How the Oil Industry Is Surviving $40 Oil

Cost cutting in the oil industry has companies revising contracts, trying new technology, and stepping up energy efficiency

The energy industry's response to the swift decline in commodities prices looks as subtle as a dull drill bit hitting hard rock. Across the oil patch, budgets are being slashed, wells closed, and long-term contracts torn up. The number of rigs drilling for oil and natural gas in the U.S. has fallen 40% in the past four months, a steeper decline than in any recent oil bust.

Hard times are forcing the industry to improve efficiency, but there is no way to soften the short-term blow. At Devon Energy, a large oil and gas producer headquartered in Oklahoma City, the overall capital budget could be cut by almost 60% this year, to $3.5 billion, from $8.5 billion in 2008. "We have no choice. We don't have the money to spend," says J. Larry Nichols, Devon's chairman and chief executive. "Everyone's revenue is a whole lot less than a year ago."

The cutbacks in drilling will crimp oil production severely. The brokerage firm Sanford C. Bernstein estimates U.S. onshore production could fall by 700,000 barrels per day—nearly 1% of worldwide supply—as a result of the cuts already in place. All this sets the stage for a probable spike in energy costs when the economy recovers at some point down the road. "The cost of the current low commodity prices won't be paid in 2009 and 2010," says Raoul LeBlanc, a consultant with PFC Energy. "It'll be 2011 and beyond."

If there's a silver lining here, it's that the oil industry also seems to be focusing much more aggressively in this downturn on such things as energy efficiency, new technology, and even wind and solar power. "Typically, cost cutting has been laying off people," says Candida Scott, a consultant with Cambridge Energy Research Associates. "Now people are taking a much harder look at everything they do."

Royal Dutch Shell, for example, is deploying small, unmanned production platforms in the North Sea that cost as little as one-third as much as larger ones. Pressure-regulating valves and monitoring devices are powered by solar panels and wind turbines mounted on the platforms, and data are transmitted via satellite. That spares the cost and risk of sending workers in helicopters to take readings. "You need to do something different," says John Barry, a Shell vice-president.

Timothy Nelson, Chevron's "energy czar," has been coordinating blitzes of company facilities looking for ways to cut energy costs, which topped $7.5 billion last year. These steps include plugging leaks in steam pipes at refineries and tuning up furnaces that heat crude oil for processing. In some cases, the company is taking engineers who could be working on new projects and using them to extract more savings from old ones. "It's the cheapest way to get new barrels," Nelson says.

Years of acquisitions and booming commodity prices have left inefficiencies. At ConocoPhillips, the product of a half-dozen mergers since 2000, manager Stein Wolden is designing new work areas with input from psychologists to get disparate teams to work together. He said travel budgets have been cut, but videoconferencing is up 30% since the economic crisis began last year.

The coming months could get even tougher for companies that own rigs or manufacture gear used in oil drilling. Some oil producers don't want their services at any price. "We'll say, 'If you keep the rig working, we'll give you a break on price,'" says Mark S. Siegel, chairman of Patterson-UTI Energy, a major operator of land-based rigs. "They'll say, 'We're not interested.'"

    Before it's here, it's on the Bloomberg Terminal.