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Raymond James Sees Producers Bullish but Investors Cautious

The recent storage- and weather-driven downturn in natural gas prices has given investors pause, but producers remain undaunted, according to Raymond James & Associates Inc.

In an industry brief, Raymond James outlined four takeaways from its Institutional Investors Conference, held last week in Orlando. Four themes to emerge from company presentations at the conference are:

However, "Recent energy market volatility likely increased the energy room attendance as many investors voiced concern and doubt regarding the sustainability of the energy cycle." Not to worry, though, as analysts Raymond James analysts J. Marshall Adkins and John Freeman note that lower gas prices already have begun stimulating demand among petrochemical companies and other industrial users of natural gas. "Likewise, as electric generation companies burn off the oil inventories that were ordered during the December gas price spike, fuel switching back to gas should cause demand to perk up. In other words, don't look for gas prices to stay down for long."

The analysts note that it wasn't that long ago, a decade, when natural gas traded between $1 and $2/Mcf and $5 gas was "nirvana." Although oilfield service company costs have risen substantially and rigs are hard to come by, "most E&P companies are still making very attractive returns at $5/Mcf gas prices." Further, unlike a few years ago, companies have "drilling prospects out the wazoo!" This is true of "checkbook" drillers and larger players, Raymond James says.

The abundance of cash and prospects has made for an ever-tightening rig market as demand continues to grow. Producers at the conference said they are not worrying about high costs now as they have more important concerns. For instance, giving up rigs means moving to the back of the line, a long one, to get them back again. Also, while companies await equipment needed to drill, the clock is ticking on their leases, making lease expiration a real concern. Finally, stopping and then re-starting drilling operations harms project economics.

The analysts say that investors don't fully appreciate the lease expiration issue. For instance, offshore lease expirations are accelerating and this will likely force offshore producers to step up drilling efforts. On land, shorter lease terms and the complication of dealing with numerous mineral rights holders can bog down efforts to drill a lease before it expires. "This could be an especially big problem if you have to wait for a rig. In today's world, rig availability is often the biggest challenge for producers."

Raymond James says a number of E&P companies have expressed interest in developing and expanding their own rig fleets, a trend that has emerged over the last two years. The firm concludes that drilling plans for the next year are secure, even with a perceived short-term pullback in oil and gas prices.

Longer term, gas prices would need to fall below $6/Mcf before anyone considers slowing activity. "Nearly all companies -- both E&P and oil service -- responded with strong convictions that the current long-term commodity up-cycle remains intact. Most emphasized that drilling activity is unlikely to materially slow down unless long-term gas prices (for example, the 12-month futures strip) fall below $6/Mcf into the $5/Mcf range." However, some marginal prospects could be postponed if the strip drops below $6," Raymond James says.

"Keep in mind that the move to $5 spot gas would be only a 25% drop from current spot prices. From a longer-term, futures strip perspective; a $5/Mcf strip would be a whopping 40% lower that the current 12-month strip. Not likely, in our opinion."

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