Worldwide exploration and production spending will climb another 19.7% in 2001 following a robust 18.5% increase in 2000, Salomon Smith Barney Inc. predicts in its 19th annual survey of oil and gas producers' capital budget plans. The New York investment-banking firm's oilfield service and supply analysts expect upstream outlays to be more geographically balanced this year, with increases of 19.1% in North America and 20.1% outside North America. That would be a significant contrast to 2000, when North American E&P expenditures jumped 40.5% and overseas spending rose only 8.2%. The survey also shows a record number of respondents-more than 80%-expressing concern about oilfield-service capacity, with a particular focus on availability of drilling rigs and field personnel. "The challenge for the industry, both operators and service companies alike, will be dealing with the strains of high capacity utilization," observe analysts Geoff B. Kieburtz and Mark S. Urness. "The positive implications for service-company earnings are self evident, but striking the appropriate balance to complete the transition from recovery to sustained growth will be a difficult, and welcomed, challenge." The 234 producers who responded to the survey plan to spend a total of $113.5 billion on E&P in 2001, 19.7% more than their estimated total outlays of $94.8 billion in 2000. Of the planned 2001 outlays, approximately 62% will likely be directed outside North America, 11% in Canada and 27% in the U.S. The 10 largest spenders account for half of the total spending, and the top 50 companies represent 88% of the full amount. The data do not include acquisitions. In the U.S., 154 independents plan to increase their total outlays 20.4% to $16.9 billion in 2001, nearly $3 billion more they forecast in 1999 to spend last year. Spending by the group jumped an estimated 48.4% year-to-year in 2000, much more than the 15.3% growth forecast in Salomon Smith Barney's December 1999 survey, and even the 30.3% growth forecast in its June 2000 midyear update. Kieburtz and Urness say this was a result of record high natural gas prices and a consensus forecast of prices above $4 per thousand cubic feet for 2001. The independents' plans Independents planning significantly higher spending in 2001 include Enterprise Oil Plc (NYSE: ENT), Cross Timbers Oil Co. (NYSE: XTO), Nuevo Energy Corp. (NYSE: NEV), privately held Mariner Energy Inc., Anadarko Petroleum Corp. (NYSE: APC), Plains Resources Corp. (Amex: PLX), Tom Brown Inc. (Nasdaq: TMBR) and Remington Oil and Gas Corp. (Nasdaq: ROIL). Several independents are linking planned spending hikes to higher production targets. Cross Timbers increased its 2001 capital budget by $50 million to develop East Texas and Louisiana natural gas properties that it acquired last year for $115 million from Herd Producing Co. of Tyler, Texas. The budget boost to $250 million targets 20% growth in total gas production. As a result, the Fort Worth independent expects to increase its year-to-year growth rate for overall production 50% to between 15% and 18% from the 10% to 12% rate planned in its original 2001 budget. To hit the higher production growth target, Cross Timbers plans to drill about 285 (211 net) wells and perform approximately 400 (290 net) workovers and recompletions. It also plans to increase gas production another 20% to approximately 535 million cubic feet per day by the end of 2002. Using current prices, it expects the bill for this to total approximately $350 million. "The development opportunities in this budget are highly economic," emphasizes Cross Timbers vice chairman and president Steffen E. Palko. "It is not dependent on gas selling for $5 per thousand cubic feet. In fact, at $3.50 per Mcf, we would expect this budget to generate an impressive 60% internal rate of return." When Noble Affiliates Inc. (NYSE: NBL) announced an approximately 40% year-to-year increase in its annual capital budget to some $700 million for 2001, it tied it to a more than 10% increase in overall production. The Houston independent anticipates its outlays will be funded by discretionary cash flow. "The substantial increase in our 2001 capital program indicates the depth and quality of the investment opportunities our organization has developed," says Charles D. Davidson, Noble president and chief executive officer, who recently joined the firm. Davidson was chief executive of Vastar Resources Inc., which was rolled up by BP after purchasing Vastar's majority stockholder, Arco. He says of Noble's plans, "This program will allow us to significantly advance both our domestic and international growth agendas." Approximately 60% of the 2001 budget is allocated to development projects; the remaining 40%, to exploration. Approximately $300 million will be spent in the Gulf of Mexico on Noble's core shelf holdings and selected deepwater prospects; $70 million onshore U.S.; and $340 million overseas, in China, Israel, Ecuador and the North Sea. The company also plans to spend $90 million on downstream projects in Equatorial Guinea and Ecuador. Nuevo Energy Co., meanwhile, is emphasizing development in its 2001 base capital budget of $181 million. It expects to increase that figure up to an additional $24 million, depending on its level of drilling success. Exploitation projects-primarily onshore California-represent $141 million, or 78%, of the total spending plans. Another $27 million will go to exploration, primarily to drill 12 wells in California and Africa, while the remaining $17 million, or 7%, will be devoted to other capital projects. "We will realize the full impact of previously initiated successful drilling projects and continue an active domestic and international exploratory drilling program," says Doug Foshee, the Houston independent's president and CEO. "We anticipate that continuing improvements in financial results, combined with operating successes, will be the catalysts needed to drive Nuevo's share price to higher levels. Finally, our capital budget does not include the amplifying impact of further share repurchases." The 11 major oil companies that participated in the survey plan to raise their U.S. spending 17.9% this year, following a 23.8% increase in 2000. Occidental Petroleum Corp. (NYSE: OXY) and BP (NYSE: BP) projected the largest U.S. spending increases, while Texaco Inc. (NYSE: TX), TotalFinaElf SA (NYSE: TOT) and USX-Marathon Group (NYSE: MRO) do not expect their U.S. outlays to change. Canadian outlays On Canadian E&P, 77 companies plan to increase their expenditures to $13.1 billion in 2001 from $11 billion in 2000. Like in the U.S., surging natural gas prices have propelled Canadian drilling to near record levels that would have been higher if the weather had been less hostile. As a result, Kieburtz and Urness expect Canadian E&P spending last year to be 50.1% higher than in 1999 and nearly twice the 30.6% year-to-year increase forecast in the midyear 2000 survey. "The 2001 spending growth plans appear to be broad-based, with just 11 respondents, or 14%, planning spending declines and a further 11 increasing budgets by more than $100 million," they say. Among the leaders in increased Canadian E&P spending plans for 2001 are Gulf Canada Resources Ltd. (NYSE: GOU), Anadarko Petroleum, Imperial Oil Ltd. (Amex: IMO), Husky Energy Inc. (Toronto: HSE), Canadian 88 Energy Corp. (Amex: EEE) and Exxon Mobil Corp. (NYSE: XOM). Overseas spending The 89 producers in the survey that operate outside North America plan to increase their total overseas spending 20.1% to $70.7 billion in 2001, or more than $12 billion-a steep growth rate considering total overseas outlays by the group rose just 8.2% last year, from 1999. Leading the increase in overseas spending will be large national oil companies such as Italy's Agip , Mexico's Pemex , Venezuela's PDVSA and Brazil's Petrobras (NYSE: PBR), and multinationals like Royal Dutch/Shell (NYSE: RD) and Exxon Mobil , Kieburtz and Urness expect. "In fact, these six companies account for $6 billion of incremental international spending, or 51% of the total," they observe. Just eight of the 89 respondents with international operations expect their expenditures to decline, while 27 anticipate increases of more than $100 million, the analysts say. Underspending cash flow The suvey also found that producers were unusually sensitive to dramatically increasing natural gas prices during 2000. "Composite spending growth of 18.5% essentially matched our June estimate of 18.6%; however, this amount was reached due to an enormous North American overspend (of approximately $3 billion), offsetting an equally large international underspend," Kieburtz and Urness say. Only 19% of the respondents, including the majors, expect to outspend cash flow during 2001, compared with an average of 45% during the last 10 years. A whopping 55% (compared with a 10-year average of 30%) anticipate underspending cash flow. Anticipated higher oil and gas prices will make it difficult for any producer to outspend its cash flow, the analysts observe. "However, we also believe reduced prospect inventories and a scarcity of qualified technical personnel may present a significant hurdle to further investment increases," they continue. "This issue is compounded by the maturity of the North American natural gas markets, limiting the amount of large, untested exploration projects." While oil and gas price assumptions are conservative compared with current prices, they are very high historically. "In fact, the average oil price assumption for 2001 planning purposes ($24.34 per barrel) is 38% above the last 10 years' average, while the average natural gas price assumption, at $3.86 per thousand cubic feet, is 90% higher than the last 10 years' average," Kieburtz and Urness note. The largest respondents use long-term planning assumptions of less than $18.50 per barrel, they add. For the second consecutive year, respondents increased exploration's share of their overall budgets nearly two-to-one. The bias was evident worldwide, but particularly notable outside North America, which showed a trend toward more exploration of three-to-one. The Salomon Smith Barney researchers infer from these responses that large-scale development projects do not represent a large part of planned 2001 outlays, but probably will take place in 2002 or later. "Accordingly, it appears that early-cycle, focused service companies again appear poised to capitalize the most in 2001," they say. More offshore, less onshore Producers in the survey also plan to shift more of their spending to offshore projects, outnumbering land-based efforts two-to-one. The movement is even stronger internationally, where offshore outlays outnumber onshore expenditures nearly four-to-one. Kieburtz and Urness attribute the trend to the aging of existing oil and gas fields and the corresponding search for additional hydrocarbons in increasing remote areas, such as ultradeepwater. Nearly 90% of the respondents-a more than 10-year peak-say they prefer the drillbit to acquisitions when it comes to replacing reserves. The trend was particularly pronounced among U.S. independents and in international markets, where 90% and 95%, respectively, of the producers consider drilling more economical than purchasing reserves. The Salomon Smith Barney analysts suggest this perspective may reflect the historically low valuations at which E&P stocks trade, leaving management reluctant to use equity as currency. While the great majority of the producers consider drilling economics more favorable than those for acquisitions, 67% of the respondents indicate they are actively seeking to acquire reserves. Kieburtz and Urness don't necessarily consider this a contradiction, since they believe a clear inverse relationship exists between the perceived economics of drilling and the number of companies seeking to buy reserves. "While the percentage of respondents with a favorable view of drilling economics increased to 89%, from 79% a year ago, the percentage of companies pursuing acquisitions fell to 67%, from 76%," they note. Respondents rated U.S. and Canadian exploration economics for both oil and gas at their highest levels in more than a decade. Two-thirds of the producers in the survey indicated good or excellent economics for U.S. oil exploration, while 84% expressed a similar view for natural gas. For Canadian oil exploration, 67% indicated good or excellent economics, while 91% said the same of gas exploration economics. For overseas oil exploration, 92% rated the economics good or excellent, while 62% said the same of gas exploration economics.