Despite the volatility in natural gas prices, Raymond James’ mid-2006 exploration and production (E&P) capital expenditure survey indicates North American producers’ total spending in 2006, which includes exploration and development (E&D), acquisitions and stock buybacks, should jump 10-15%.
Of the North American producers Raymond James covers, E&D spending in the first six months was up 35% from a year ago, and total cash flow, before changes in working capital, was $25.1 billion, a 27% increase, according to energy analysts Wayne Andrews, John Freeman and Pavel Molchanov. “While some of this increase was a result of the exceptionally robust oil price environment, we estimate that at least 10% came from production growth.”
Raymond James’ spending analysis represents only about 25% of U.S. production, and the 48 producers surveyed “pursue among the most aggressive drilling programs in the industry,” and likely have some of the best drilling prospects. The analysts said their conclusion that E&D spending should rise “should not…be extrapolated for the entire industry. In particular, U.S. drilling activity by the majors has been little-changed over the past 12 months, and in the second half of 2006, the majors are unlikely to grow their E&D spending by more than 10%. At the same time, we think that 2006 E&D spending by independents outside our coverage universe should post smaller but still solid growth of 15% to 20%.”
Raymond James estimated total spending for the first six months of this year among the producers it covers at $32 billion, a 29% increase. The spending included $20.6 billion (64%) for E&D, $9.2 billion (29%) for property acquisitions, and $2.2 billion (7%) for share buybacks. The “most important fact,” noted the analysts, is that E&D spending is “by far the largest component of capital expenditures for our universe.”
Capital budgets “keep going up, up up. For 2006, our universe had initially budgeted $39.3 billion for E&D, up 15% over actual 2005 spending. Now the mid-year budget increases are in, and they are averaging a healthy 5%.” Mid-2005 budgets were up 14% over initial 2005 budgets, “so there may be a moderation in the growth rate, but the upward trend is very much intact.”
In total, revised budgets for 2006 are at $41.3 billion for the 48 producers, but “as has historically been the case, we believe that companies will outspend even these higher budgets.” Raymond James’ updated forecast is for E&D to total $43.1 billion this year, implying growth of 26% over 2005 spending and 10% over initial 2006 budgets. “Given our $51.2 billion cash flow forecast, this leaves plenty of room for acquisitions and/or stock buyback.”
Capital expenditures so far favor drill-bit growth, but acquisition spending also is strong. Raymond James had originally projected a “noticeable” shift toward more E&D spending and fewer acquisitions this year. “However, given the significant number of large property acquisitions announced by several of the companies in our coverage universe year-to-date, 2006 looks likely to be a record year for property M&A in the E&P space. In 2005, acquisitions by our coverage universe totaled $12.8 billion, and year-to-date, we have counted over $8 billion already (not counting the large number of corporate mergers). Accordingly, we now believe that the percentage of cash flow spent on E&D will still rise, but moderately, into the 80% to 85% range.”
According to Raymond James, the most prolific 2006 acquirers include Chesapeake Energy, which has bought more than $1.5 billion of producing properties in several transactions, most notably in the Barnett Shale; Apache Corp., which has bought $1.3 billion of producing properties in the Gulf of Mexico; and Occidental Petroleum, which has bought $865 million of producing properties in Texas and California.
Drilling spending this year is estimated to rise about 25% this year, assuming E&D spending remains high, said the analysts. “Our full-year E&D forecast of $43.1 billion implies $22.5 billion of spending in the second half, which would be about 9% higher than the amount spent in the first half. In other words, spending is likely to be back-end-loaded. This bodes well for drilling activity in the second half. Of course, normal industry-wide cost inflation is one of the factors behind this increase.”
With near-record commodity prices, the incentive to drill is “arguably the strongest it’s been in the past two decades,” said the analysts. “In the rig market, prices are determined, like anywhere else, by supply and demand. Demand is, to put it mildly, very robust, as can be seen by the soaring North American rig count. Supply, meanwhile, is struggling to catch up. Thus, prices must go up to bring the market into equilibrium.”
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