E&P companies that survive and profit in the continuing volatile natural gas market will have to balance growth with profitability and avoid some of the typical pitfalls that can send a company into a crisis mode, Arthur L. Smith, chairman of John S. Herold Inc. told a GasMart/Power 2002 audience Tuesday.

One recurring mistake companies make is in failing to do adequate due diligence when making an acquisition. “They buy before they really assess what they’ve got. Another is mismanagement of a company’s balance sheet that results in over leverage. “Your capital structure looks good when your reserves are valued at high levels, but deplorable when prices fall. I always tell companies to listen to Wall Street, but don’t do anything they tell you. They’re very good at valuing companies, but they don’t know how to run them.”

Another element that trips companies up is putting too much emphasis either on growth or on profitability. Success lies in a balance. Smith, who heads up the Stamford, CT-based petroleum consulting firm, and Richard Sharples, senior vice president of Anadarko Petroleum and president of Anadarko Energy Services, pointed to the precipitous decline in the number of independents as evidence of the expensive and sophisticated technology and management necessary to succeed in today’s market.

The E&P industry has not returned the cost of capital in 14 years except in 2000 and 2001, Sharples said, pointing out that the industry “ate tremendous amounts of capital.”

Sharples said the key is “aggressively managing your asset base, matching capital expenditures to the business cycles, and sitting on expensive projects until prices are high enough to make a profit on them. “It takes a tremendous amount of capital discipline and balance sheet management. It’s not easy to cut capital spending.” The trick is to “capture the resource in areas where it is economic.” Less mature basins, such as the deep Gulf of Mexico, the Rockies and Canada can be more expensive and require a longer lead time, but they will pay off in a higher-priced market. Sharples said Anadarko is “very excited” about prospects in the upcoming Eastern Gulf lease sale.

Because of the dramatic decline in the reserve life of new wells being drilled — 52% in a year — small changes in prices have a swift and dramatic effect in deliverability, Sharples said. And “any slowdown shows up very quickly,” which is part of the reason prices are starting to go up again after the drop in drilling in the second half of last year. At the same time production was declining in the fourth quarter, “we are now finding out that demand was picking up.” Currently demand is exceeding production by 2.8 Bcf/d, he said.

Sharples said the producing industry needs to focus on developing its human resources base. “People in senior positions are at or near retirement” and petroleum engineering graduates are at an all-time low.

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