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Analyst: E&Ps Face Spending More, Cutting Activity

Exploration and production (E&P) companies that chased natural gas liquids (NGL) targets in the second quarter may have spent more than they had planned and could be forced to raise full-year 2012 capital expenditure (capex) guidance or cut incremental activity, which in turn would affect production growth, according to Tudor, Pickering, Holt & Co. (TPH).

Energy analysts took a look at the E&Ps within their coverage group and said the outlook doesn't look promising as producers get ready to unveil their 2Q2012 reports. Domestic E&Ps are "at risk of spending at or above the high end" of full-year 2012 capex guidance based on their 1Q2012 spending and 2Q2012 rig allocation.

"It's no secret," said the TPH analysts, that natural gas liquids (NGL) prices continued to fall through the second period, and that's impacting the sector. Baker Hughes Inc. said NGL drilling activity declined during the second quarter (see related story).

The NGL hub at Mont Belvieu, TX, pricing "averaged 50% of West Texas Intermediate (WTI) in Q12012, 44% in Q22012 and 40% in July, while Conway [KS] has fared significantly worse with Q12012, averaging 42%, Q2012 averaging 35% and July down to 30%," said the TPH analysts. "The precipitous fall in June for Conway ethane pricing is concerning with July average prices at 3.5 cents/gal as E&Ps are now earning a negative margin on ethane processing to strip the remaining barrel."

For those producers delivering into the Kansas NGL hub, "we believe there will be some ethane rejection having occurred in June. The effect is either lower NGL growth/higher gas production or much lower ethane pricing (45 cents/Mcf versus $2.75/Mcf natural gas) due to lack of rejection ability." The issue may be "more impactful" in 3Q2012 earnings with current ethane pricing at negative margins, which accounts for 40-45% of the NGL volume, said analysts.

In combination with lower crude prices and lower cash flow generation, some operators may be pressured to "revisit drilling programs." Basins that "typically" feed into Conway, said TPH, include the Granite Wash, Cleveland/Tonkawa, Anadarko, Denver-Julesburg, Rockies and some Permian plays.

Producers with NGL and/or WTI exposure are likely to post earnings below Wall Street's forecasts, said the TPH team.

For North American E&Ps, there's "not a whole lot to get excited about" in 2Q2012, said analysts. "We expect 2Q2012 results to be plagued by earnings misses" on 30% or more of their E&P coverage universe on lower NGL/crude realizations with second half 2012/2013 estimates "biased lower." This year's capex budgets appear to be "under pressure" for many onshore producers that shifted to NGL and oily targets early this year.

Because oilfield service companies are reporting they expect to see lower margins through 2012, "it's easy to make the leap that E&Ps must be realizing all of these savings," said the TPH analysts. "But this is too much of a leap as North American oil service misses have been predominantly cost driven, not revenue misses. Cost increases ate the lunch of many [hydraulic fracture] companies...Longer-term E&P costs will come down from capacity adds/lower activity, just don't expect significant relief until late 2012."

Questions may be raised about the price level needed to cut the oil rig run rate, but the TPH analysts said "most E&Ps will punt on making significant downward revisions to capital programs" for the second half of this year. Instead, many producers may increase their 2012 spending."

TPH is estimating the 3Q2012 land rig count to fall 1% from 2Q2012 and to drop another 2% in the final three months of this year, followed by a flat U.S. land rig count in 2012. Previously the analyst had expected the 2013 U.S. oil rig count to climb by 6%.

It's "far from doomsday but it represents our best guess about activity, netting out the impact of mid $80s WTI, weak NGL pricing and improving natural gas prices," said TPH analysts.

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