The worldwide upstream investment of 232 oil and gas companies increased 21%, to $492 billion in 2008, according to a new report by oil and gas research firm IHS Herold Inc. and upstream corporate advisor Harrison Lovegrove & Co. Ltd., a Standard Chartered Group company.

Total U.S. upstream capital spending rose 23% to $160 billion.

Yet, despite record development spending, up 23% from 2007, finding-and-development replacement rates fell in 2008 to 88% of production, the first year since 2004 in which production was not replaced.

The “2009 Global Upstream Performance Review,” IHS Herold’s 42nd annual study, is based on publicly available data filed with the U.S. Securities and Exchange Commission and other similar agencies worldwide and measures the upstream energy industry’s performance.

Development spending accounted for 63% of total investment, similar to 2007 levels. Exploration dollars spent increased 21% and have doubled since 2005.

Reserves replacement. Global reserve-replacement and finding-and-development costs surged 70% and 66% respectively, to $23.44 and $25.50 per barrel of oil equivalent (BOE), due to a sharp drop-off in positive reserve revisions, the authors report. Reserve additions, both from all sources and via the drillbit, were down more than 20%.

Total oil and gas reserves were 0.4% lower at year-end 2008. The 3% increase in gas reserves was “more than offset” by a decline of 4.4 billion barrels in oil reserves.

The oil-reserve decline, nearly 3%, was due primarily to a 5.2-billion-barrel decline in revisions caused by the steep drop in commodity prices. Although gas reserves grew at the same rate as during the past five years, production accelerated nearly 5% to 44.2 trillion cubic feet.

“Negative revisions in the U.S. caused replacement costs to more than double and replacement rates to plunge,” according to the report. “Unit profitability declined for the third consecutive year despite robust price realizations.”

Elsewhere, capital spending in South and Central America surged 34%. There, “profits soared as the tax rate fell.” While oil reserves continued to decline, major reserve bookings from pre-salt development are “on the horizon.”

In Canada, mineable bitumen reserve additions offset conventional and in-situ oil-sands reserve declines. In contrast to the U.S. region, per-unit profits were higher as cost increases were more moderate than gains in realized prices.

Russia and Caspian capital spending—the only region with lower investment—dipped 8% percent. The region’s negative oil-reserve revisions severally impacted replacement rates and drove costs higher.

Also, oil and gas reserves throughout Europe continued to decline sharply as companies redirected cash flows to other regions. The reserve-replacement rate hit a 10-year low.

M&A. Acquisition spending declined some 30% from 2007, due to the collapse of the M&A market during the last five months of the year; however, unproved-acquisition outlays more than doubled to $62.4 billion and surpassed proved outlays. Proved-acquisition spending dropped 30%, to $44 billion, although competition for unconventional resources was up sharply, led by the U.S.

Meanwhile, 2008 worldwide oil and gas revenues increased by $293 billion, implying an average realized price of $61.91 per barrel and representing a 30% increase from 2007, according to the report. Cash flow per BOE increased 35% to $29.66 per barrel. For the second consecutive year, cash flow exceeded investment dollars.

Net income. Although higher commodity prices increased revenue bookings, global net income was moderate. “Higher prices drove revenues 31% higher, to $1.232 trillion,” says Robert Gillon, IHS Herold senior vice president and insight leader. “But net income gained by a more modest 24%, held back by rapidly rising depreciation charges. DD&A (depreciation, depletion and amortization) was driven higher by escalating finding-and-development costs.” Net income rose to $16.07 per BOE, but margins were lower for the fourth consecutive year.

The Asia-Pacific region remained the most profitable region, despite higher taxes in China. However, the authors predict that significant and recently generated excess cash flow will shrink as final investment decisions are made on several large liquefied natural gas projects.

Shareholder returns. Not surprisingly, the IHS Herold/Harrison Lovegrove study found shareholders were affected by the plunge in commodity prices in late 2008. Although dividends rose to a record level, exceeding $100 billion for the first time, common share repurchases were 23% lower, falling for the first time since 2004. As revenue fell in the second half of the year and financing options closed, many companies reduced or ended stock buyback programs to conserve increasingly scarce cash.

“With very strong commodity prices in 2008, the industry generated record cash flow of $590 billion from oil and gas operations,” says Standard Chartered managing director Rodney Schmidt. “This was up 36% from 2007 and exceeded capital spending by roughly $100 billion. However, with upstream revenue and cash flow for 2009 already well off of last year’s levels, many in the industry face some serious challenges for investments and strategies going forward.”