Natural gas production in 3Q2009 by the top domestic explorers showed little sign of pulling back, and aggregate output by the end of the year likely will be 9% higher than in 2008, according to an analysis by the exploration and production (E&P) research team at Tudor, Pickering, Holt & Co. Securities Inc. (TPH).

Most of the gas-directed E&P companies showed no signs of slowing their strong production growth in the last quarter, especially the “fastest growing, ‘shaliest’ companies,” said the TPH team, which covers 30 of the top-rated publicly held domestic gas producers.

Spending is likely to increase on average in the new year, the TPH analysts said.

Going into 2010, “we think overall cash flow for our coverage universe grows 25% (to $58 billion) as higher benchmark prices should drive higher cash flows with production growing only 9% y/y [year/year],” said the team. TPH now expects capital exploration (capex) budgets will be up 19% y/y “as E&Ps begin ramping activity during the year, supported by higher commodity prices, but they will be fighting against the production declines created by slower overall 2009 activity levels.

“We think of 2010 production as lower in the first half of 2010, higher in the second half,” which would set up “nice 2011 volume growth (assuming gas prices don’t make life difficult).”

Service costs fell drastically this year from 2008, but TPH expects costs to be almost flat in 2010.

“After coming in 5% below our estimates in 2Q2009, all-in, per-unit costs came in as expected in 3Q2009; we forecast a 1% y/y increase in 2010,” said the analysts. “With higher cash flow expected in 2010 (plus 25%) we increased our capex outlook next year (plus-8%) and now forecast the sector plows back 77% of cash flow in 2010 (versus 90% in 2006-2008).”

More cash will go toward increasing liquids production from the gas plays in 2010, the TPH team predicted.

“We’re forecasting overall plus-9% y/y [growth] in 2010, with liquids contribution to overall production growth increasing,” said the analysts. “Liquids growth is 8% y/y in 2010 compared to 7% in 2009, while gas growth is plus-9% in 2010 compared to plus-11% in 2009.”

The TPH 2010 price deck is $7.50/Mcf for gas and $67.50/bbl for crude oil.

“Assuming the current 2010 strip ($5.35/Mcf and $82.95/bbl), 2010 plowback would be 79%,” said the TPH team. “Assuming $6/Mcf, 2010 plowback would be 85%. Assuming $5/Mcf, 2010 plowback would be 91%, inline with 2006-2008 averages. So companies will be generating free cash for acquisitions, or their budgets will increase as gas prices rise. We bet some of both.”

The TPH-covered universe has an estimated average 40% of total production hedged at $8.67/Mcfe (43% gas at $7.00/Mcf; 58% oil at $74/bbl).

“We expect as gas prices move higher into winter months/early 2010, more companies will take advantage of opportunities to layer in additional hedges at more attractive prices, locking in cash flows for 2010 and even 2011/2012, depending on each company’s views of the longer-term gas price outlook.

“Many are more cautious than we are for 2010 and more bullish than we are for the longer term.”

In a separate research note, Barclays Capital’s Tom Driscoll reminded investors that gas storage “continues to set records — and it would likely be even higher without infrastructure constraints and voluntary curtailments.”

The 3Q2009 gas volumes “were fairly robust…even with company curtailments,” said Driscoll. EnCana Corp., he noted, curtailed 500 MMcf/d of production in 3Q2009 and “most large producers have indicated further growth in 2010. We believe production remains too high and gas prices are likely to be weak over 2010.”

The Barclays analyst said gas production capacity “appears very strong. We estimate the largest public companies, accounting for over two-thirds of U.S. natural gas volumes, had 3Q2009 gas volumes 1.5% below 2Q2009, and if volumes were not restrained, production would have grown quarter to quarter.”

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