Cutting CapEx Still Popular (VQ, XOM, CVX)

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It’s no longer news when an oil E&P company cuts its capex budget. As oil prices fall, profits are squeezed and companies rein in discretionary spending, of which capex is a principle component. So, it’s no surprise that a small-cap E&P outfit like Venoco (NYSE:VQ) announces a 25% cut in capital spending for the coming fiscal year.

This has been standard operating procedure in the oil business sincethe early days: when profits are rolling in, spend; when profits aredeclining, save. For the little guys, like Venoco, this approach makessense, especially when credit is as tight as it is now.

But what about the big guys? They’re sitting on piles of cash. How arethey planning to use it? Exxon Mobil (NYSE:XOM) expects to spend about$25 billion on capex in 2008. No word so far on plans for 2009. Capitalspending at Chevron (NYSE:CVX) is on track to be about $20 billion for2008. Both are increases over 2007.

But the increases were budgeted when the price of oil was climbingtoward $150/b, not falling in the direction of $30/b. If history is anyguide, Big Oil will restrict its capital spending on exploration for2009, and then when demand starts to pick back up as the economy comesout of its doldrums, there will be a shortage of supply that will takeseveral years to correct.

When China and India put a strain on oil supply in 2004, there was noway to keep up with demand. Prices soared as companies scrambled toinvest in new exploration. They found more oil, but it’s still in theground because it takes so long to develop a new discovery. And the oilmay stay there until crude prices head north again. Then, of course,the companies will start to re-invest in exploration, but it willdevelop too slowly to stop another spike in prices.

Big Oil might try to mollify investors with share buybacks, but that’sjust a continuation of business as usual. It’s time for these guys tothink about what’s next. How about some serious investment inalternative energy? The big oil companies have the money to do it, butthey lack the will. They think like the railroad companies (rememberthem?). Railroads forgot they were in the transportation business, notthe railroad business. Oil companies are in the energy business, notthe oil business. Think any of them will notice?

Paul Ausick
December 5, 2008