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Independents Encouraged to Spend More on Exploration

The top North American exploration and production (E&P) companies have stashed away billions from higher oil and natural gas prices in recent months, but very few are returning to what made them great in the first place -- exploration -- two oil and natural gas executives said Wednesday.

The question of what North American E&Ps should do with all of their extra cash was the focus of an industry forum Wednesday at Cambridge Energy Research Associates' CERAWeek 2005 in Houston. Sharing the panel with PricewaterhouseCoopers and Morgan Stanley consultants were Aubrey McClendon, CEO of Chesapeake Energy Corp. and Stephen Hurley, president of the privately held Hunt Oil Co.

"Asking me what to do with extra cash is like asking a fraternity boy what to do with the beer. I know what to do with the cash," said McClendon, who co-founded the Houston-based producer in 1989. "Drill. That's our number one option. We produce 2% of the nation's gas, and we drill 6% of the wells. The problem is, if we're just reconciled to sustain higher prices, it's game over. The leaseholds have all been acquired. Finding costs are higher."

McClendon said that Chesapeake, which focuses its operations in the Southwest, has followed the majors' production progress over the past few years. Even though the majors still provide about 25% of domestic gas, "they're not drilling. The way the majors look at it is, North America is a great place to sell gas, not find gas. We don't think that will change. The shift is good news for the shareholders, but it's bad for gas prices."

As the majors have cut back in North America, Chesapeake has been using its extra cash to ramp up. Drilling is one area that holds true value, McClendon said. "Another option is to acquire. We've bought $5 billion in [assets] in the past five years. But the proposal packages of size are few and far between these days in North America. To be a bigger player, you've got to be willing to drill." If a company is only using the extra cash for mergers and acquisitions, "it's pretty tough at the end of the day. Some are not viable at any price."

Hurley, who worked for public E&Ps before joining Dallas-based Hunt, said there are "compelling reasons" E&Ps are choosing not to invest their cash in new drilling -- but those choices offer the risk takers "tremendous opportunities" today.

"It's hard to find efficient prospects, and frankly, the capital markets are averse" to investing in new exploration, Hurley said. "The truth is, most companies aren't very good at exploration. It can destroy value very quickly..." Hurley also cited the technical obstacles that large producers face if they spend money to explore. "There are rising finding and development costs, and there have been no technological breakthroughs" to bring the costs down. "It's a very tough business."

However, because the majors spend a "woefully low" amount on new U.S. exploration, Hurley said independents should be using their excess cash for expanded drilling programs.

"Why invest in new exploration?" Hurley asked. "It creates value that didn't exist before." He also cited organic growth and reduced competition. "There are big finds being made around the world," including the shallow and deepwater Gulf of Mexico, the Rockies and Canada. "One area that is not emphasized is in the frontier, or new concept plays. Very few invest in new concepts."

E&Ps that don't take risks are the antithesis of everything that made oil and gas companies great in the first place, said Hurley. "Exploration is not for the timid," he said. "To be successful, besides management techniques, you have to have a contrarian mind set," he said. "You have to foster and emphasize exploration, and you have to have a long-term value focus. You have to focus on your prospects. You have to do these things or you're very unlikely to be successful."

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