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Raymond James: Operators Testing Liquids Ideas

The upstream industry could see its drilling inventory grow if horizontal drilling opportunities being explored by several companies pan out, according to analysts at Raymond James & Associates Inc.

Companies are at work "testing new concepts and plays in order to add to liquids-rich inventory," the firm's analysts said in a note Monday. Raymond James cited the example of Goodrich Petroleum, which is joining companies such as Devon Energy and Encana Corp. in the emerging Tuscaloosa Marine Shale.

Raymond James noted that Anadarko Petroleum, Swift Energy and EOG Resources "may also have exposure" in the Louisiana play.

"We also expect data from other prospective liquids plays like the Brown Dense (Southwestern Energy, Cabot, Devon, EOG) and Utica [Shale] (Chesapeake Energy, Anadarko, EV Energy Partners, Consol-Hess joint venture) to intrigue investors over the next 12 months," the analysts wrote.

"While these areas are still in the early innings of exploration, operators are also testing new concepts to exploit the multi-stacked pay zones in more developed plays like the Permian and the Bakken," the analysts wrote, noting that Concho Resources has disclosed plans to drill its first dual-lateral well in the Delaware Basin, its first horizontal Yeso well, and to test the Cline Shale this year. The firm also said it expects Continental Resources to test deeper Three Forks branches.

While the firm's analysts detected much enthusiasm for oil and liquids-rich plays at the recent Raymond James Institutional Investors Conference, dry gas can't catch a break these days.

"...[W]e don't envision a return to $4 gas until 2014 at the earliest," the firm said in a note Monday. For one, $3 gas is sufficient to grow domestic production in the near term given liquids-directed drilling and increased efficiencies in the energy patch.

"Second, we see increased gas-to-coal fuel switching as gas prices approach $4/Mcf. Third, while industrial gas demand (chemicals, fertilizer, etc.) is growing nicely and may eventually solve the oversupply problem, the key word is 'eventually.'"

Gas industry interests and automakers have increasingly been making noise about gas-fueled vehicles, but it won't be until after 2015 that these efforts bear fruit sufficient to "move the needle" on demand, Raymond James said. Ditto for potential exports of domestic production as liquefied natural gas, the analysts said.

With dry gas distinctly out of favor, oil and liquids-rich plays took center stage at the conference. Cost-wise, things are seen to be looking up for exploration and production companies (E&P) on the services side.

"Activity in the hottest liquids plays (Permian, Eagle Ford and Bakken) is as robust as ever, but it seems the chokehold that service costs have had on E&Ps over the past year is finally loosening its grip," the analysts said. "Many operators are seeing service costs stay flat or even soften this year, particularly in these most 'overheated' plays. The reasons appear to be two-fold: 1) an increase in availability of service crews, sand proppant and equipment; and 2) realization of cost savings through increased utilization of pad drilling and zipper fracks as operators progress to development mode."

Merger and acquisition activity will continue to be robust as well, they said, because E&P companies will remain encouraged by strong oil prices and will enjoy access to capital needed to complete deals, the analysts said.

Master limited partnerships will also continue to be able to leverage their lower weighted average cost of capital to drive above-average distribution growth to unitholders with less relative risk, the analysts said. "Preliminary 2012 organic capital budgets represent substantial increases, on average, of 25-50%-plus versus year-ago levels," they said. "While ongoing commodity price fluctuations will influence producer capital allocation, the relative inelasticity of energy demand and the supply volatility will support capital being spent through the drill bit and midstream infrastructure investment."

With regard to natural gas liquids (NGL), the analysts like others see a "lumpy" supply-demand outlook but don't appear overly concerned about the threat of an ethane glut. "...[T]he favorable crude-to-gas and ethane-to-crude ratios (on a Btu-equivalent basis), coupled with a growing abundance of cost-advantaged NGLs, continue to support the petrochemical push to maximizing ethane usage," they wrote.

"As such, when considering the global cash cost curve for ethylene production, we believe North American ethane will remain in the driver's seat as the feedstock that provides ethylene producers with the highest margin per pound of ethylene produced over the long term."

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