Barring a snap back to cold weather, look for natural gas prices to remain "soft" at around $7/MMBtu and perhaps less for the remainder of the first half of this year, Standard & Poor's Ratings Service said in a 2006 oil and gas trends research note released last week.
"Strong economic growth and continued recovery of natural gas demand from the petrochemical sector should support prices at that level; a warm summer would only serve to boost prices given the lack of production growth in recent years," S&P said in its 12-page report, which focuses on reserves replacement, finding and development costs and merger and acquisition trends.
As for acquisitions, S&P said it expects growing independents, such as XTO Energy Inc. and Chesapeake Energy Corp., to continue their role as consolidators of domestic exploration and production assets. Elsewhere in its report, S&P noted that unconventional resources -- coalbed methane, tight gas, and shale -- have grown in attractiveness to domestic producers, and that trend is expected to continue. The economics of unconventional gas resources could be challenged if gas prices fall below $5/MMBtu, though.
"Standard & Poor's expects North American operators to continue to increase spending on developing unconventional plays and resources and that transaction activity in these areas will continue to remain robust."
As the industry is challenged to replace reserves and grow production through the drillbit, more M&A is expected by S&P, with large, gas-focused independents as attractive targets for major companies. "Royal Dutch Shell had $27 billion of surplus cash at year-end 2005 and stated that it could consider smaller acquisitions of less than $10 billion," S&P said. "Ample cash balances, strong balance sheets, and improved equity currency are expected to provide the financial clout to allow bigger transactions, particularly if markets continue to punish companies that are considered underperformers. Consequently, it is expected that the oil and gas M&A market will continue its buoyancy in 2006."
Given historically high commodity prices and the consequent ramping up in E&P activity, it is no surprise that finding and development costs continue to rise and pose a concern for the industry. S&P noted that rising costs could affect E&P credit quality, "particularly for marginal credits where rising costs have been previously cited as areas of concern."
While at least one producer, EnCana, has said it will scale back some activity due to rising costs, there is little else E&P companies can do to combat rising costs. S&P noted that hedging can provide protection against a downturn in commodity prices, but "hedges cannot protect a company from rising costs or 'bottom-up' margin erosion."
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