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Beaucoup Reserves Additions in 2010 Expected for Shale Gas Producers

"Shaley" natural gas producers and Bakken oil explorers should be reporting "lots" of reserves additions as they roll out their year-end 2010 reports, the research team at Tudor, Pickering, Holt & Co. (TPH) said Friday.

Exploration and production (E&P) companies are readying their year-end and final quarter reports, and as usual, the reserves number will be a key investor draw, said the analysts. Gas and oil reserves numbers -- up or down -- indicate how efficiently an exploration and production (E&P) company has invested its capital expenditures (capex), and imply the "economics of the assets owned and the company's underlying value."

For U.S. E&Ps, 2010's higher year/year (y/y) commodity prices, which are used to estimate reserves numbers, indicate that "revisions should be positive almost across the board," said the TPH team. According to TPH, first-of-month oil prices in 2010 averaged $79.43/bbl versus $57.65 in 2009, while gas prices y/y averaged $4.38/Mcf versus $3.87 (Canadian E&Ps book reserves using forecasted prices and sliding-scale royalties based on oil prices that result in negative price revisions, noted TPH).

Of the 39 U.S. E&Ps within TPH's coverage universe, 2010 reserves numbers y/y should show an aggregate "17% increase in proved reserves on a 40% jump in capex, which would yield a 17% increase in all in finding and development (F&D) costs." Drillbit-only reserve growth is expected to be 21% higher y/y, augmented by a 3% rise in positive revisions that are mostly price-related. Estimated all-in F&D costs in 2010 are $1.92/Mcfe, drillbit F&D is $1.86/Mcfe, and organic F&D (defined as drillbit F&D, after including the effect of price-related revisions) is $1.50/Mcfe. All of the TPH averages were "size-weighted," so that the larger E&Ps had a more significant impact on the figures.

"Lots of rigor and calculation goes into our estimates," said the TPH team. "In the end, however, reserve estimating by those of us from the outside requires an artistic touch." Analysts attempted to add value by focusing on a company's "base programs." They "triangulated" the year-end reserve drillbit additions using:

"Our drillbit additions forecast does not segregate reserves added into the extension and revisions categories," said the analysts. The Securities and Exchange Commission "requires wells drilled inside known field boundaries to be revisions; our revisions are purely commodity price-related." And "small (unannounced) acquisitions can also shift the mix from y/y and will not be captured...Bottom line -- we can't be perfect -- but we think we have an exploitable edge compared to the casual Wall Street observer."

Analysts expect to see F&D costs rising after a cycle correction.

"Commodity prices are flattish and costs continue to move higher in high-activity, oily basins like Bakken, Eagle Ford and Permian." That means "some guys are getting squeezed, though [proved undeveloped reserves] bookings and a high oil price help soften the blow...Assuming our flattish outlook for commodity prices in 2011 ($4 gas and $90 oil) and continued cost inflation, adding inventory becomes more difficult in 2011."

Among TPH's coverage universe, none of its E&Ps are declining reserves-wise, and those on the low-end are there mostly because of asset sales.

"Gas companies that have robust drilling programs and LOTS of shale resource to add should have super-low organic F&Ds," said analysts. "Oil is harder to add than gas," and those companies will have the highest F&D costs.

"Although overall we expect drillbit-only (excluding revisions) F&Ds to be relatively low compared to the highs of '08 (at less than $2/Mcfe), this still represents a weighted-average 33% increase versus 2009 as cost inflation and transition to oil for many companies makes it harder to add resource through the drillbit."

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