain constant for operators and service companies.
Arguably, the industry's most valuable resource, upstream labor, suffers the most when the tap closes. Many people who are laid off exit the industry, and potential new entrants remain wary. "We've reached a critical juncture," said Bruce Peterson of Korn Ferry Recruitment Consultants. "An aging population has created a labor deficit across all skills and capacities, but is largest in technical areas. Companies searching for their future leaders are fast realizing they are going to have to do things differently; there are lots of intellectual gaps. We're seeing more outsourcing, greater dependence on suppliers to solve problems and higher demand for consultants."
Craig van Kirk of the Colorado School of Mines, which has tracked upstream labor demand since 1917, said, "Over the last 25 years, insufficient people have been groomed in-house. This has led to a severe shortage of labor in the last 12 months. Our senior-class petroleum engineers receive an average of 41/2 job offers from operators, service companies and consultancies." Salaries are up too, by 6.9% compared with 2000. This year's average annual US salary, including bonuses, for petroleum engineers rose from $93,000 to $99,407, based on the Gallup/Society of Petroleum Engineers 2002 worldwide salary survey.
In short, if world economies don't slow down, drilling should increase 10% by mid-2003. But even if they do, investing against the cycle enables drilling to produce more oil for less cash. In either event, the message is simple: Hang onto your employees and train future leaders. Otherwise, we might find the tap doesn't open anymore.

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