Raymond James’ analysts took away several key things from their 25th Annual Institutional Investors Conference in Florida last week, led by a belief that rising steel prices will significantly impact many areas of the energy business and potentially create a “bottleneck” for activity. However, despite oilfield inflation, bullish exploration and production (E&P) capital budgets still have room to grow.

“The potential impact of rapidly rising steel prices was a recurring issue at our conference,” said analyst J. Marshall Adkins in Raymond James’ latest “Stat of the Week.” With steel prices up more than 30% since December, and April purchases now expected to be near double December levels, “both service companies and E&P companies expect higher steel costs to have a significant impact on the oilpatch in many different ways, including higher tubular prices, pipeline construction costs, rig component and well head prices, platform and spar costs, etc.”

However, there also was a general belief is that the “exceptional returns for E&P companies and strong drilling activity levels will continue despite oilfield inflation. In fact, with rates of return currently exceeding 50%, E&P companies are probably the most inelastic consumers of steel.”

Many of the E&Ps represented at the conference “appear to be in the unique position of being able to grow both production and generate solid financial returns,” Adkins wrote. “We continue to look for above-average growth and stock price appreciation from those E&Ps that reinvest the bulk of their cash flows into organic expansion and accretive acquisitions, while striving to maintain fiscal discipline over the commodity cycle.”

Management teams emphasized at the conference that they “continue to aggressively reinvest their cash flows into exploration and development in anticipation of continued high prices,” said Adkins. “At the same time, most capital budgets are based on more moderate price assumptions than what the market is currently providing, and as a result, we expect many E&Ps to boost their budgets during the course of the year — as was the case in 2003. Furthermore, projected cash flows are high enough to simultaneously fund incremental debt reduction, further improving E&P balance sheets.”

The conference also showed companies with “significant leverage to the North American natural gas market to be especially attractive from a fundamental perspective.”

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