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E&Ps Cutting Capex Heading into 2013

November 19, 2012
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Exploration and production (E&P) companies have cut their capital spending and are hedging their bets going into 2013, according to a review of 3Q2012 by energy analysts.

U.S. Capital Advisors (USCA) analyst Cameron Horwitz concluded in his review that E&P capital expenditures (capex) are trending down.

"E&Ps got ahead of their capex skis early in the year and have pared back activity in 2H2012 to avoid busting budgets," Horwitz wrote in a note. "Third quarter spending confirmed this trend, with total drilling/completing capex declining 8% quarter/quarter ($425 million) for our coverage." Unless oil prices fall, he expects a "similar pattern" in capex going into 2013 " as anecdotal commentary suggest desire to re-engage activity after the ball drops."

It's worth noting, he said, that the median capex/cash flow imbalance in 2013 at $95/bbl oil/$3.75 natural gas "is 25%, better than the 60% median outspending '12, but still implying the need for incremental financing and/or asset sales across the industry."

Oilfield service cost "tensions" for E&Ps appear to be abating, he said, and operators continue to "trumpet service cost declines, especially in the Eagle Ford, where many contracts are being renewed at 10-15% lower levels," normalized for laterals. In the Permian Basin, E&Ps "cite services loosening more than in the last couple of quarters, with increased competition among vendors becoming more pervasive."

Permian Basin well costs appear to have peaked for now, but the USCA analyst said he's not expecting a material decline "as the ramp in plays like the Wolfcamp/Cline shales should soak up excess capacity."

The emerging plays -- including the Brown Dense, Delaware Wolfcamp, Jo Mill and Tuscaloosa Marine Shale (TMS) -- offered mixed results in the last quarter, said Horwitz. The Brown Dense formation results were positive for Southwestern Energy Co., as were Plains Exploration & Production results in the lower Spraberry, or Jo Mill, he said. The Delaware Wolfcamp was mixed, while the TMS was negative, because the play "continues to face technical challenges."

The E&P research team at Tudor, Pickering, Holt & Co. (TPH) found a couple of "broad themes" in its review of the previous quarter's earnings related to capex/rig activity and 2013 guidance and expectations. Analysts picked out a few independents within their coverage universe to demonstrate what the last quarter appeared to indicate going forward.

With less than two months before year-end, most E&P spending bets have already been made, and it's fairly well known at this point that many E&P companies have capex at run-rates higher than full-year budgets would dictate," said the analysts. "Thus, as expected based on E&P company commentary, the slow-down into 4Q2012 continues what has been a second-half reduction of rig-directed activity within our space.

"Total operated rig count in our coverage group has declined by 13% from the end of 2Q2012 to the 3Q2012 exit, with a further continuation into 4Q2012 (minus 5% versus 3Q2012 exit). The November spot rate (Nov. 9) now stands at 708 (38% oil, 36% high-liquids, 11% low-liquids, and 15% gas), down from 857 at the end of June (mostly driven by cuts in oil rigs: minus 83 rigs)."

The producers that have slowed down activity "most dramatically," according to TPH analysts, include Chesapeake Energy Corp., down 39 rigs (29%); Occidental Petroleum Corp. down 30 rigs (44%); and Pioneer Natural Resources Co., which is down 15 rigs (28%). Only a handful" have added more than one rig to the contracted fleet, including Apache Corp., four rigs (8%); SandRidge Energy Inc., plus three (13%); and Oasis Petroleum Inc., which added two rigs (20%).

Merger and acquisition "advisers and lawyers are not likely to get much sleep in the remaining six weeks of the year due to what we believe are a substantial number of sellers of asset packages currently on the market who are incentivized to close deals before year-end," said TPH analysts. "We would think most deals that may close before year-end are well along in the negotiation stages, but [the] election more than likely pushed negotiations into high gear."

Chesapeake, which had planned to get some of its needed asset sales completed before year's end, indicated earlier this month that some of the sales will be delayed into 2013 (see Daily GPI, Nov. 5).

"Expiring tax regulations (on capital gains) and a potentially more onerous fiscal regime regarding drilling tax breaks for the years to come should cause more expedited selling by family-owned and private-equity backed E&Ps," according to TPH.

"We believe the likely buyers are mostly public companies, as well as private equity funds, and doubt that there are going to be many (or any) corporate transactions at this point, or any acquisitions/divestitures as they would likely not close before year-end. Tax changes and the potentially material negative impacts to the energy space probably show up in a number of areas..."

TPH also said some of the gassy producers are layering in 2013 hedges following a poor year for gas pricing, which offers "a glimmer of hope for at least a near-term positive correction as we head into winter. With the average 2013 strip running up to a high of $3.90/Mcf at the end of 3Q2012, and continuing the rally to $4.10/Mcf in October, gassy producers have certainly taken notice."

The biggest changes to gas hedge programs by TPH's count are at Cabot Oil & Gas Corp., which added 383 MMcf/d in $3.60 by $4.29 collars on average); Talisman Energy Inc., which added 140MMcf/d in $3.16 by $4.72 collars on average; and Exco Resources Inc., adding 110 MMcf/d in $3.95 swaps.

"It's likely that a number of operators will be looking for chances to lock in cash flows if we see a cold enough winter and the strip moves back above $4/Mcf again," with the "obvious" companies to watch to include Chesapeake, Range Resources Inc. Southwestern Energy Co. and QEP Resources Inc.

In its latest review, Standard & Poor's Ratings Services (S&P) said the domestic E&P sector "remains mostly stable" because of robust oil prices.

"Our outlook for a majority of the oil and gas companies in the U.S. remains stable in 2012 and 2013, particularly for those operators with exposure to robust oil prices," said S&P credit analyst Marc D. Bromberg. "However, mixed economic indicators in the U.S., a potential fiscal cliff in 2013, and a deeper Eurozone recession remain wild cards that could pressure global oil prices and thus decrease future profitability and lead to ratings actions on our E&P issuers."

Even though natural gas prices have rallied over the past six months, they've remained "relatively weak by historical standards, with Henry Hub trading at $3.41/Mcf on Nov. 6. Based on the energy equivalent relationship, oil-to-natural gas prices should be 6:1; however, it is currently 25:1.

"As a result, most of our issuers continue to allocate nearly all capital to liquids (crude oil and natural gas liquids) prospects, especially to oil-weighted plays such as the Permian and Eagle Ford in Texas and the Bakken in North Dakota. For some of our E&P issuers, the shift from natural gas to liquids has been several years in the making, but for others it is relatively new, posing the risk that the transition can occur successfully and without weakening credit protection measures."

Under S&P's baseline forecast, economists expect West Texas Intermediate (WTI) crude to be about $89/bbl to year-end, and "close to" $90/bbl in 2013. "Under this scenario, credit protection measures will continue to remain healthy. Those companies operating in the Gulf Coast, which prices according to Brent crude oil, will continue to see a positive differential relative to WTI prices at least into 2014, in our view."

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