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Some Upside for E&P Seen in 2Q2009

July 13, 2009
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The downside risk for natural gas and oil prices remains high, but U.S. exploration and production (E&P) companies are achieving lower-than-expected production declines by squeezing value from their existing assets, energy analysts said in previews of 2Q2009 earnings.

FBR Capital's Rehan Rashid and Michael Jones offered their forecast after visiting with 10 E&P management teams earlier this month.

"Off the visits, we believe that common themes this earnings season will revolve around company efforts to mitigate near-term downside risk and thoughts of intermediate- to long-term growth and value creation," the analysts wrote in a note to clients.

"We think that companies will generally meet or beat production guidance, as focus on optimization of existing production systems during the quarter results in lower-than-expected sequential production declines. We believe that management teams will talk about the initiation of new hedging for the remainder of 2009 and 2010 production."

More broadly, Rashid and Jones said in their opinion, "value creation at the asset level is progressing at an elevated rate. Companies are finding new shale or reserve sources, while older ones are showing progressively better delineation, and costs are decreasing aggressively (as technology contributes)."

FBR analysts adjusted 2Q2009 gas prices upward to $3.71/Mcf from $3.25, and revised oil prices higher to $59.70/bbl from $45. However, for 3Q2009 they adjusted gas price estimates down to $3.25 from $3.75, "with oversupply risk exiting injection season." New York Mercantile Exchange (Nymex) prices, they noted, are at $3.55/Mcf for the quarter.

Crude oil prices for 3Q2009 were reset at $60/bbl and for 4Q2009 at $65/bbl from $50/bbl for both, in line with Nymex.

In their E&P discussions, the analysts focused on a variety of topics that included the "relative oil strength providing capital planning support for drilling," as well as Haynesville Shale drilling results, the Marcellus Shale, the Uinta Basin and South Texas.

"Our company meetings indicate that the industry is split on natural gas pricing," said the FBR analysts. One "camp," which includes EOG Resources and Chesapeake Energy Corp., "believes that the massive rig decline will create a price response" by the second half of 2010, "in line with the Nymex contango" of $5.50/Mcf in the first half of 2010, and up to $6.50/Mcf by year-end 2010. "In the other camp, companies that are not accustomed to hedging are willing to look out into 2010 and protect their cash flows either to get R&D [research and development] projects off the ground or programs restarted without conviction from either the demand or supply side with more gas yield per rig.

"For 2009, how full will storage be?" asked the analysts. "We are lowering our 3Q2009 estimate to $3.25/Mcf on this risk, as any incremental supply beyond the working capacity available will surely sell for a steep discount in the spot market."

Operating earnings for the integrated oil and gas sector are forecast to rise 12% sequentially in 2Q2009 from 1Q2009, but earnings are predicted to be off 64% year/year (y/y), according to Barclays Capital analysts. Upstream earnings are expected to fall 65% sequentially in the quarter from early this year.

Barclays analysts track 17 major oil companies within the integrated sector, including U.S.-based Chevron Corp., ConocoPhillips, ExxonMobil Corp., Hess Corp., Marathon Oil Co. and Murphy Oil Corp.

"While we think the 1Q2009 has marked the low point of the sector's current earnings down cycle, 2Q2009 result appears to remain disappointing compared to their consensus expectations," Barclays analyst Paul Y. Cheng wrote in note to clients. "Despite the sharp run-up in oil prices since early May, we believe results will be adversely impacted by a weaker worldwide natural gas market as well as a continuing weak refining and marketing margin environment."

The earnings for onshore drillers and related oilfield services businesses also are predicted to fall below Wall Street's estimates because of "plummeting North American activity and margins, as well as lower international margins are activity moderates abroad," said FBR's Robert MacKenzie, Doug Garber and Christopher Breaux.

Analysts with Tudor, Pickering, Holt & Co. Securities Inc. (TPH) were a bit harsher in their assessment, writing in a note that the "North American oilfield service business will be broken for the foreseeable future."

The TPH research team expects "a more concentrated E&P focus with fewer rigs operating in fewer places. New shale plays will add enough gas supply that we'll need fewer rigs than last cycle...

"With 25%-plus excess capacity, North American assets are going to kill each other to stay [at] work," the TPH team wrote. "Margins will not recover to 2008 levels and North American profitability will be substantially less..."

Lower domestic gas prices and the impact of a weak U.S. dollar pressured Chevron in 2Q2009, the company said in an interim quarterly earnings report last week. Chevron's realized U.S. natural gas prices averaged $3.26/Mcf in the quarter, down 21% from 1Q2009 and down 67% from 2Q2008.

ConocoPhillips in its interim report last week said it expects to report higher output in the quarter because of the start-up of some global projects. Oil and gas output is expected to reach 1.86 MMboe/d in 2Q2009, compared with 1.75 MMboe/d in 2Q2008.

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