NGI The Weekly Gas Market Report
Flush with profit from surging natural gas prices and a stockrise across the board this year of about 85%, North Americanindependents still appear to be in no rush to secure financing formore exploration and production activities. And unless you’ve gotequity or a strong balance sheet, lenders still may be wary beforejumping into any financing deals.
Instead, the independents — especially the smaller ones —are rebuilding the bloody balance sheets devastated in the bust twoyears ago, and cautiously looking for ways to secure shareholdervalue and regain investors’ confidence. Despite the hesitation, itis falling more and more to the smaller independents to exploit thenatural gas reserves in North America, as the majors turn moreattention toward exploration in the deep Gulf of Mexico andoverseas. Soon, say analysts, some independents may announcesignificant investments in North American E&P.
“For the blue chip companies, like the Apaches, investmentopportunities have already opened up and actually never stopped,”said David Khani, senior energy analyst with Friedman, BillingsRamsey & Co. “The smaller guys are just starting to look forinvestments. I think later this month and into October, we’ll seefive to 10 offerings by some of the smaller independents.”
Because about 70% of most independents’ portfolios is in naturalgas, “if the independents can’t find financing now, they’ll neverfind it,” said Fahnestock & Co.’s Fadel Gheit, an energyanalyst and research director who covers a lot of independents.”It’s now or never.”
Still, Khani pointed out that investors have to be confidentthat the high natural gas price cycle will last. “It’s starting tosettle in that gas prices will remain high,” he said. “The lendersare starting to gain confidence.”
Investments will be easiest to come by for those companies withequity, said Khani. “Equity is the first way to obtain financing.The next is when the high-yield market opens up, and finally, thecommercial banks start to increase their lending. Equity financingis just opening up now. But it’s just starting.”
For an independent looking for financing, it has to have hadsome drilling success, a focused strategy and a balance sheetrepaired from the last bust two years ago.
“No one wants to lend to companies with damaged balance sheets,”Khani said. “They want to see a good, clear view of drillinginventory.”
Drilling inventory, though, is certainly not the most importantthing anymore, said Gheit.
“We’re not seeing a rush to glory like we did a few years ago,”said Gheit. “We’re not seeing a rush to spend money. Theindependents got wise. They are looking for shareholder value and areturn on the capital employed.”
Gheit, who covers Mitchell Energy and Development Co. amongother independents, said companies no longer are rewarded fordrilling holes, but for “drilling holes that produce.” Before thelast bust, independents would book all of the drilling rigs theycould and when they went to the bank, the lenders would look at thedrilling program and make the loans based on that information.
“Amazing,” he said. “It’s not that way anymore.” He even knowsof companies that until two years ago, would drill in areas theyknew would not produce. “My view, and we can joke about it now, butthose companies could have been sued by shareholders. At the time,the exploration programs were geared toward a big noise and notnecessarily a result. Nobody cared.” Two companies thatparticipated in dry hole drilling, which he would not name, arenear bankruptcy today.
“In the last bust, a lot of companies lost their credibility,and their investors dropped out and are not coming back,” saidGheit. “Making promises and not keeping them…that’s a killer.”
Irene Haas of Sanders, Morris Mundy said it’s still “tough forthe small guys.” She said the market is “warmish,” but theindependents have to have one of three things to gain financialbacking these days: a good balance sheet going in, a healthycompany with excess cash flow or minor problems with the balancesheet that are in the process of being fixed. “Those with evenminor problems are still having difficulties obtaining loans,” shesaid.
Another problem is with the lending institution itself. Sincethe last bust two years ago, many of the commercial banks have beenrestructured and many no longer service loans for less than $100million, she said. “The need for financing comes from the equityside in those cases.”
Analysts said that some of the smaller companies that aresetting an example for other independents to follow includeComstock Resources, based in Frisco, TX, Spinnaker, based inHouston, and Nobel Affiliates.
“Comstock Resources is very small and very focused,” said Gheit.”It has 97% of its holdings in natural gas, and there’s no hedging.This is the kind of company that’s in a dream position today.”
Haas said that Houston-based Spinnaker recently completed somesuccessful financing because it improved its balance sheet andfocused its attention on specific properties in the shallow waterGulf of Mexico.
And Khani pointed to Nobel Affiliates, which had been down to1/3 of what it is today after the last downturn. “Now they’veturned the corner after waiting and cutting back on production. Alot of investors had given up on Nobel, but this is the kind ofindependent that took its time.”
Other areas where analysts expect to see independents shine inNorth American exploration, specifically the United States, will bein East and South Texas and the Powder River Basin in Wyoming.
Khani said it may be surprising, but many of the best pricedstocks today are the highly leveraged independents, who were “sobeaten up in the last downtown and now the stock prices areperforming.” He said that with the commodity prices up, the cashflow is helping even highly leveraged companies with their balancesheets.
To improve domestic natural gas production, expect to see moreof the smaller independents merge. “The best ones will be theprospect-rich company combining with the cash-rich company,” saidKhani. “The small guys have a second shot at life because commodityprices are strong. We’ve seen companies on the brink of goingunder, already in Chapter 11 and then come out. Those are the oneswho go out and make the deals.”
Carolyn Davis, Houston
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