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North American E&P Downside Risks 'Clearly' Outweighing Gains

North America's oil and gas producers have underperformed the broader market since the beginning of October, but the disconnect now is wide enough that the downside risk to equity values "clearly" outweigh potential gains if oil prices were to recover, Barclays Capital said Wednesday.

U.S. and Canadian exploration and production (E&P) shares have underperformed the broader market since Oct. 1, down 31% versus a gain of 4% for the S&P 500, noted analyst Tom Driscoll and his team. Following OPEC's Nov. 27 meeting, in which members decided to hold oil production targets unchanged, the North American sector has fallen by close to 25%, versus a 2% decline for the S&P 500.

The latest Barclays report is a companion to one issued last week, the firm's 30th annual global E&P survey (see Shale DailyJan. 12). Driscoll's 72-page report details specific company performance.

With the continuing decline in oil prices, "the disconnect between the oil futures curve and commodity price assumptions the market is reflecting in E&P shares is now wide enough that we think the downside risk to equity values clearly outweighs any potential gains if oil prices do recover," Driscoll and his colleagues said. "Further, we think the likelihood of an oil price recovery back toward levels anticipated by the equity markets is becoming increasingly unlikely, at least through the end of this year."

Barclays continues to expect oil volumes from U.S. tight plays to "outpace expectations, which could serve to delay the anticipated price recovery or at least minimize its magnitude."

The analysts' updated forecasts for North American E&Ps are based on WTI assumptions of $50.00/bbl in 2015 and $65.00 in 2016. Henry Hub natural gas assumptions are $3.25/Mcf in 2015, down from an earlier forecast of $3.75. For 2015, Barclays assumed a gas price of $3.50.

Under the new assumptions, Barclays is forecasting an average downside to price targets of 4% for the large-caps and 15% for the small-to-midsize E&Ps. The large-cap E&P sector also was downgraded overall to "negative" from "positive."

"Expectations for mid-cycle oil prices may not be realistic," Driscoll said. "We continue to envision strong oil production growth in the U.S. in 2015. Our recent analysis of U.S. tight oil supply suggests that supply costs on a per barrel basis have fallen 25%-plus over the last two years. We anticipate that supply cost reductions could accelerate as U.S. producers cut back on capital expenditures and high-grade their activities..."

North American E&P price targets were cut by an average of 17%, with forward cash flow estimates reduced by an average of 16%.

"Enterprise values would need to decline 25% to achieve valuation parity with historical levels, assuming investors eventually recalibrate oil price expectations to the current strip; equity values are at risk of 30% downside in such a scenario," Driscoll said.

There is some upside for producers with strong balance sheets. The "best positioned" natural gas-levered E&Ps are Range Resources Corp., Antero Resources Corp. and Cabot Oil & Gas Corp., all with solid, long-term Appalachia prospects. Those faring toward the middle of gas-levered E&Ps are QEP Resources, WPX Energy Inc., Encana Corp. and Southwestern Energy Corp. The "lowest" gas-weighted group per Barclays includes Ultra Petroleum Corp. and Chesapeake Energy Corp.

Producers downgraded to "equal weight" included onshore oil heavies Continental Resources Inc., Devon Energy Corp. and Marathon Oil Corp. Downgraded to "underweight" from "equal weight" were Halcon Resources and SandRidge Energy Inc.

According to Barclays, the "best positioned" oil-levered producers in North America are Canadian Natural Resources Corp., EOG Resources Corp., Cimarex Energy Co., Concho Resources, Apache Corp., MEG Energy and Newfield Exploration Co.

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