North American exploration and production (E&P) executives now have confidence in sustained higher commodity prices this year, which may lead to larger capital spending increases from those publicly announced as well as more mergers and acquisitions (M&A), according to a report by Raymond James & Associates.
Analysts conducted an informal survey at the recent North American Prospects Expo (NAPE) in Houston. In particular, said analysts, the questions to about 40 E&P and oilfield service executives revealed that they expect natural gas and oil prices to average 10-15% higher than Wall Street expectations.
The average 2005 gas price estimate of those surveyed was $5.27/Mcf, with a high of $6.35 and a low of $4.25. The average oil price estimate was $30.89/bbl, with a low of $28 and a high of $35. “Given the large disparity between what the Street thinks and what the industry insiders really think, current cash flow and spending forecasts are likely too conservative,” said analysts J. Marshall Adkins and John Tasdemir.
Asked why capital spending remains conservative in light of the high commodity price outlook, the surveyed group generally thought that budgets reflected expectations of less than $4.50/Mcf gas and less than $26/bbl oil. “If commodity prices do remain above expectations, spending levels could be meaningful higher. In fact, many companies were ‘front-end loading’ their budgets with the expectation of increasing spending if energy prices hold up.”
For companies leveraged 40% or higher debt-to-equity, capital spending is expected to remain below cash flows to fund more debt reduction. Also, the majors “likely” will continue redirecting the largest amount of cash flow outside of the United States. “Overall, we expect industry capital spending levels to make up about 70% of generated cash flows pushing overall capital spending levels 10% to 15% higher in 2004.”
Many of those surveyed were willing to invest more in natural gas than oil drilling in the United States. Gas prices, said respondents, are determined by North American supply and demand rather than by oil-related external market forces and “political wild cards.” And, the past decade, oil producers have strategically abandoned many North American exploration and development operations in oil basins.
Concerning expectations for service costs and their impact on drilling activity, the general consensus among the E&P executives was that service costs would only move up modestly this year and would not have a negative impact on drilling plans. Some thought there could be a “meaningful” price increase in the last half of 2004, and many of the smaller operators have locked in contracts for the next few months.
The survey also questioned E&P executives about lagging Gulf of Mexico activity. “First and foremost were comments that the larger scale and higher risks associated with offshore drilling are causing offshore players to be more conservative than onshore players.” On example was that deep-shelf exploration, with success rates as low as 10-15%, requires long-term confidence in prices and larger capital outlays — and “there are significantly fewer players with that type of capital.” Energy price volatility also is still too high for the smaller players to justify some offshore projects, respondents said.
“Additionally, recent asset turnover in the Gulf could be enhancing the lag factor,” said analysts. Some executives also noted that the majors “still hold a large percentage of blocks in the Gulf with declining production and have shown limited willingness to divest or farm them out.”
Asked about the mergers and acquisition (M&A) market this year, respondents expect more than in 2003 because of the “huge amounts of cash generation by large E&P companies and their inability to grow organically.” The majors, which are focused on productivity, “have continued to shed higher-cost, non-core assets, and private companies are finding it difficult to refuse higher bid prices.”
Raymond James’ analysts also noted that they “would not be surprised by an increase in corporate transactions” this year. “One of the more interesting things we heard concerning the M&A market was the opinion that as much as 30% of Canadian properties changed hands last year.”
Most of the respondents did not believe passage of a energy bill would change their operating plans. “The general feeling was that tax credits and incentives aren’t deal makers, but access to restricted acreage, streamlined permitting and loosened environmental restrictions would be the keys to a successful policy.”
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