Cabot Oil & Gas (COG) saw its stock jump to an all-time high this week as it reported strong profit growth. In the stock market hype, however, Cabot's natural gas outlook fell prey to an oversimplification in media sound bytes. True, like other natural gas players, Cabot will benefit when natural gas prices go up. But these pundits overlooked that Cabot is producing cash flow now, at $3.50 billion cubic feet (BCF), and has 45 new wells coming online at its high-return Marcellus Shale property.
Cabot is active in three shale projects - Marcellus, Eagle Ford and Haynes. At Marcellus Shale, Cabot owns eight of the top 25 producing wells. The company is benefiting as technological improvements are shifting market share to lower cost producers at the Marcellus formation, which contains one of the largest deposits of natural gas in the world. Cabot uses hydraulic fracking technology that allows for deeper and horizontal drilling, thereby lowering the cost of recovering natural gas situated in pore spaces of shale. Estimates of recoverable natural gas resources at the Marcellus Shale running through the Appalachian basin in Pennsylvania range from 262 to over 500 trillion cubic feet (tcf).
Cabot is part of a shakeout in the Marcellus Shale in which higher cost producers are slowing production and lower cost producers are moving in. Chesapeake Energy (CHP), for example, which holds $9 billion in shale gas assets, says it cannot afford to drill at current prices of $3.50 bcf. The early vertical driller at Marcellus has diverted its attention to Ohio's Utica Shale formation, where it holds 71 percent of the permits. Cabot, on the other hand, says it will continue to generate positive cash flow at gas prices of $3.50 bcf at Marcellus in 2013.
Another low-cost producer, Southwest Energy (SWN), has quickly ramped up production to 300 Mmfce per day in 2012 and expects to reach 800 Mmcfe/d by 2017. By way of comparison, Cabot is currently producing just under 800 Mmfce/d at Marcellus. The energy company, which was an early investor in Marcellus acreage but only recently started production, is one of the lowest cost producers. Southwest claims it can drill gas at Marcellus at natural gas prices below $3 on about 120,000 of its 190,000 acreage. Another low-cost player worth looking in on is Range Resources (RRC). It is extracting 557 mmcfe per day in shale gas from its 750,000 acreage and directing 86 percent of its capital spending to Marcellus.
At higher gas prices, more shale acreage will be drilled and supply will tighten. The lack of drilling of shale by some large energy players may be tied up with an LNG strategy. Exxon Mobil (XOM), for example, is buying up shale assets across North America with future plans to ship LNG from the west coast to the higher priced Asian natural gas markets at attractive margins. But for now, deeming extraction not cost effective at current prices, drilling at Exxon Mobil's 660,000 acres at Marcellus is dry. Asia's LNG demand may loosen up the supply situation.
At the current low-natural gas prices, Cabot is profitable. In the third quarter, profits were up 29 percent to $36.6 million, or $0.17 per share on a 13 percent revenue increase to $269.9 million. The energy firm increased production 33 percent to 66.5 billion cubic feet - 62.7 was natural gas production while 639 was liquids production. Liquids production was up 61 percent and natural gas production 31 percent. In the quarter, oil prices rose 17 percent to $101.34 while natural gas prices were down 20 percent to 3.68.
Going forward, the company is focused on increasing liquid natural gas production. In the fourth quarter, 45 natural gas wells in Marcellus will begin production, up from previous estimates, for a total of 84 wells in production in 2013. Finishing up 2012, on expectations of industry leading production, Cabot has upped its 2012 oil production growth range to 38 to 44 percent. For 2013, growth of 35 to 50 percent is anticipated. Liquids production has been upped to 60 to 70 percent. In 2013, liquids production growth should be up 44 to 55 percent.
Cabot's capital expenditures will increase from $775 to $825 in 2012 to $950 to $1.025 billion in 2013. Seventy percent of capex will be targeted to higher rate of return wells at Marcellus. At current commodity prices of $3.50, the rate of return at Marcellus exceeds other gas plays and many oil plays, says, says CEO Dan Dinges. Cabot expects to continue to have positive cash flow at $3.50 for natural gas and $90 for oil.
Year-end 2012 production numbers for Cabot competitors show it was a good year for low-cost shale producers. Southwestern Energy (SWB) has forecast production growth of 13 percent for the year.
Southwest's earnings were hit harder by low-natural gas prices across its portfolio of natural gas projects, some of which are producing at higher costs than Marcellus. It has an operating margin of 32.30 and EPS of -0.14.
Range Resources expects a 35 percent production increase in 2012. However, the company's earnings were down as a result of incurring a loss on a hedging position entered into to offset low-natural gas prices. It has an operating margin of 8.36 and EPS of -0.24. EOG Resources expects production to be up 9 percent in 2012. EOG, with higher shale gas extraction costs and over production, is diverting its attention from dry liquified natural gas wells to oil shale plays. EOG Resources has an operating margin of 20.44 and EPS of 5.13.
Cabot stands out as a profitable producer of liquified natural gas at today's gas prices. Its operating margin of 18.06 is well above the industry average. Following its recent stock rally, its earnings per share is .55 times. It is well positioned to benefit from a future export market in liquified natural gas.