Petroleum Accounting(Chapter One part (2))

THE 1920s: THE AUTOMOBILE COMES OF AGE

With increased competition in the oil industry and an increased demand
for petroleum products (created by the growing number of automobiles),
many small companies were formed and soon joined the few large
companies in the search for and production of petroleum. New demands
for petroleum were created in the 1920s; petroleum products were used to
generate electricity, operate tractors, and power automobiles. The oil
industry was able to increase production to meet the greater demand
without a sharp rise in price.
The search by American companies for foreign oil began around 1920
and was encouraged by the United States government, which feared that a
shortage of oil was developing domestically. By the middle of the 1920’s
approximately 35 companies had invested upwards of $1 billion exploring
for and developing reserves in the Middle East, South America, Africa,
and the Far East. However, the discovery of the giant East Texas oil field
in 1930 created a world surplus of oil, and companies slowed their
operations in foreign countries. Some companies did continue to search
for oil in the Middle East during the 1930s, and significant discoveries
were made, especially in Saudi Arabia and Kuwait.

THE DEPRESSION: STATE CONTROL OVER PRODUCTION




When the depression began in the 1930s, the oil industry entered a
period of increased production with the discovery of the East Texas oil
field by an independent wildcatter. This field is the third largest in North
America; only the Prudhoe Bay field on the North Slope of Alaska and a
Mexican field are larger. The abundance of oil from the East Texas field
and the economic depression coupled to temporarily reduce oil prices by
90 percent to just ten cents a barrel.
In 1933 the Texas legislature recognized the need for conservation
measures to avoid wasting oil and, thus, gave the job of industry
regulation to the existing Texas Railroad Commission. Since that time
other oil-producing states have created agencies or commissions to
regulate the development and production of oil and gas reserves.
The 1930s also saw an increase use of gasoline, natural gas, and natural
gas liquids. While some shallow "offshore" drilling occurred as early as
the late 1800s, it was not until the late 1930s that wells were drilled from
structures resembling the offshore drilling platforms of today.

WORLD WAR II: PETROLEUM FOR DEFENSE

The United States started to recover from the economic depression by
the mid-1930s. The onset of World War II in 1939 accelerated the pace of
economic recovery. Compared with World War I, World War II used
more mechanized equipment, airplanes, automotive equipment, and ships,
all of which required huge amounts of petroleum. The industry easily met
the United States' and allies' demands for petroleum. However, as World
War II progressed, the U.S. and British governments feared an eventual
shortage of crude oil. In 1943 the U.S. government even proposed buying
from Chevron and Texaco the petroleum company that became Saudi
Aramco, now the world's largest oil producing company.
During and after World War II, huge capital investments were made to
further develop the enormous reserves found in the Persian Gulf area.
Chevron, joined later by Texaco, and still later by Exxon and Mobil,
owned the Arabian-American Oil Company or Aramco, which developed
the giant Saudi Arabian oil fields and downstream infrastructure. Today
the company is owned by Saudi Arabia and has been renamed Saudi
Aramco. Other companies explored, developed, and produced oil in other
countries, but in the first half of the twentieth century, the United States
typically produced and consumed from 50 percent to 75 percent of the
world's annual oil production.
AFTER WORLD WAR II: GROWTH OF THE NATURAL GAS AND
PETROCHEMICAL INDUSTRIES
At the end of World War II, two events contributed to the tremendous
growth in the natural gas industry. Natural gas had previously been
discovered in large quantities in Texas, Louisiana, and other southwestern
states; however, it was difficult to transport the gas long distances. This
problem was alleviated by the development of a new technique for
welding large pipe joints; gas under high pressure thus became
transportable to the heavily populated midwestern and eastern regions of
the country. Also, after World War II, the country witnessed the birth of
the petrochemical industry, which used natural gas liquids for some of its
basic raw materials.
THE 1950s AND 1960s: IMPORTED OIL AND THE FORMING OF OPEC
During the 1950s and the 1960s, there was ample world oil production,
with prices remaining stable and averaging approximately $3.00 per
barrel. However, these two decades also saw an increased U.S. reliance on
imported crude oil and refined products. In 1950 ten percent of oil used in
the United States was supplied by imported oil and refined products; by
1970 that percentage had increased to 23 percent.
In 1960 the Organization of Petroleum Exporting Countries (OPEC)
was formed by Saudi Arabia, Kuwait, Iran, Iraq, and Venezuela. Later,
eight other countries joined OPEC—the United Arab Emirates and Qatar
in the Middle East; the African countries of Algeria, Gabon, Libya and
Nigeria; and the countries of Indonesia and Ecuador. Ecuador withdrew in
late 1992. By 1973 OPEC members produced 80 percent of world oil
exports, and OPEC had become a world oil cartel. Member countries
began to nationalize oil production within their borders.
THE 1970s: OIL AND GAS PRICES SKYROCKET. U.S. IMPOSES PRICE
CONTROLS
Beginning in October 1973, Arab OPEC members cut off all oil exports
to the U.S. in response to the U.S.'s proposed $2.2 billion military aid
package to Israel, which was reeling from surprise attacks by Egypt and
Syria that month. The price for Saudi Arabian oil rose dramatically—
$1.80 per barrel in 1971, $2.18 in 1972, $2.90 by mid-1973, $5.12 in

October 1973, and $11.65 in December 1973. Thereafter, world crude oil
prices increased slowly through 1978 when Saudi oil sold for $12.70 per
barrel. The 1979 Iranian Revolution caused prices to again escalate
rapidly, peaking at $42 per barrel for some U.S. crude oil in December
1979.
During the 1960s and early 1970s, some people warned of petroleum
shortages, but their warnings went unheeded until the 1973 Arab oil
embargo. Because of the embargo, a large portion of the oil normally
imported by the United States was cut off for several months, and citizens
were faced with a shortage of gasoline and other petroleum products and
with increasing prices. The federal government created the Federal Energy
Administration in 1973 and gave it the power to control prices of crude
oil. The price regulations were complex, and compliance procedures were
not always clearly determinable, even after petroleum company personnel
consulted with officials of the Federal Energy Administration, predecessor
to the U.S. Department of Energy (DOE).
A two-tier oil pricing structure was established with a low price for
"old" or "lower-tier oil" and a higher price for "new" or "upper-tier oil."
Lower-tier oil generally came from properties that were producing prior to
1973, while upper-tier oil came from properties that began producing after
1972. Producers often had both kinds of properties and therefore sold
some oil at less than half the price of other oil of the same quality. By
1979 the U.S. allowed free market prices for U.S. oil from newly drilled
properties or properties producing less than 10 barrels per day per well.
However, on average, domestic oil was selling at only a fraction of the
price paid in this country for imported oil.
Foreign oil continued to be imported (at prices exceeding domestic oil
prices) to meet the continued growth in domestic demand. In 1977,
approximately 47 percent of the United States' needs were met by
imported oil.
THE WINDFALL PROFIT TAX (1980 TO 1988)
President Carter's call for phased decontrol of oil prices by late 1981
was coupled with enactment of the Windfall Profit Tax Act in March
1980. The Act levied a tax from 30 percent to 70 percent on windfall
profit, i.e., the excess of the selling price of a barrel of oil over the
adjusted base price for that barrel. The adjusted base price was an
inflation-adjusted average price of similar oil sold in late 1979. Congress
repealed the windfall profit tax in 1988 after oil prices had fallen so low
that no windfall profit was left to tax.
ALASKA NORTH SLOPE OIL
In 1968 Prudhoe Bay, the United States' largest oil field, was
discovered on the North Slope of Alaska bordering the Arctic Ocean. In
1969, the giant Kuparuk field adjacent to Prudhoe Bay was discovered.
Prior to the Prudhoe Bay discovery by Atlantic Richfield Company
(ARCO), seven very expensive, but unsuccessful, exploratory wells had
been drilled in the area, and ARCO almost canceled drilling the discovery
well. Even after discovery, Prudhoe Bay development was stalled until
the 1973 Arab oil embargo prompted Congress to allow the Trans Alaska
Pipeline System (or TAPS) to be built. Finally, in 1977 Prudhoe Bay and
Kuparuk crude oils were produced and marketed.
For Prudhoe Bay and Kuparuk, estimated ultimate oil production, i.e.,
all prior production plus estimated future production, is 13.2 billion and
2.6 billion barrels, respectively. Gas reserves approximate 4 billion
additional equivalent barrels. These North Slope fields are immense. In
the entire lower 48 states where over one million wells have been drilled,
only three discovered oil fields have ultimate oil production exceeding 2
billion barrels, and their combined ultimate production is only 10.9 billion
barrels. Alaska North Slope oil (ANS crude) made up approximately 18
percent of all 1998 U.S. oil production.
The North Slope infrastructure for production of Prudhoe Bay and
Kuparuk is used to economically produce some 20 smaller North Slope
reservoirs. However, the huge 32 trillion cubic feet (tcf) of recoverable
natural gas reserves from North Slope fields cannot now be economically
transported to the Lower 48 states. Advances in converting gas to liquids
(GTL, described on page 5) offer hope. Alternatively, the gas may
eventually be chilled as LNG and shipped to Asia’s Pacific Rim.
North Slope operations are an industry model for environmental
protection, far different from the typical Russian operation. A Russian
environmental scientist touring the Prudhoe Bay production facilities
declared that north slope production must be a government hoax because
he found no oil leaks or spills. Gas produced at Prudhoe Bay is not vented
into the atmosphere or burned as waste, but reinjected back into the
reservoir. Gas reinjection improves oil recovery and saves the gas for
potential future use. The North Slope’s Alpine field, the largest U.S.
onshore oil discovery in fifteen years, spans 40,000 acres; yet its oil
(70,000 barrels per day) will be produced from two 50-well gravel pads on
less than 120 acres. The Alpine field has no permanent roads or bridges.
In 1998 Alaskan oil production (nearly all from the North Slope)
provided 73 percent of the state government’s unrestricted general fund.
The oil royalty has provided a permanent and growing $25 billion trust
fund for the half million residents of Alaska.
Despite the industry’s success in safeguarding the North Slope
environment and adding to the nation’s wealth, and contrary to the wishes
of most Alaskans and local Inuits, the North Slope’s 19 million acre Arctic
National Wildlife Refuge (ANWR) remains closed by the federal
government to drilling and production. The federal government estimates
that the western half of ANWR’s 1.7 million acre coastal plain has
recoverable oil reserves of several billion barrels.
THE 1980s: BOOM AND BUST. MARKET FORCES PREVAIL
Several factors set the stage for a U.S. petroleum industry boom in
1981 and 1982:
♦ World oil prices had increased astronomically in 1973 and 1979.
These price increases improved exploration economics and created
an expectation of substantial price increases in the future.
♦ In January 1981, President Reagan removed U.S. price controls on
crude oil, which gave producers additional cash to reinvest. In the
1970s, Libya and several other countries seized U.S. companies'
interests in petroleum fields. These nationalizations encouraged a
preference for U.S. companies to explore within the United States.
♦ The Natural Gas Policy Act of 1978 created incentive pricing
schemes to stimulate the exploration and development of natural
gas reserves.
In 1981 U.S. tax laws were changed to reduce the highest individual
income tax rates from 70 percent to 50 percent and reduce windfall profit
taxes on new oil fields. Individuals investing in wells drilled in 1981
could earn a 40 percent profit, after income tax effects, on wells that had
no profit before income tax effects. Consequently, in 1981 and 1982, U.S.
individuals invested billions of dollars in limited partnerships for
petroleum exploration and production.
Figures 1-2, 1-3, and 1-4 present a history of annual production, prices,
and E&P expenditures from 1979 through 1999 that portray the boom and
bust of the 1980s.