Spending Continues to Balloon Across the Oil Industry

Spending Continues to Balloon Across the Oil Industry

Oil majors ExxonMobil (NYSE: XOM), Chevron (NYSE: CVX), Imperial Oil (NYSEMKT: IMO), and ConocoPhillips (NYSE: COP) have all come under pressure from concerned shareholders during the last few quarters, as capital spending has in some cases exceeded cash generated from operations.

Unfortunately, as oil and gas become harder and harder to find, especially offshore, companies are having to come up with ever more imaginative ways to access these reserves, and each megaproject is more expansive than the last. Indeed, ExxonMobil and Petrobras alone are expected to clock up $409 billion in capital spending through 2016.

Time is money
However, some of these projects are not going to plan. For example, Chevron's Gorgon LNG joint venture with Exxon and Royal Dutch Shell has seen costs spiral from an initial estimate of $37 billion, projected back in September 2009, to a current figure of $52 billion -- an extra $15 billion is not small change, even for Chevron.

The reason for this multi-billion dollar cost blowout? Rising labor costs, the strong Aussie dollar and project delays are all to blame.

What's more, Gorgon's cost blowout is part of the reason that Chevron has overrun its capital spending budget for 2013. Specifically, Chevron's management has announced that 2013's capital spending would be 10% over the initial estimate, a total of $36.7 billion; the original budget was $33 billion.

Bigger that ever
It's not just Gorgon that is reporting ballooning costs; the world's largest, most complex and most expensive oil project, the Kashagan oil field, operated by a consortium of companies including ExxonMobil, Royal Dutch Shell, and France's Total, has seen costs explode during the last decade. From an initial cost estimate of $57 billion for the life of the project, the Kashagan project is now expected to cost a staggering $136 billion over its lifetime -- that's 138% more than originally planned.

Still, Kashagan has an estimated 38 billion barrels of reserves in place, so the project still looks viable. Nevertheless, the project is suffering yet more delays as engineers try to battle to find out why a major pipeline began to leak (it is believed that high levels of acidity in the water is eating away at the pipeline). According to the last reported figures, the Kashagan filed has cost $50 billion to get to where it is today, five times original estimates.

Costs rising, prices falling
Meanwhile, Exxon's partner in crime, Imperial Oil, recently upped its cost estimate for the Mackenzie Gas Project in Canada's far north by about 40%. This project has yet to even begin construction, and costs are already rapidly escalating. Actually, it is not fair to blame the company for this one; project costs are rising due to the ballooning cost of labor within Canada and a shortage of construction materials.

However, as Mackenzie is a natural gas project, designed to develop natural gas fields within Canada to supply the United States' natural gas market, if costs continue to rise the project may become unviable as the shale oil boom continues to weigh on natural gas prices within the U.S.

Bucking the trend
On the other hand, one company that has been keeping a lid on spending is ConocoPhillips, which plans to spend $16.7 billion on capital projects next year, with more than half earmarked for shale projects within North America. This capital budget is only marginally bigger than last year's budget of $16 billion. In addition, Conoco has also stated that its capital spending will average around $16 billion a year for the next five years, which is, in real terms, a decline in spending.

Should investors be concerned?
Of course, many investors will be asking if these escalating costs are anything to worry about. I believe that the answer is no, as while the cost of these projects is rising, over the long term these projects still look profitable. For example, costs at Chevron's Gorgon project are rising, but over its lifetime the project could produce up to 13.8 trillion feet of gas. With a current LNG price of around $10 per thousand cubic feet, Chevron could generate revenues of $138 billion from the project .

What's more, the troublesome Kashagan oil field is expected to contain 38 billion barrels of oil. If oil continues to trade around $100 per barrel, the project over its lifetime could generate revenues of $3.8 trillion -- need I say more?

Foolish summary
So overall, the cost of these megaprojects may be rising, but investors shouldn't be worried. Over the long term these projects still look viable as the vast size of their reserves more than makes up for the effort and resources the oil and gas majors are committing to get them into production.

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The article Spending Continues to Balloon Across the Oil Industry originally appeared on Fool.com.

Fool contributor Rupert Hargreaves owns shares of Chevron. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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