Admitting that this month may not be the same “March Madness” byexploration and production companies that was experienced a yearago, the sector is expected to advance “strongly” again this yearbecause of the “mounting confidence” in relatively firm natural gasprices and under-appreciated crude oil prices in the near term,according to a Salomon Smith Barney E&P report released thisweek.
Noting that February had been a “dismal month” for most of theother broader markets, SSB analysts Robert Morris and MichaelSchmitz said that E&P stocks “held up fairly well.” The SSBE&P composite declined by only 1%, compared with a drop of 10%in the Standard & Poors 500 and a 23% drop in the NASDAQindices. At the same time, they noted, natural gas prices posted anearly 30% decline as fears of shortages this winter abated. Forthe year-to-date, SSB’s E&P composite was off almost 8%compared with a 5% decline in the S&P 500 and a 15% drop n theNASDAQ.
“We continue to believe that the E&P sector, on average,will advance again in 2001,” they said. The analysts noted thatthere is a “clear indication” that increased spending by U.S.independents is limited “by a lack of ‘drill-ready’ projects andexperienced geoscience personnel to accelerate the timeline on theexisting inventory of projects. In addition, we believe thatcompanies are beginning to be constrained by a lack of oilfieldservice equipment and drilling rigs.”
While many independents will continue to generate “significantexcess cash flow,” SSB said that it likely would be used to reducedebt and to repurchase stock. “Consequently, it is not surprisingthat most independents are less concerned with their balance sheetsat this juncture.”
As the year progresses, Morris and Schmitz said that investorswill gain confidence in the sustained natural gas prices, whichthey view to be between $4.00-$5.00/MMBtu — even higher duringpeak periods for the foreseeable future. In the near term, theanalysts said that the upside to expectations “may lie more withcrude oil than natural gas prices, although we still expectrelatively firm natural gas prices to provide much of the ‘heavylifting’ for this group longer-term.”
“The larger debate surrounding natural gas prices currently ishow much domestic production will expand this year,” said theanalysts. “Our detailed analysis indicates that volumes should growby around 3%, although this would entail a drop in rig efficiencyfrom roughly 22 MMcf/d/rig/year in 1999 to 10 MMcf/d/rig/year forthe last 100 rigs put to work in the U.S. drilling for naturalgas.”
They said that nonetheless, “if domestic production expands 3%this year and GDP growth is 1.25%, and incorporating numerous othervariables, then storage levels are likely to approach, or perhapsslightly exceed, the nearly 2,800 [Bcf] mark attained at thebeginning of November last year.”
With “only five weeks left to be reported in the traditionalstorage withdrawal season, it appears that storage levels willlikely end March at around 700 Bcf, plus-or-minus 50 Bcf dependingon temperatures, compared with just over 1,000 Bcf last year at theend of March,” said Morris and Schmitz.
“With storage levels on course to end this season well belowlast year, composite spot natural gas prices now stand at roughly$5.00/MMBtu, or 95% higher than last year at this juncture. Whilethe larger debate currently surrounds how much domestic productionwill grow this year, our $5.00/MMBtu composite spot forecast forthe full year incorporates an average composite spot price of$4.75/MMBtu for the second quarter and $4.25/MMBtu for the thirdquarter…Obviously, prices in the fourth quarter will again belargely dependent on temperatures across the country, but we haveconservatively assumed a $4.25/MMBtu composite spot price for now,”they said.
On production growth, the analysts noted that this year, itwould largely depend on the “extent of the drop in rig efficiency.”They said it is “still too early to precisely gauge the extent ofthe drop in rig efficiency for the last 400 rigs put to workdrilling for natural gas in the U.S.” Longer-term variables will bethe weather and U.S. economic conditions. “We would note thatdomestic natural gas production growth is not expected to exceed3.0% in 2002 while additional incremental liquefied natural gassupplies next year will depend on the timing of the recommissioningof two existing facilities.”
SSB’s top picks among the larger market capitalization groupincluded Anadarko Petroleum, Apache Corp., Devon Energy and EOGResources. Small- to mid-cap names that SSB said “stood out” wereChesapeake Energy, Cross Timbers Oil, Stone Energy and VintagePetroleum.
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