Sunday, November 9, 2008

Natural Gas 2009 - Drill What You've Got

Fort Worth Star Telegram

Less can be more, at least in the view of independent petroleum producers grappling with how to adjust their operations to plunging natural gas and crude-oil prices.

In the past two weeks, energy producers have issued a near-uninterrupted string of improved third-quarter earnings announcements. But often as not, Wall Street was more interested in what the companies had planned for 2009 and how it would square with an environment of lower prices.

The answer was commonly along the lines of "drill what you’ve got," which likely comes as no surprise to Tarrant-area residents who witnessed the recent collapse in new leasing activity in the Barnett Shale.

For example, XTO Energy Chairman Bob Simpson said that 2009 will be "the year of the drill bit" for the Fort Worth-based producer.

The company closed $4.8 billion in acquisitions during the quarter, bringing its total for the year to $7.5 billion.

"We’re going to turn to drill that area, having wrapped up a very successful acquisition effort that gave the company, in my opinion, the best set of assets it’s ever had," Simpson said during a conference call with financial analysts.

Simpson also voiced a common theme when he said that "cash flow, at the moment, is king."

Just about every independent producer swore in the coming year to live within available cash from operations, rather than drawing down lines of credit or issuing debt.

"We will not outspend our cash resources in 2009 and 2010," Aubrey McClendon, Chesapeake Energy chairman, said during his third-quarter conference call with analysts.

That’s a sharp contrast to the previous three years, when the 80 largest exploration-and-production companies spent 147 percent of their cash flow, said Michael Bodino, director of research for SMH Capital.

He said the industry was generally operating at a consensus price level of $80 a barrel for oil and $8 for gas, but that’s come down to $70 and $7.

"We’ve seen such a big change in spending habits" in response to the plunge in natural gas and crude oil prices, Bodino said.

Or, as financial analyst David Tameron of Wachovia Capital put it: "The chorus of 'We got Shale’ during the summer has quickly turned to 'We will live within cash flow.’ "

But Tameron, in a research note to clients, said he believes that there is more political correctness than change of heart in those pledges.

"If prices turn around, we think the same management teams, facing a declining production profile, will quickly ramp back up," he said.

The issue of declining production represents another trend of the third-quarter reports. Most producers, while cutting their capital spending budgets, also forecast higher production in 2009.

It sounds counterintuitive, but it’s probably right, Bodino and others said.

"When you retrench, the first thing that gets cut is money for new acreage or exploration," he said. "What does get spent is money for production projects," which offer the fastest return of capital and best chance to pad cash flow.

XTO President Keith Hutton said the company might not run as many drilling rigs as it might have next year, but it also likely will remain at its current level of 93 active rigs and perhaps slightly more.

"We’ve got a couple more [rigs] coming, so we maybe go to 95, but that’s really it," Hutton said during last week’s conference call.

Previously, the company had estimated that it might go as high as 100 rigs, he said.

"What we did was basically say, look, there’s some rigs that are drilling in areas where we can’t bring the wells on for three or four or five months. So we just dropped out there."

Range Resources Chairman John Pinkerton has been making a similar case.

After spending about $200 million in 2008 on acquiring new acreage, he said, the company will redirect that money to drilling, which will produce cash flow faster.

Quicksilver Resources President Glenn Darden joined the chorus of getting more from less.

The company was running 14 rigs in the Barnett Shale as of Sept. 30 but has already dropped that to 10 and expects to reduce it to nine by year’s end. And it will run nine rigs in 2009.

The result?

"We will grow production, at a minimum, to 25 percent" companywide, Darden said during the company’s earnings call last week.

And Quicksilver closed its $1.3 billion purchase of properties in the Alliance Airport area during the quarter and is quickly bringing production online from the 13,000 acres that came with that purchase.

The company has 300 sites it expects to drill on that property, Darden said.

There is also widespread sentiment that the cost of drilling each of those wells is coming down and could come down further. For example, Darden said he expects service costs to decline at least 10 percent and as much as 20 percent next year.

"All of this pullback in activity leads inevitably to a better price environment for us," he said. "We are aggressively pursuing better prices on all of our services."

XTO’s Hutton said that, given the softening market, "we might as well wait" on drilling.

"You should hold off on picking up any rigs for three months and pick them up later, because you’re going to catch them at 15 percent less," Hutton said.

Chesapeake’s McClendon agreed, speculating that costs could decline "as much as 15 to 20 percent, and we think it’s already happening today."

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