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Barclays: North American E&P Spending to Target Oil, Liquids in 2012

North American producers plan to target their 2012 capital expenditures mostly to oil and liquids-rich basins, with the Permian Basin and West Texas leading the list, according to a new spending survey by Barclays Capital.

Barclays surveyed 339 exploration and production (E&P) companies worldwide, including 173 producers in the United States and 96 in Canada. Based on the North American responses, analysts Shiyang Wang and Michael Zenker concluded that E&P spending should be 8% higher in 2012, which is the same as the Barclays spending forecast for 2011. For the second year in a row natural gas prices were not the leading factor in spending plans; they had been the most important factor in producer spending plans for 10 out of the past 13 surveys.

"The survey results indicate that in 2012, oil will be driving capital spending in North America, while natural gas was the principal driver for the surveys conducted from 2006 to 2010," said the Barclays duo. "Indeed, this is reflected by the rise in oil-directed drilling in North America."

The Permian Basin and West Texas, traditionally rich in oil and liquids, were chosen by 20% of the survey participants as the place where they plan to put the most E&P money in 2012. Other top choices also were in oily and liquids basins. The Midcontinent was chosen by 18% of those surveyed while the Bakken Shale got 11%. The gassy Marcellus Shale was the top pick for 7% of those surveyed.

"Shale technology continues to rule the E&P sector," said Wang and Zenker. Unconventional drilling "is clearly dominant in North America. Specifically, hydraulic fracturing/well stimulation reigns as the most vital technology for the fourth year in a row."

Despite a significant increase in pressure pumping capacity coming into the North American market next year, "producers' needs for well completion services will most likely outpace the incremental supply additions of equipment," said the analysts. "Yet prices for pressure pumping services are flattening, and our oil services and drilling research team expects a decline in prices in selected regions" including the Haynesville and Fayetteville shales, both gas basins.

In last year's survey, "producers indicated that they would cut spending if [gas] prices fell below $4.00. This year more than half of respondents indicated that they would cut spending at $3.50. Similarly, most producers last year indicated that at prices above $6.00 they would increase spending. For 2012 about half of the respondents said they would increase spending at $5.00."

The latest spending survey "provides a mixed message for gas. Producers may be more prepared to respond to lower prices with less gas-directed drilling. Yet the strength of oil prices is supporting budgets overall. But the fact that gas prices must fall to about $3.50 to get close to half of the respondents to cut spending suggests that producers are adapting quickly to lower prices."

More than half of the respondents (54%) voted for oil prices as the biggest determinant of spending, followed by natural gas prices (47%) and cash flows (46%).

"At this time last year the gas price used by producers for 2011 capital budgeting averaged $4.27/MMBtu, which was the lowest since 2003," noted the analysts. "On average, producers are using a $4.08 gas price for budgeting purposes for 2012." For the past three years producers had tended to use "a gas price that was higher than the resulting year's price. We expect them to do so again for 2012, as we forecast that gas prices will average $3.80 next year."

Producers will continue to drill as long as it's economic to do so, the Barclays team said. Most producers said in 2012 they "expect to spend an amount that is either the same as or greater than cash flow. Yet a growing percentage of producers are planning to spend less than their cash flow than in 2011."

In any case it's too soon to tell if a pullback in gas spending will be a clarion call for bulls, said the analysts.

"Some market watchers view the recent pullback in the gas-directed rig count as producers' response to low prices...In our view, it is too early to call the recent rig drop-off a turning point for gas. Both oil and liquids-rich drilling yield some gas. Given the current mix of drilling, the gas-directed rig count must fall below 750 to stall U.S. gas production. Plus, drilled-but-uncompleted wells and bottlenecked supply will combine to increase supply even with a moderate pullback in drilling. As a result, we continue to expect gas supply growth in 2012. If a faster-than-expected diversion of drilling to oil and liquids is under way, we will have plenty of data points to plot that shift."

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