Even if oilfield prices go up by 15-20 % next year, as Raymond James expects to occur, the negative ramifications on exploration and production returns will be surprisingly small, according to Raymond James analyst J. Marshall Adkins.

Addressing questions surrounding its prediction that the average rate of return on the average U.S. gas E&P project currently has above a 50% internal rate of return (IRR) at $5.00/Mcf gas price, Adkins said the impressive return rate won’t be eroded by higher oilfield service costs because drilling and equipping costs represent a little less than half of all finding and developing (F&D) costs.

“When we include lifting costs, oilfield service costs represent less than 30% of the total cost of finding and producing natural gas in the U.S,” he said in Raymond James’ Stat of the Week. “That means that even with a 50% increase in oilfield service pricing, E&P companies would still generate over a 30% rate of return at $5/Mcf natural gas prices.

“It stands to reason that if natural gas prices hold in the $5/Mcf range (as we believe they will), cash flows and drilling activity levels next year will average higher than in 2003,” Adkins continued. “Likewise, after experiencing only minor oilfield service price increases so far this year, continued upward movement in activity levels are highly likely to push oilfield pricing up further next year. The question is, how much higher and what does this do to E&P reinvestment returns?”

From the study, the Raymond James analyst found that a very significant oilfield service price increase in the 25% range would still allow average E&P returns above 40% at $5/Mcf natural gas prices. Even if the service industry puts through an amazing 50% increase in overall service costs yields, E&P returns should still reach about 30%. Even assuming a natural gas price of $4/Mcf, Adkins found that price increases of up to 25% still yield E&P investment returns of 20% or more.

“While some may fear that the slow, almost non-existent rise in oilfield service pricing to date is a sign that it won’t or can’t increase much further, a thorough analysis of current E&P rates of return show that oilfield service pricing can increase meaningfully without compromising solid returns,” he said. “This is precisely why we think the next couple of years should provide the best of both worlds as oilfield service companies and E&P companies prosper from a sustainable higher U.S. natural gas price environment.”

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