The upstream industry reported a 7% increase in combined oil and gas production in 2009, but revenues fell 36%—and after-tax profit slipped 97%, according to Ernst & Young’s latest benchmark study of the top 50 E&P’s U.S. operations.

During the same period, drilling and development costs, which had climbed to new heights during the previous five years, finally fell back.

“From this study, we see many companies working very hard through difficult economic circumstances and making necessary spending cuts to return value for shareholders,” says Marcela Donadio, Ernst & Young LLP’s Americas oil and gas leader, based in Houston.

“Aside from major changes in energy regulations, we see the realignment of costs as a very positive indication of opportunity for increased E&P activity in the coming years.”

According to the study, E&P revenues decreased from $190.2 billion in 2008 to $122.3 billion in 2009, driven by lower commodity prices. However, oil and gas production increased 7% in 2009. Meanwhile, production costs, which hit all-time highs by mid-2008, fell 22% in 2009 to $36 billion.

“The industry is now facing the challenge of lower commodity prices and the substantial reinvestment that is still necessary,” Donadio says. “That there is some relief with respect to costs is very important.”

After-tax profits dropped to $1.3 billion in 2009, a 97% decrease from 2008. Integrated companies posted after-tax profits of $11.5 billion, while the large independents and independents had losses of $4.2 billion and $6 billion, respectively.

The 50 companies in the study reported a 5% increase in U.S. oil reserves, from 15.5 billion barrels in 2008 to 16.2 billion in 2009. The increase is mainly due to field extensions and discoveries, which increased 18% from 2008 to 924.3 million barrels of reserves, and positive revisions of 923.3 million in 2009. During the same period, oil production climbed 10% to 1.3 billion barrels.

In spite of lower commodity prices last year, the quest to develop unconventional gas continued, and ultimately contributed significantly to gas-reserve growth. The companies in the study had year-end gas reserves of 156.6 trillion cubic feet in 2009, representing 4% growth from 2008 and 40% growth over 2005. Gas production rose 6% in 2009 to 11.9 trillion cubic feet and has posted 38% growth since 2005, Donadio says.

While production grew, most spending dropped, as belt tightening became the watchword when the financial and commodities markets crashed.
“Looking at upstream spending, it was cut nearly in half in 2009,” says Donadio. “Total expenditures, including proved and unproved property acquisitions, fell 47% to $73.4 billion in 2009 from $139.8 billion in 2008, as companies sought to rein in spending and weather the economic storm…it’s a very significant downward trend.”

A few companies actually increased their combined exploration and development spending in 2009, notes Donadio, including Comstock Resources Inc., Concho Resources Inc., EQT Corp., ExxonMobil Corp., Petrohawk Energy Corp., Plains Exploration & Production Co. and Royal Dutch Shell.

The 50 companies’ plowback percentage, or total capital expenditures as a percentage of netback or revenues less production costs, decreased in 2009 to 85%. Plowback percentages peaked at 122% in 2006 because of increased upstream investment and higher commodity prices. The lowest plowback average of the five-year-span was 68%, in 2005.

“Eight-five percent is still remarkably strong when you look at the revenue lost,” says Donadio. “Yes, adjustments were made to preserve liquidity. And this overall decrease in reinvestment will likely impact supply over time, but it is fair to say that the industry worked hard through recent economic struggles to maintain people and production.”

As the industry and the U.S. government work to recover from the Deepwater Horizon blowout incident in the Gulf of Mexico, Donadio says it’s important to recognize the importance of E&P activity in the Gulf to oil supply and the labor workforce in the U.S. The Gulf of Mexico has accounted for 47% of U.S. oil reserves, extensions and discoveries during the past 10 years.

John Russell, Ernst & Young assurance partner, adds, “If you have a long-term moratorium in place, the deepwater-focused companies are going to take their cash and go to other parts of the world. And the jobs they provide will go with them. These are five- to 10-year projects, so once they make the decision to spend capital elsewhere, those jobs and investments could be gone for up to a decade. Another result of this scenario is that our oil imports would increase.”

Collectively, the 50 companies included in the study account for about 85% of total U.S. oil reserves and 64% of gas reserves.