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Analysts: Top Independents' 2012 Gas Output May Rise 3%

A sample of 20 of North America's top natural gas explorers indicates that 2012 output will continue to rise, despite low prices, according to Barclays Capital energy analysts.

In a note to clients last week, Barclays' Shiyang Wang and Michael Zenker said they examined historical North American gas production guidance for 20 producers and found that some expect to see gas output fall this year, but in general, many still expect to hit their original guidance targets. This is in part because they work in a "manufacturing" mode, which is difficult to slow once it's in place. Several of the liquids-focused producers also expect year/year (y/y) growth in gas production.

"Overall, the total guidance for our 20-company sample indicates that [gas] production for this year should grow by 3% y/y, in line with our outlook of moderate production growth for this year," said the analysts.

In the latest conference calls to discuss year-end 2011 and fourth quarter results, the analysts said North American exploration and production executives announced plans to cut capital spending directed at dry gas drilling because of the downturn in prices.

"Whether this reduced capital spending and smaller gas-directed rig count translates to falling production remains to be seen," said the Barclays duo. "Lower capital spending may not translate to lower production, owing to growing associated gas from liquids and oil wells. Nevertheless, producer intentions are important, as they in aggregate have signaled the growth in gas production over the past few years."

Wang and Zenker started with a list of the largest gas producers by volume, then deleted companies more focused on international assets, such as supermajors and the ones that are primarily oil producers, to reach the list of 20.

The 20 exploration and production (E&P) companies used for the Barclays review, which produced about 31% of total U.S. gas supplies in 2010, were Anadarko Petroleum Corp., Bill Barrett Corp., Chesapeake Energy Corp., Cimarex Energy Co., Devon Energy Corp., EOG Resources Inc., Encana Corp., Exco Resources Inc., Forest Oil Corp., Newfield Exploration Co., Noble Energy Inc., Pioneer Natural Resources Co., Plains Exploration & Production Co., QEP Resources Inc., Quicksilver Resources Inc., Range Resources Corp., SM Energy Co., Southwestern Energy Co., Talisman Energy Inc. and Ultra Petroleum Corp.

Wang and Zenker assumed for the review that the percentage breakdown between liquids (oil and natural gas liquids) and natural gas production was the same as the one estimated by Barclays' E&P equity analysts for each year of the analysis (2010, 2011, and 2012). They applied the percentages to the total production guidance to estimate a company's gas production outlook for the year. Producers routinely revise their guidance through the year but for their analysis, the duo used the guidance given at the beginning of each year.

What they found is that producers are likely to meet or beat their guidance targets, in part because output forecasts usually are given within a range. In addition, drillers today are able to better estimate output results from shale drilling because of drilling techniques. "With very few dry holes, a producer can now anticipate the volume resulting from a spending budget," said the analysts.

If the Barclays 20-company sample accurately represents the industry as a whole, "total natural gas production generally meets the aggregate group production guidance of natural gas. In other words, the amount of the production that beats guidance generally offsets the amount of the production that does not meet guidance when the group is examined as a whole."

The analysts said most of the producers appear able to engineer their output to "come close to their guidance given at the beginning of the year. Some beat guidance by a large margin. If one were to simply add up production guidance for years past, this would have been a good estimate for that basket of producers. This result indicates that producers' production guidance for 2012 is most likely a robust proxy for natural gas production this year."

About one-third of the producers in the sample survey expect company-level production this year to decline from 2011. Four of the companies had expected y/y gas production declines at the beginning of 2011, Barclays said.

"Clearly, our sample indicates that more producers expect the drilling pullback in their dry gas plays to lead to a y/y drop in their natural gas production," said Wang and Zenker. "On the other hand, several companies targeting liquids-rich plays (producers that have more than 40% of liquids in their production portfolio) still expect to see y/y growth for their North American natural gas production."

The sample as a whole indicates that 2012 gas production still will be higher than a year ago even with dry gas rigs dropping and declining production guidance.

"This is in line with our view that despite a more concerted effort from producers to shift from gas to liquids drilling, natural gas production this year should continue to show moderate growth, albeit at a slower rate than previously," said the analysts. "The story would not have been so convincing if producers, in general, struggle to beat production guidance. But our sample, especially in the aggregate case, shows otherwise."

Including the top U.S. gas producers, which would add ExxonMobil Corp., BP plc, ConocoPhillips, Chevron Corp., Royal Dutch Shell plc and Occidental Petroleum Corp. -- among others -- may have provided a more accurate reading, said Intelligence Press Inc. senior analyst Patrick Rau. It's also difficult to determine the extent that private company production losses may play on this year's decline in gas output. Intelligence Press publishes Natural Gas Market Data.

"Overall, I estimate that publicly traded companies account for roughly 60%, and perhaps up to two-thirds, of all marketed U.S. natural gas production," he said. "A good chunk of that total is from majors/integrateds, and they tend to grow production at a slower rate (and certainly at a different rate) than independents. So to use 30% of total production to represent up to 67% of total production is something of a stretch.

"The other one-third of production comes from privately held companies. By their very definition of being private, they don't have the same access to capital as publicly traded companies. That, along with low gas prices, will probably help keep the clamps on their production, everything else being equal."

Publicly traded companies "tend to hedge 40-50% of their annual production in aggregate, so they will produce no matter what," Rau noted. "I bet privately held companies don't have the capital to hedge to the same degree, which means they are more price-sensitive. That means they are more likely to slow their production growth this year, everything else being equal."

Based on those indicators the 3% y/y growth in gas output in 2012 "may be overstated somewhat," said Rau. "Remember, also, that 2012 production growth will be measured against a higher base. Gas production was up 7-8% y/y the last few months of 2011. That is a tough pace to keep up, especially considering how chock-full storage is. However, cycle times (the amount of time to drill and complete a well) continue to come down, and there is still some drilling to hold properties to happen in 2012, so that could keep the production spigot open for awhile longer."

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