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Banker: Savvy Contrarians Should Think Conventional

Breakeven shale play economics in a low-gas price environment have driven a migration to liquids-rich and oil plays. "Being in liquids is not only cool; it's profitable," an investment banker said in Houston Tuesday. "You can produce gas even if you don't make money on the gas because the liquids are worth so much more." But maybe now is the time to be a contrarian, she suggested.

At the Argus Shale Liquids & Gas Summit Sylvia Barnes, head of energy investment banking for Madison Williams and Co., recalled how during the first half of 2008 gassy assets were in favor. All of a sudden, that changed in 2009 and the first half of 2010, she said. But in "tortoise and hare" style, the stocks of gassy companies are coming back, she said.

"Here's a question," Barnes said. "Should we rethink conventional gas? It is an asset class out of favor. You can buy [it] cheaper. There's less competition. We're seeing situations where people are just paying the PV10 [present value of estimated future revenues, net of estimated direct expenses, discounted at an annual discount rate of 10%] of the PDP [proved developed producing] reserves and getting the proved undeveloped for free, never mind the probables and possibles."

The holder of conventional assets can generally sit on production and wait for prices to improve without spending a lot of money to do so, Barnes said. This is partly due to the fact that there's usually no pressure to drill in order to hold leases. Additionally with conventional plays, any needed infrastructure is usually already on the ground.

"The question may be: is conventional gas one of the best deals in town right now? Do you have the conviction; do you have the willingness to be a contrarian? Or do you want to be a naysayer? This is what I'm living through with clients," Barnes said.

To those who would assert that shale gas production is going to keep a lid on prices into the future, she would respond: "History tells us otherwise. The point is, even a modest increase in natural gas [prices] can make a big difference.

"Think about what's happening in the world situation, not just in Houston, TX, but elsewhere. There is an LNG [liquefied natural gas] trade. There is an increased focus on environment, health issues, natural gas for power generation... natural gas as a vehicular fuel."

Barnes suggested that acquirers focus on smaller conventional deals where they can be more nimble and creative than the industry's larger players. She allowed that the reluctance of shareholders and company boards can be a constraint on contrarian strategies. "Explain the economics [to constituents]...But don't go off the reservation. This strategy isn't for everyone...'What if I'm wrong?' Well, your downside is limited.

"I will urge you to remember what Gen. [George S.] Patton said: 'If everyone is thinking alike, then somebody isn't thinking.'"

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