Natural gas explorers appeared to be cutting their capital expenditures (capex) almost as soon as the new year began, but some producers are beginning to spend more and drill more — a scenario that may lead to more pain in the next few months, Raymond James & Associates Inc. analysts said Monday.

In their mid-year capex survey of exploration and production (E&P) companies, Raymond James’ J. Marshall Adkins, John Freeman and Kristal Choy found that about three-quarters of their covered gas-weighted producers, which are 80% or more weighted to gas by reserves, have cut their capex since January.

“No surprise here since gas prices were still in the $5 to $6 range at the beginning of the year (versus sub-$3 today),” they wrote. However, “the average budget decrease over all gas-weighted producers has been a meager 2%.” In addition, the gas rig count has risen 4% since bottoming in mid-July.

The Raymond James capex survey covers 50 companies, which represent about one-third of U.S. gas production; those companies not covered include the majors and private producers. The covered producers, wrote Adkins and his colleagues, tend to “pursue some of the most aggressive drilling programs in the country — not to mention that they have some of the best drilling prospects as well.”

That said, several “gassy” operators have “substantially” increased their capex since January, they wrote. Petrohawk which is onshore-focused, has increased its capital spending almost a third since January (30%), while Bill Barrett Corp., also an onshore gas producer, has lifted spending by 17%. XTO Energy Corp., another big-time onshore explorer, has increased its capex by 13% since the start of the year.

“What this indicates is that while spending on gas projects is down significantly in 2009, continued reinvestment by the top gas-producing independents is still strong enough, in our opinion, to slow the decline in gas supply,” said the analysts, who reviewed the supply data in a note earlier this month (see Daily GPI, Aug. 18). “With newly printed E&P balance sheets (about 15 of our companies have issued equity this year, some even more than once!), many companies will largely continue drilling into the winter, as the decline in service costs has made a number of plays at least marginally economic even at sub-$4 gas prices.”

Analysts said the “biggest surprise” in their capex review was seen among Gulf of Mexico (GOM) operators, which have “actually upped their budgets as a group, focusing more on deepwater projects that provide more long-term upside (a reaction to the currently weak environment is to invest capital in an asset that won’t commence production for two years anyway, when things should be better).”

Meanwhile, the large-cap E&Ps, which comprise more than 60% of the spending in Raymond James coverage, have reduced their capex budgets by 6% in aggregate since January. Most of the large caps have actively pulled rigs and reduced activity in onshore gas plays and have refocused their efforts overseas or on longer-term GOM projects, said the analysts.

Looking ahead to 2010, the Raymond James trio said companies “think spending is probably going up…we think it’s likely going down. While it’s simply too early for us to have a high degree of confidence on 2010 U.S. natural gas prices, the markets seem to be confident in a 2010 gas price rebound. In light of this, very early E&P capex discussions indicate that producers generally feel that 2010 spending will be flat to up modestly.”

On the surface, producers’ optimism makes sense, said Adkins and his team. “2010 gas futures have been remarkably strong through most of this summer (averaging close to $6/Mcf) and average year/year drilling costs will average down about 20% from 2008 averages.”

However, “we would take the ‘under’ on these preliminary 2010 rising capex forecasts. Even though E&P balance sheets have improved dramatically over the past year, we think there is more pain to come. We predict that a number of E&P companies will have borrowing bases cut from current levels from bank debt ‘redeterminations’ over the next two months,” when banks reset debt limits based upon current gas prices and reserve estimates.

“This could create a double whammy for some E&P companies as low gas prices over the next few months combine with lower reserves to whack borrowing capabilities,” the analysts wrote. “In other words, the ‘redeterminations’ of bank lending limits over the coming months could hamper liquidity and lead to a reduction in projected spending on gas projects. This may be somewhat offset by the growing amount of capital put into oily plays and probability that companies will come to the equity markets, but we believe 2010 spending will more likely be down an aggregate 5% in 2010.”

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