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Papa Sees Pain (shut-ins) and Gain ($7.50-$8.00) Ahead for Producers

EOG Resources Inc. CEO Mark Papa said Friday it will be "real close" as to whether U.S. natural gas producers will be forced to curtail their output this year. If gas pipeline pressures increase, there could be "automatic curtailments pretty much across the board." But for those who tough it out, there are higher prices ahead.

Papa's remarks came during a conference call with financial analysts to discuss EOG's quarterly performance. His views are similar to some made a few days ago by Chesapeake Energy Corp. CEO Aubrey McClendon, who said he sees "pain across the whole industry" because of high gas storage levels (see separate story).

"On the storage side, it's obviously going to be real close as to whether we have shut-ins or not," Papa said. "In my own opinion, we will get to about 3.9 [Tcf] in storage, and the question is, do we have 3.9 Tcf of storage out there?...The West is almost full of storage today. My guess today is, most of the pressure will be in the West, the deterioration or basis blow-outs in September or October...In terms of shut-ins, that would be my view."

In the western United States, EOG has significant gas operations in the Green River Basin of Wyoming and in the Uinta Basin of Utah.

"Our feeling is, if gas prices reach a certain price, and I won't say what that is, we've got to...curtail production. What also may happen is that we may just see pipeline pressures nationwide go up as storage fills up most everywhere...If pipeline pressures go up, and there's more back pressure on some wells across the nation, that could cause automatic curtailments pretty much across the board.

"If that were to happen then production would drop for everybody," he said. "That may be what actually occurs. What we're seeing right now is, [EOG's] 5.5% production growth [target] is at some risk, depending on the storage situation. Particularly in September and October, we'll have to see how that plays out."

But going forward EOG Resources Inc. is even more bullish about 2010 and 2011 than it was earlier this year, Papa said.

EOG's domestic gas supply model "is telling us that December 2009 domestic production will be 4.8 Bcf/d lower than year-end 2008, and this deficit will deepen further throughout 2010," Papa told financial analysts during an earnings conference call. He shared EOG's macro gas views and detailed the company's 2Q2009 performance.

"When added to the Canadian supply drop of at least 0.8 Bcf/d, we expect the gas market to turn sometime early in 2010, almost regardless of what happens to LNG [liquefied natural gas] imports," he said. "Everybody seems to be focusing on the supply growth from new horizontal plays, but the 800-pound gorilla in the room is Texas vertical gas production. This represents the largest single block of production in the U.S, 16.3 Bcf/d in December 2008, and the rig count here has fallen from 450 rigs in January 2008 to 145 rigs today."

EOG's model "shows production from this large segment of domestic production will fall from 16.3 Bcf/d at year-end 2008 to 13.2 Bcf/d by year-end 2009, and then to 11.6 Bcf /d by year-end 2010, down 4.7 Bcf/d over two years," Papa noted. "In my opinion, this is the most important well population that people should be focusing on if they want to understand what is going to happen to gas supply over the next 24 months."

EOG has hedged almost half of its North American gas from July through December 2009 at $9.03/Mcf, but it has only a "small amount of first-half 2010 gas hedged at $10.27" because of its optimism on gas prices, said Papa.

"We believe that the gas price for 2010 is going to average full-year somewhere between $7.50 and $8," he said. "And I know that sounds dramatically bullish relative to today's Henry Hub price. So we would have to see a price that amount or higher before we would consider hedging for 2010...Our overall 2009 production growth target of 5.5% is still intact, but I will caution investors that this assumes we don't curtail any North American gas in the second half because of market storage issues."

EOG, whose production as late as a year ago was weighted to gas, now is about half-weighted to oil projects, including a development in the Bakken play in North Dakota and oil projects in the Barnett Shale of Texas.

"I am aware that we've piqued a lot of investors' curiosity regarding the shift in our mix toward oil, but let me assure you we are making that shift because of the unique early mover opportunities currently available to us for horizontal oil resource plays and not because we are running away from North America gas," said Papa. "We have a powerful arsenal of gas assets, both horizontal and vertical..."

In 2Q2009 EOG completed five Haynesville Shale wells in DeSoto Parish, LA, and "all five wells" had initial production (IP) rates of 14-16 MMcf/d, he said. "I will also note these wells were at pipeline-restricted rates. Each had the capability to produce at higher IP numbers." Around 90% of EOG's Haynesville wells "have IP rates greater than 10 MMcf/d, the highest percentage among the peers, and only 10% of our wells have IP rates of less than 7 MMcf/d, the best overall performance of the peers."

EOG currently is running four gas rigs in the play; it expects to average 10 Haynesville rigs in 2010.

The company's activity in the Barnett Shale is down from the year-ago period, with only seven rigs now running compared with 20 in 2Q2008. However, by year-end 2012, total Barnett output is expected to be more than 700 MMcfe/d, compared with today's 480 MMcfe/d, Papa said.

The company also is encouraged by results form the Horn River Basin in British Columbia, where it is in the process of fracturing seven wells drilled earlier this year. Flow test results are expected in the next quarterly conference call, said the CEO. EOG also is "pleased" with the province's "proactive steps" to enhance the economics of the play through a revised royalty scheme (see related story).

EOG also is testing "multiple areas" in the Marcellus Shale, where it holds 240,000 net acres. The company is "generating wells with net reserves of 2.4 to 3.1 Bcf and we expect to commence our first Marcellus gas sales in the fourth quarter of this year once pipeline hookups are completed," said Papa. "We have increased from one to two rigs in this play and will be moving into development mode by year-end."

In addition to its horizontal gas basins, "we have also had positive results in two vertical North American gas plays," said Papa. "In Mississippi we discovered a new prolific Cotton Valley gas field. The first three wells, the Williams 9-12, Ramsay Williams 9-7 and Shirley 9-14, are currently producing at 10 million, 7 million and 5 million cubic feet per day with 250, 175 and 125 barrels of oil per day respectively."

The Houston-based producer reported a net loss of $16.7 million (minus 7 cents/share) in 2Q2009, compared with net income of $178.2 million (71 cents) in 2Q2008. Net operating natural gas revenues fell to $460,044, from $1.34 billion in the year-ago period. Quarterly U.S. gas volumes were flat compared with a year ago at 1,139 MMcf/d. Canadian gas volumes rose slightly quarter/quarter to 225 MMcf/d from 215 MMcf/d, and in Trinidad volumes were higher at 266 MMcf/d versus 217 MMcf/d.

Average realized U.S. gas prices in the United States fell to $3.37/Mcf in 2Q2009 from $10.36 in the year-ago period.

EOG is forecasting its gas production in 3Q2009 to fall from a year ago, with U.S. gas output at 1,110 MMcf/d, down from 1,135 MMcf/d in 3Q2008. In Canada, output is expected to drop to 200 MMcf/d from 220 MMcf/d. Natural gas liquids output in North America in 3Q2009 is expected to fall to 20,600 b/d from 25,400 b/d.

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