EOG Resources Inc. CEO Mark Papa is hoping Punxsutawney Phil sees his shadow on Friday to help extend the winter season by a few more weeks. Papa warned Thursday the warmer-than-average winter season has placed the natural gas market in a “perilous condition,” and without a cold February, EOG may cut capital expenditures and trim its production forecast for 2007.

Apache Corp. CEO G. Steven Farris echoed some of Papa’s comments about prices and service costs Thursday afternoon. Apache trimmed its 2007 exploration and development spending in North America by $600 million from 2006, and Farris warned more cuts are possible if service costs don’t keep pace with natural gas prices.

“While service costs have moderated somewhat from the unsustainable levels of 2006, a rebound in costs would require Apache to revisit its 2007 capital plans — especially in North America, which experienced the greatest cost increases,” Farris said.

“We review Apache’s budget quarterly, and so it’s subject to change very quickly, subject to the level of commodity prices and service costs,” Farris said. “We have seen a moderation in service costs as we entered this year…but if service costs don’t stay in line with prices, others, including us, will reduce our spending and our drilling in North America to stay in line with margins…”

Apache has a bank of international assets to balance its North American plays, with core properties in Egypt, Australia Venezuela and the United Kingdom. Apache’s North American exploration is focused in the Gulf of Mexico (GOM), along the Gulf Coast, East Texas, the Permian Basin, the Anadarko Basin and the Western Sedimentary Basin of Canada. Two weeks ago, Apache paid $1 billion to acquire controlling interests in 28 Permian Basin fields (see Daily GPI, Jan. 19). Last year, it bought about $800 million in GOM assets from BP, and Apache remains one of the most active drillers on the Outer Continental Shelf (see Daily GPI, June 7, 2006). Controlling costs, though, remain paramount.

“If you look at any of the service [companies’] financials, their greatest profit center is North America,” said Farris. “Because of our property mix, in Egypt for instance, there are a lot of dampers for the cost there. In Argentina, there are lower commodity prices, lower service costs. North America has the greatest volume, but also the greatest service costs. It’s the easiest region to move very quickly to change the activity level. We’re projecting a capital budget down about $600 million from 2006, but we budget quarterly. This could vary greatly.”

Apache Chairman Roger Plank noted that “prices are about as predictable as the weather. Apache has the momentum, and our investments ensure us of another year of production growth at 6-10%.” He said Apache has “an abundance of low-to-moderate drilling opportunities that ensure predictable results and offer upside potential” not just in North America but on an international scale.

During a conference call to discuss EOG’s 2006 performance, Papa blamed the lower average gas prices on the weather in January 2006, which was the warmest January on record. The high temperatures that month led to higher-than-expected gas storage levels at the end of the heating season. The hefty storage stifled gas prices for the rest of the year, he said. And this year is not looking any better.

Despite a cold snap in the past two weeks, Papa said “it’s too soon to tell whether the cold spell will have any effect on storage.”

On Thursday, the Energy Information Administration reported a 186 Bcf storage withdrawal for the week ending Jan. 26, stunning many market forecasters who were expecting about a 200 Bcf withdrawal (see related story). Earlier this week, three energy consultants estimated that even with the current cold weather, storage levels still could surpass 1.7 Bcf at the end of the season (see Daily GPI, Jan. 31).

“We’re likely to have decent 2007 prices if we have a cold February,” said Papa. If it’s cold through the month, storage levels could drop to between 1.4-1.55 Tcf. In that range, he estimated Henry Hub gas in 2007 would be between $7.25-8.50/Mcf. “It primarily depends on where storage ends.”

However, if the short month turns warm and remains above normal, EOG is ready to slash its projected $3.4 billion capital expenditure budget for 2007. The cuts also would affect the 10% projected gain in oil and gas production in 2007 “by a few points.”

Asked by a financial analyst to clarify what he meant by a “few points,” Papa said EOG’s production this year likely would grow 7-8%. EOG is estimating a 10% global production growth rate, with the company’s oil and gas output in North America expected to rise 16%. EOG’s North American gas production in 2007 is expected to jump 18%; excluding its gas-rich holdings in the Barnett Shale, North American output is expected to grow 6%.

Papa could not pinpoint how much of a cut to capital expenditures would be made, but he said prices would have to tank for EOG to reduce its capital budget below 2006’s $3 billion.

“If prices fell to some horrible number, at this stage…I don’t know… I don’t contemplate prices would be that low,” he said. “I hope not anyway — not lower than in 2006. If prices went into a free fall…we’re just not going to balloon our debt past a certain level.” Papa said if EOG management “felt the full year 2007 Henry Hub was going to end up below about $7.25 [per Mcf], we would probably look at whacking the budget some. I wouldn’t quantify it at this time, but we’d reduce the budget some.”

Only some of EOG’s areas would see production delays if the budget is reduced, said Papa. Two programs unlikely to see any cutbacks are the Barnett Shale and the Uinta Basin, he said.

“If gas prices were to take a plunge…the last place [where there would be cuts] would be the Barnett,” Papa said. “We [would probably] begin in Canada. We would be whacking that program even though the cost basis has dropped a bit in the last six months. In the Uinta Basin, we’d maintain that. Probably in Wyoming, there’d be some cutting, and probably in the Permian Basin, perhaps East Texas and the Midcontinent might be turned back a bit. But the base programs in the Uinta Basin and Barnett are likely some of the last on the priority list to cut.”

Last November during EOG’s analyst conference, he forecast a price range for gas in 2007 of $7.50-9.50 “based on what I thought would be a 5% warmer or 5% colder winter than normal. It’s 17% warmer this year, and the change is, at least the first half of winter, is that it’s a whole lot hotter than what we thought it would be.

“We want to end 2007 with the most pristine balance sheet in our peer group. That’s an overriding goal. There’s a limit as to how much debt we want to take on this year. If gas prices don’t look good, then we’ll take the appropriate action to lower the budget,” Papa said.

Under certain circumstances, EOG might consider more hedges on its gas this year if there is a downturn in prices. “We would look at it, but the bottom line is the only way to lay on hedges is if there’s a cold February and the Nymex continues to run. If there’s a cold February and storage goes to decent levels, to 1.4 to 1.55 Tcf, we can lock in some decent gas prices through pretty much until we get into next winter,” he said.

“We would look at it if the full-year strip got up to $8.50 or so, and I’m not that concerned if we get shafted by winter. Winter is going to be over by the time the price gets up that high, I think,” said Papa.

Ending EOG’s conference call, Papa added, “I’m hoping that we have a cold February. Then everything will work out just fine for us.”

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