Few opportunities opened this year for exploration and production (E&P) companies to hedge their natural gas production and now many are entering 2011 with an elevated exposure to gas prices, Raymond James & Associates Inc. analysts said Monday.

A team of analysts led J. Marshall Adkins reviewed the hedging positions for Raymond James' E&P universe in the latest Stat of the Week. Among other things the analysts determined that less hedging was done this year, with most by swaps instead of collars. E&Ps also have become "comfortable" hedging at depressed prices -- with some locking in sub-$5/Mcf hedges.

If gas prices remain below $4.50/Mcf, 2011 capital budgets, as well as the rig count, likely will be cut as the coming year progresses, said Adkins and his colleagues.

"The past year has been a very discouraging time for E&P companies looking to hedge gas," said the team. "While prices started the year around $6/Mcf, they quickly fell into the low $4/Mcf range by early spring as the market realized that supply was actually growing -- not falling (as we had warned). As the supply/demand imbalance deteriorated through 2010, the opportunity to hedge 2011 worsened as well."

The natural gas futures curve "flattened substantially through 2010, and Cal 11 (average of all 2011 gas contracts) fell by nearly $2/Mcf. Even short-term weather-driven opportunities to hedge were nonexistent."

During the record summer heat, prompt prices rallied above $5/Mcf, but "Cal 11 didn't budge, hovering around $5.50/Mcf," said the analysts. "Even now, the futures curve is the flattest we have seen in years, and Cal 11 is averaging only 30 cents higher than January. The flat futures curve is reflective of the low-risk, developmental nature of supplying natural gas these days."

On average, in 2011 the E&Ps covered by Raymond James have hedged 34% of gas production at $5.92/Mcf and 27% of oil production at $73.03/bbl. Not surprisingly, producers are more bullish about oil prices in 2011, but "we believe that E&P companies are equally bearish, if not more so, on gas in 2011 but are often reluctant to lock in prices at such low levels."

Most companies haven't finalized their 2011 budgets. However, a preliminary forecast by Raymond James indicates that spending will be "merely 2%" higher year/year.

Using the current Raymond James price deck of $4.24/Mcf and $80/bbl, the analysts determined that "E&P spending is set to outpace our 2011 operating cash flow assumptions by 10%. With the market looking for more capital discipline, especially from natural gas producers that are outspending cash flow, we believe that budgets are likely to be cut through 2011 as gas prices remain at depressed levels, possibly even lower than our $4.25/Mcf forecast.

"In addition to cutting spending and laying down rigs once acreage is held by production, we anticipate that producers will focus a higher percentage of spending on liquids drilling."

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