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Raymond James: E&P Showing Readiness for Gas Price Volatility

Many exploration and production (E&P) companies appear ready to face natural gas price volatility this year, with average producers hedging about one-third of their gas at $7-8/Mcf, with "room for upside" should the energy markets improve, a trio of Raymond James & Associates Inc. energy analysts said in a new "Stat of the Week."

Last week, Raymond James sharply reduced its 2007 U.S. gas price forecast to $7.50/Mcf from $10 because of the so-far disappointing warm winter and high gas storage (see Daily GPI, Jan. 4). However, analysts J. Marshall Adkins, Wayne Andrews and Kristol Choy said the hedging positions of producers "will help generate ample cash flow to fund bullish capital spending programs and even free cash flow (which could be used for share repurchases or dividends, for instance)."

The analysts acknowledge that there could be further price fluctuations and milder weather throughout the rest of the winter season; however, "we feel that E&P stocks should still fare well in 2007."

Within Raymond James' coverage group, the top five large-cap gas-hedged producers are El Paso Corp., Questar Corp., Newfield Exploration, XTO Energy and The Williams Cos. In the mid/small-cap group, the top gas-hedged producers in 2007 are Linn Energy, Range Resources, Denbury Resources, Encore Acquisition, Southwestern Energy and Goodrich Petroleum.

"What prices are companies looking to lock in?," asked the analysts. "In general, the large-cap group includes hedges that cover 25% of 2007 gas production in swaps at approximately $8/Mcf. To compare, this price is more than 6% higher than our full-year gas forecast of $7.50/Mcf. The smaller cap names have entered swaps that cover about 11% of production at about $8/Mcf as well.

"The large caps with collars have about 15% of gas hedged with floor/ceiling prices of $7/$11. Small/mid caps with collars have nearly 30% hedged with similar floor/ceiling prices. We believe that these collar prices provide an attractive floor and offer room for upside should actual gas prices end up higher than expected."

The hedging "patterns," they noted, support E&P's bullish long-term outlook on the energy markets.

"We estimate that our universe will spend approximately $50 billion in 2007, which is roughly a 7% increase over that of 2006. We believe that this increase can be fully funded from internal cash flow, and in fact the generation of free cash flow...should be an entirely realistic prospect." Raymond James' recent capital expenditure survey indicated that its covered companies would generate more than $7 billion in free cash flow in 2007, "and hedging has helped significantly in this regard."

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