With three-quarters of the year complete, producers are “well positioned” to generate cash flow that exceeds drilling budgets by about 30% this year — and a similar situation in 2004 could lead to more acquisitions, according to a recent analysis by Lehman Brothers.

Analyst Jeffrey Robertson used New York Mercantile Exchange benchmark price deck estimates of $30.25/bbl and $5.45/MMBtu and found that first half exploration and development spending “consumed 47% of current capital budgets.” Capital budgets in turn inched higher for several producers over the summer, and some have announced plans to increase spending through the rest of the year.

However, while much of the surplus cash currently is going toward balance sheet improvement, Robertson noted that most management teams may begin to see acquisitions as “an important means to add new drilling opportunities” and thus evaluate purchases on a competitive basis with internal drilling projects.

“Finding and development cost creep is likely to keep acquisitions as an attractive alternative to some incremental drilling programs,” Robertson added.

Management teams now are writing up 2004 budgets, and Robertson said most are “trying to balance expected cash flow with the funding requirements of exploration and development projects generated by technical teams.” But in 2003, “we do not believe that many producers had the project inventory to prudently spend all of their cash flow…instead, taking the opportunity to improve their capital structure and/or acquire assets.”

In a preliminary review of 2004, the Lehman analyst compared discretionary cash flow estimates using a price deck of $25/bbl for oil and $4.25/MMBtu for gas to 2003 budgets. The modeling estimated a 20% surplus over this year’s spending levels, which “suggests there is some room for spending increases in 2004. The key consideration will continue to be a company’s ability to generate enough attractive drilling projects versus the relative attractiveness of acquisition opportunities.”

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