Producers Advised to Reinvent the Business
The only thing John Olson, senior energy analyst for Sanders
Morris and Mundy, needed last week following his speech at a
producers' conference on gas supply and demand at the Canadian
embassy in Washington, D.C., was a producer to volunteer to step up
on stage and be slapped around.
If there was even a smidgen of doubt that producers are headed
in the wrong direction following a quarter with huge financial
losses, Olson clearly erased it. His speech, titled "Gas Supply?
What Gas Supply?" sounded like a half-hour tirade by a teacher
handing out Fs to the entire class.
"I am like the fox in the hen house," he said. "I want to show
you what Wall Street is really looking for out there," and it's
clearly the opposite of what you're doing.
Olson noted the industry is in "crisis mode," has been since
last November, and probably will stay "in the ditch" for some time.
It's time for some significant changes to take place.
The average E&P stock price was down 41% in 1998. The average
producer earned nothing and may do the same in 1999. There were
billions of dollars in year-end ceiling test write-downs on
producing assets. In fact, many producers now are working for the
banks, selling off assets to pay down notes. Most production is
unhedged and not flowing under long-term contracts. U.S. producers
have lost 14% of the domestic gas market to Canadian producers.
Drilling budgets for 1999 are down 25-30% at a time when well
decline rates are 5-20%/year. To top it all off, 50,000-75,000 out
of a total of 477,000 stripper wells are being shut in, possibly
"I don't mean to be overly negative," he said, insisting he's
"bullish on this business. But it depends on how you reinvent the
system over time." The industry cannot stay on the path that it
currently is on because it diverges so completely from the
direction everyone-including Wall Street, the government and
consumers- - expects it to follow.
The government is expecting 3% annual growth in production and
27 Tcf/year in gas production by 2020 from only 19 Tcf last year.
"I don't have a clue where you are going to get [another] 8
Tcf/year," said Olson.
Anadarko Vice President Richard J. Sharples spent half his
speech detailing the sharp production declines in nearly every
major Mid-Continent and Gulf Coast producing area and he held out
little hope that the deep-water area of the Gulf of Mexico would be
the savior of lower-48 production. He agreed this is a time of
crisis, but Sharples was somewhat more confident than Olson that
the industry could overcome its problems without fundamental
"This is a call to arms to producers, although they probably
don't need another call to arms after cost management actions
they've already undertaken to get through this period," said
Sharples, noting the thousands in staff reductions and $160 billion
in mergers that took place in 1998. "But there are significant
regulatory and legislative actions that can impact our ability to
come out of this period and add to a strong healthy industry and
fuel the gas demand growth that we'd all like to fuel.
"[This] is a request that energy policy makers carefully weigh
the potential impacts of their actions on the viability of the U.S.
energy industry." He mentioned the need for federal action allowing
producers to pay the government royalties in-kind (in production),
moving electric restructuring legislation, lifting the offshore
moratorium and easing the tax burden. He also mentioned the Federal
Energy Regulatory Commission's various notices of proposed
rulemaking and inquiry as potentially helpful to producers.
Producers can't expect the government to do the job, according
to Olson. They have to reinvent the business themselves, including
doing away with the traditional "netback model," where producers
live "hand-to-mouth in the spot markets, taking whatever prices are
left over in the value chain." Part of the reason the Canadian
producers have been able to capture 14% of the U.S. market from
only 6% in 1986 was their willingness to sign long-term agreements
with Northeast cogenerators. U.S. producers have something to learn
from that. And more buyers seem eager to help them by offering to
prepay long-term agreements.
"You have to protect yourselves in situations like this," he
said. "That's what Wall Street is really looking for:" companies
with locked in long-term contracts and hedged production. He called
on producers to "maximize contract bullet proofing [with more]
indexing, swaps and rolling hedges."
Another key strategy for the future for producers will be to
capture more of the value chain, said Olson. Move mid- and
downstream. Invest in cogens. "You may be in the wrong business or
you may not be in all of the businesses you should be in." There
couldn't be a better time for a producers to invest in the
gas-fired power business and sign-more long-term agreements with
end-use markets, particularly power generation, he said. "That's
where the money is, ladies and gentlemen."
The Department of Energy is forecasting the need for 383
gigawatts of total new power generating capacity by 2020 and 90% of
that will be gas-fired. Even being very conservative, that
translates into 16 Bcf/d of incremental gas demand. "This is where
the E&P industry is likely to have its best and brightest hope
to make a massive comeback over the next 10-12 years," said Olson.
Power plant developers "need you more than you need them. You may
be down at rock bottom with a smile on your face and a shine on
your shoe, but they need you.
"I think this is going to be the engine that drives the whole
train of the North American exploration and production industry.
There's nothing else out there that can do it."
Olson's "1999 Unofficial Game Plan" for independent producers,
many of whom he says probably won't be around much longer, includes