Are Natural Gas Producers in Denial? - Canaccord

While global economies continue to weaken, natural gas production appears to be growing despite soft demand and the threat of liquefied natural gas heading to the U.S. this summer without a home.

Many producers in the exploration and production space have made more than one round of spending and production cuts for 2009. Their primary concern is liquidity, while the sentiment in the oil patch is that the current downturn will be worse than previous cycles in the recent past.

But despite this negative backdrop, recent earnings updates show guidance for positive natural gas production growth this year. This has prompted Canaccord Adams to ask: Are natural gas producers in denial?

Analyst Irene Haas explains that producers are still generating cash based on the money hedges put in place during 2008. Others are drilling to secure new leases.

“In our view, the U.S. gas market will not establish equilibrium until 2010,” Ms. Haas said in a research note. “We expect more negative revisions to production guidance in the upcoming months.”

In anticipation of a prolonged period of economic dislocation, most companies Canaccord covers are barely breaking even on an unhedged basis. Ms. Haas noted that in some cases, $45 per barrel oil and $5 per mmbtu gas will likely result in negative cash flow for a prolonged period for producers, which will put pressure on their balance sheets.

Canaccord downgraded Cano Petroleum Inc. (CFW) to “hold” from “buy” and Warren Resources Inc. (WRES) to “sell” from “buy” largely due to margin compression and related balance sheet stress. It recommended companies with the leanest cost structures and strongest balance sheet, highlighting Concho Resources Inc. (CXO) and Arena Resources Inc. (ARD) on the oil side, and EOG Resources Inc. (EOG) and Approach Resources Inc. (AREX) in the gas space.

Canaccord also cut its WTI oil price assumptions for 2009 and 2010 from $62.50 per barrel and $75 to $45 and $60, respectively. It also reduced its NYMEX natural gas price assumption from $7 per mmbtu and $8 to $5 and $6, respectively. This produces across-the-board cuts to its earnings projections and price targets.

Ms. Haas said:

We believe there could be further downside to these estimates based on the current U.S. natural gas glut. We expect gas storage numbers to show weak year-over-year comparisons starting in March, with no relief in sight for 2009.

Comments

[Heaven, Hel...:]

Good point on the hedges which were put in place during 2008 for CAL-09. Without offsetting production, they become speculative positions, which is a gamble in which oil and gas companies should not be engaging. Still, companies do not hedge 100% of their production, so the hedges alone do not explain the positive y-o-y production numbers.

While rig counts have come off, marginal vertical wells have been the main ones targeted. However, there is a much greater proportion of "more prolific" horizontal wells in the Baker Hughes rig count than historically has been the case. While horizontal counts have begun to come off, the pace must accelerate for the rate of supply to decrease faster than the rate of demand destruction, especially with the high level of shale plays coming online now (in which decline rates for individual wells total 80% in the first year of commercial production!).

Feb 25 03:31 PM

[Mmarrkk:]

You may be missing the point. While some companies are forecasting production growth, many aren't. They are forecasting flat production. The ones forecasting growth are the "Shale Have's" in Aubrey McClendon's terminology. Then, you have to factor in the Big Gas guys like COP and BP and XOM and others. While they quote production growth in the very low single digits, this is a worldwide number and doesn't tell you much about their Lower 48 natural gas totals. So, while a HK grows its production at 20% or whatever it is, that's a small drop compared to a COP or BP (#2 and #3 US nat gas producer) that at best will hold relatively flat.

Our nat gas supply/demand imbalance isn't a huge number right now. We are not 20% out of balance, really only a small number. So a small imbalance weighted toward too much gas derives a huge decrease in price. Guess what happens when we get a very small imbalance weighted toward not enough gas? Prices skyrocket. Predicting winter 2009/2010.

Feb 26 09:31 AM

[jack kreg:]

OMG, when will we (USA) convert to LNG fuels in our transportation fleet, cars, buses, trucks, trains, etc.???
-stable supply,
-low cost to producer,
-not OPEC priced,
-priced in ?? north America,
-clean burning,
-available today,
-does not require massive gov subsidy, (as does hybrid)
nice article on pricing,
but it also relates to uses in Americas transportation vehicle fleet.

Feb 26 11:39 AM

[jarco:]

There isn't really any good rationale with gas under 5 and oil under 50 for anybody. Low oil will impact Canadian Tar Sands and subsequent export levels to the US. Buy and hold scenario

Feb 28 06:57 PM