North American exploration and production (E&P) "capital intensity," otherwise defined as finding and development (F&D) costs, appears likely to be 20% higher than average this year, twice the long-term 10% historical trend but less than a year ago. Higher oilfield service costs are pushing up F&D costs, said energy analyst John Gerdes, but the rise also follows the continued growth in domestic resource plays, most notably, shale gas.
Gerdes, an energy analyst with SunTrust Robinson Humphrey/The Gerdes Group, said last year's F&D costs were up 60%, or about 50% above average, as domestic E&P accelerated and the use of oilfield services and their related costs jumped. But those higher costs haven't necessarily been absorbed in higher earnings for producers.
"Unfortunately, in an increasing F&D cost environment, E&P stocks require a steadily higher commodity price to support a given stock price," Gerdes wrote. "Currently, E&P share valuations imply approximately $7.50/MMBtu [New York Mercantile Exchange] Nymex natural gas and $60/bbl Nymex oil prices. While these imputed commodity prices may seem high, they're necessary to achieve a reasonable per annum return on equity (12.5%-15%) given the ongoing deterioration in E&P capital productivity."
Gerdes' F&D cost estimate equates capital spending and reserves converted to producing status, regardless of how they are classified by the required Securities and Exchange Commission (SEC) filings. No presumption was made for the addition of proven nonproducing/undeveloped reserves. Because of this, the F&D costs calculated by Gerdes are generally higher than SEC-reported F&D costs.
Of the 17 domestic E&Ps covered by Gerdes, XTO Energy, Range Resources and EOG Resources ranked "as standouts in terms of low North American F&D costs; not surprisingly, these companies have generally outperformed the sector the past few years." All three of the producers concentrate their talents in domestic onshore plays -- including the still-growing Barnett Shale.
According to Gerdes, XTO's 2006 North American F&D costs will be about $2.30/Mcf, while Range's will be $2.50 and EOG's $2.60. At the high end, Newfield Exploration, Brigham Exploration and Goodrich Petroleum will have F&D costs this year of about $3.50/Mcf, Whiting Petroleum's will be $3.45 and Cimarex Energy's will be $3.35.
Operating/overhead expense per unit of production increased about 20% in 2005, or four-times the long-term trend. Gerdes expects the increase in per-unit cash expenses to approximate the long-term average of about 5% through 2010, with companies exhibiting the strongest growth profiles experiencing lower year-over-year per-unit cash expenses. Combined, he wrote, "[depreciation, depletion and amortization] D,D&A, operating and overhead expenses per unit of production of our coverage portfolio now exceeds $4/Mcfe on average."
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