North American natural gas exploration and production (E&P) hasn’t lost its luster for many U.S.- and Canadian-based independents, but for the moment anyway, the exploitation prospects are running parallel or second to producing a strong balance sheet.

At the RBC Capital Markets 2002 North American Energy Conference in Houston last week, several producers painted in detail what’s ahead for drilling and production, but they also were as specific in explaining their companies’ credit and debt picture.

Managing to escape the financial drubbing of the energy merchant sector this year, E&Ps nonetheless have kept close watch on the bottom line, they told institutional and venture investors. High natural gas prices in 2001 built up cash and paid down debt, but still, several believe that the slow and steady approach will earn a better pay off down the road.

Houston-based Southwestern Energy Co., increased its capital budget for 2002 by $10 million just three weeks ago, allocating it to an infill drilling program in East Texas. But CEO Harold M. Korell said the money was going toward low-risk drilling — not just a prospect.

Cost reductions from its drilling program at its Overton Field in East Texas helped the company to hedge a portion of the expected production at about $4/Mcf, he said. The investment return will be more than 40% of the drilling there, he said, which will create about $2 of discounted value for each $1 dollar invested.

Although the budget for this year was increased significantly in the late stages, the 2003 budget remains incomplete — for good reason, noted Korell.

“We’re doing our planning for 2003 right now…in the throes of building it,” he said. The outlook may not be completed before February, but he hinted that the spending will be close to that budgeted for 2002, now around $88 million. “We want to have the ability to fund our capital expenditures and lives within that as well.”

Investors should consider three things when considering an E&P, said Korell. “First is development costs. Not all barrels are created equal. Our development costs have been about $1/Mcf for the last three or four years. Second is reserve replacement. Is it growing or shrinking? We are in fact, growing our reserves.”

Last, he said, and the “only thing I care about,” is the discounted value received for the investment. Korell explained that notionally, Southwestern plans to attempt between $1.30-$1.50 as discounted value. “We have achieved that,” he said. Southwestern uses year-end pricing indexes for its reports, except for the end of 2000, when it used $3/Mcf instead of $8. In 2001, the notional price was $2.65/Mcf.

“We are going in the right direction,” Korell maintained, by maximizing cash flow and staying the course in balancing its strategy through low-cost drilling and a few prospects. For instance, he said that Southwestern will keep its focus on the steady and profitable Arcoma Basin, but will “swing for the fence in South Louisiana,” where success is more tricky.

Richard A. Bachmann, CEO of New Orleans-based Energy Partners Ltd. (EPL), an independent less than three years old, said that his company would “create value in any price environment,” and is pinning its hopes on the central Gulf of Mexico. “Our company is driven by a return on the capital employed,” he said. With a “drill-to-earn” philosophy, the young company has positioned itself in large mature fields with expiring leases and existing infrastructure. Bachmann said the company was “opportunistic,” and would go after moderate-to-high potential prospects.

Going forward, EPL’s priorities are to increase production 20-35%, grow its reserves 25-35% and “focus on cost control,” Bachmann said. Like many of the other smaller independents, EPL will “employ discipline in capital deployment” and “maintain significant liquidity.”

Brought down in the third quarter because of the Gulf of Mexico storms, Bachmann explained that the short-term impact on production and operations “overshadowed” what was otherwise a good quarter. However, even with the production disruptions, EPL’s natural gas sales volumes were near record levels, and cash operating costs per boe were “still lower than they were in the same period last year.”

In the third quarter, natural gas sales volumes rose 56% to 55.2 MMcf/d, compared with 35.3 MMcf/d for the same period of 2001. Total production on a boe basis rose 3% to 16,930 boe/d, from 16,448 boe/d a year earlier. The third-quarter storms impacted production by about 1,100 boe/d.

The RBC conference also was abuzz about a report in the Wall Street Journal concerning a review that is apparently being conducted by the Securities and Exchange Commission (SEC). The newspaper reported that the SEC has initiated a review of how companies account for offshore oil and natural gas reserves, and suggested that the SEC may be updating its guidelines.

The Journal reported that the SEC has “sent a round of information requests” to dozens of oil and gas producers, asking specific questions about how they account for offshore oil and gas reserves, particularly those in the Gulf of Mexico. A spokesman for the SEC declined to comment, but the query was sent by the SEC’s Division of Corporation Finance.

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