Some exploration and production (E&P) insiders are expecting 2008 oil and natural gas prices to average up to 5% higher than Wall Street's expectations, according to an informal survey by Raymond James and Associates Inc.

The survey appeared to contradict Raymond James internal forecast that gas prices would be "ugly" through the rest of this year (see NGI, Feb. 18a).

The firm's energy analysts earlier this month surveyed about 40 executives to determine, among other things, what commodity prices they expect to see this year. Their generally bullish answers may explain "why many are planning further increases in capital spending and are open to acquisition opportunities, despite the credit market tightness," wrote Raymond James' Wayne Andrews, Pavel Molchanov and Kristal Choy.

The survey, which was conducted at the North American Prospects Expo in Houston, revealed a more bullish sentiment than a year ago but not as strong as in 2005 and 2006. Most of the E&P management teams agreed with Raymond James' call that oil prices over the coming year would be above consensus expectations. And many were bullish on gas -- even though many of the biggest producers have boosted their hedging.

"In 2005/2006, the general attitude of most E&P companies was positive, and of course that was to be expected given the 'onward and upward' trend of oil and gas prices during that time frame," wrote Andrews. "In 2007, despite the intense volatility in the commodity markets, the tone remained broadly positive. This year the sentiment is actually more bullish than in 2007, though not quite as it had been in 2005/2006."

Asked what they thought gas prices would average in 2008, those surveyed said it would be around $7.63/Mcf, with a high of $10.25 and a low of $6.12.

"Reflecting our bearish call on gas heading into the summer months, our forecast of $6.50 is not far from the low end of the range," Andrews noted. "The group's average 2008 oil forecast was $85.31/bbl (5% above consensus of $81.13), with a high of $115.00 (!!!) and a low of $70.00. Our forecast of $90.00 is higher than the group's average oil forecast but by no means the highest. Interestingly, the low end of the oil range, $70.00, is consistent with our view on the oil price floor that OPEC is defending."

Preliminary results from Raymond James' 2008 E&P capital spending survey "are fairly bullish," wrote Andrews. More than half of Raymond James' E&P coverage universe has announced 2008 budgets.

"The average budget is up nearly 10% year/year and several are planning increases of 30%+," according to Andrews and his team. "At a minimum, we think that the average E&P budget in 2008 will be up about 5%. Assuming relatively flat commodity prices versus 2007 in the aggregate (lower gas offsetting higher oil), this can be funded via (1) production growth and (2) increased cash flow from hedges in place.

"In fact, assuming our current 2008 commodity price forecast proves correct, at least some companies in the E&P space -- especially the more oil-weighted ones -- would generate free cash flow, although this is more the exception than the rule. This would put these companies in the enviable position of choosing between deploying free cash flow into (1) further growth initiatives in the M&A [merger and acquisition] market or through the drillbit; or (2) returning capital to shareholders through share repurchases or dividends. Each individual company's decision will, in our view, be based on its valuation, drilling inventory and expected returns on capital."

The Raymond James analysts noted that their discussions were useful to ascertain the "threshold of pain" for E&Ps -- the commodity price level below which producers would cut spending.

"We asked the group if any of them would lay off rigs if oil fell to $70 and gas to sub-$6.00 on a sustained basis. A few hands went up, and they referred only to a limited subset of prospects that would be marginal under such a price scenario. Producers also emphasized the point we have made earlier on many occasions -- that they focus not on the spot market but rather the long-term price outlook, as indicated by the futures strips."

Several management teams, including large-cap producers, also said that they have in fact been increasing their hedging positions from a year ago.

"In other words, while most of them are more bullish on gas for the next 12 months than we are, they are hedging their bets in this regard -- quite literally," said Andrews. "For context: On average, the heavily gas-weighted names in our E&P universe (65% or more by percentage of reserves) have hedged roughly 50% of 2008 gas production. On the other hand, their oily counterparts (65% or more by percentage of reserves) have hedged only 10% of production on average, even as oil prices have soared to new highs."

Top North American gas producers including EnCana Corp., EOG Resources Inc., Devon Energy Corp., Anadarko Petroleum Corp. and Williams all have announced substantial gas hedges for 2008 (see NGI, Feb. 18b; Feb. 11).

According to the survey, E&P acquisitions should continue in 2008, albeit at a tempered pace. M&A activity slowed in 2007 compared with the previous two years. However, analysts reported that "the general view was that such activity will continue, especially if asset values were to moderate, because astute buyers with a bullish long-term outlook could then snap up properties at attractive prices. Most companies still emphasize asset deals, though corporate M&A remains an option for many large-cap and mid-cap producers.

"Some management teams noted the credit market challenges but emphasized that they would be willing, and able, to seek out financing even for a large transaction if the right opportunity came along."

The trend to create master limited partnerships also "is likely to be sustained as companies seek to maximize the value of their assets in the public markets, albeit not as aggressively as it may have looked a year ago."

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