North American exploration and production (E&P) companies’ cost structures and current share prices suggest that natural gas prices need to be more than $8/Mcf and oil has to be more than $70/bbl to deliver a market return on equity capital, according to an analysis by SunTrust Robinson Humphrey/the Gerdes Group (STRH).

Moreover, as E&P company gas price realizations generally reflect a 75-cent/Mcfe discount to the New York Mercantile Exchange’s (Nymex) Henry Hub futures contract, the Nymex-normalized all-in E&P cost structure is about $8.25/Mcfe, wrote STRH’s John Gerdes and Ryan Oatman.

Natural gas futures were trading below $8/Mcf at the start of trading Monday (see related story).

In a note to clients Monday, Gerdes and Oatman reported that projected unleveraged cash expenses, which include overhead/operating costs, should rise around 15% this year. E&P development cost pressures also continue to rise and should be up around 10% this year, which is down from the 25% rise in 2007, the analysts said.

“Notably, the E&P sector remains +10% free cash flow negative in ’08/’09 even in a upper $9 gas and +$100 oil price environment, given management’s desire to spend sufficient capital to generate competitive per annum growth (+15%),” wrote the duo.

However, the depletion, depreciation and amortization rate for E&Ps “is about $1.50/Mcfe lower than the actual development capital intensity,” because of lower historic costs, more allocation of capital costs to unevaluated (i.e., nonproven, nondepleting) property, plant and equipment, “and likely indicates somewhat aggressive proven reserve booking in the depletion cost pool,” said Gerdes and Oatman.

They estimated median costs for North American E&P development is around $4.50/Mcfe, which is slightly more than in 2007, according to STRH. “Grossing up development capital intensity to account for exploration spending, which generally comprises about 10% of total E&P capital outlays, equates to an all-in E&P capital intensity of about $5.00/Mcfe.”

Assuming $9.99 gas/$113 oil prices, E&P cash margins “should increase 30%+, while gross profit margins should expand by 70%+,” said the analysts.

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