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One of the biggest concerns in the energy market today has to do with the various cuts that are taken place by companies in dry gas drilling. We discussed this issue several weeks ago and since then, more names have been added to the list of companies opting to cut pack on production in a way to manage the current dreadful short term realities impacting the industry. But the question is, has this concern reached its peak, or should investors anticipate more reduction during this all-important earnings season?

One of the first names to draw attention to this issue is Chesapeake Energy (CHK). The company first announced the cut as a means to mitigate the low cost of natural gas. For Chesapeake, according to a recent publication, it plans to halve its dry gas drilling by the second quarter, bringing to 12 the number of Marcellus Shale dry gas rigs that it operates in the region, primarily in northeastern Pennsylvania. It wasn't immediately clear how many the company had operating now, but a spokesman said that Marcellus production would continue. On the subject, the company's CEO said the following:

An exceptionally mild winter to date has pressured U.S. natural gas prices to levels below our prior expectations and below levels that are economically attractive for developing dry gas plays in the U.S., shale or otherwise.

The concern in the industry surrounds the fact that weakness in demand suggests that energy companies are on the verge of being severely weakened economically if the supply and demand for natural gas does not regain its proper balance. These actions, while drastic might be a great way to help stabilize the falling prices, but just how effective they are remains to be seen. In the meantime, investors will be better served to avoid this situation all together until normalcy is restored and thus higher prices over the long term.

Other companies facing similar challenges include Continental Resources (CLR), which recently announced that the company would discontinue drilling in the Arkoma area of the Woodford Shale. This announcement followed led to another firm, CONSOL Energy (CNX) opting to cut $200 million from its capital budget in 2012, lowering spending from $1.7 billion to $1.5 billion for the year. The company cited low natural gas prices due to "mild weather and high production" as the rationale for the cuts. The new names that have been added to the recent rash of cuts include the following:

  • BHP Billiton (BHP) - The company is reducing the number of rigs working in this dry gas area from eight to six due to low natural gas prices.
  • BG Group (OTCQX:BRGYY) - announced a draconian reduction in dry natural gas drilling in the United States for 2012.
  • WPX Energy (WPX) - The company has reduced its capital budget in response to low natural gas prices, and now plans to spend no more than $1.2 billion in capital during the year.
  • Unit Corporation (UNT) - Unit Corporation has already incorporated lower natural gas prices into its capital budget for 2012, and plans to spend $385 million for drilling and completion activities during the year. This is an 11 percent decline from the amount spent in 2011.

I remain hesitant and will avoid jumping into or adding current positions in any of the above firms until all of the uncertainty regarding these measures are addressed. Instead, I have turned my attention to some safer energy plays for the time being. These include the following names:

Schlumberger (SLB)

It is hard to value a company like Schlumberger. The company ranks either number one or number two in terms of market share in an assortment of oil service sub segments. These range from services needed during exploration to those critical for drilling and completion. The company is committed to this market dominance and has made several acquisitions when needed to keep pace in oil services. It recently assured investors that it has a clear plan of execution over the next 5 years. Some of which includes growing market share in various oil service lines, growing earnings per share faster than revenue, establishing the highest margins in the business in North America as well as continuing its strong share buyback and dividend policy.

Halliburton (HAL)

Halliburton often gets mentioned when discussing prominent oil companies, yet with a forward P/E of 8 it intrigues me how the market continues to discount growth potential. From an earnings standpoint, it has steadily demonstrated an ability to beat expectations and deliver on its bottom line. I have a near term price target on the stock of $40 and a 12 month target of $55.

Aside from the benefits it stands to gain as demand increases for more drilling, the company has also been doing pretty well as it relates to its earnings. From that standpoint, there aren't many companies that have fared better and have proven to be more consistent than Halliburton, except maybe Apple (AAPL). It has steadily demonstrated an ability to beat expectations and deliver on its bottom line. It goes without saying that its management will want to continue this trend, and will be doing just about everything under its power to make certain that these types of performances continue.

Exxon Mobil (XOM)

What is not to like with Exxon Mobile, until very recently the largest company in the world. But it's odd that more investors are enamored with HAL. Exxon has huge reserves and plenty of capital, which often is an appealing quality to conservative investors. Not to mention that it has a well earned reputation - something that many of its competitors are working hard to rebuild. Investors should keep in mind that Exxon Mobil is still a dominant player even among the big oil companies.

It has nearly three times the market cap of even the other oil giants, but it is hardly a lumbering, stumbling giant. The company is still in the mix of all phases of upstream and downstream operations, and its portfolio of exploration and production projects should make it able to continue to weather these lean times.

Summary

As unsettling as the cuts in dry gas drilling appears to be at the moment, nobody truly knows what the long term impact will be - because it's too early. I tend to think that order will be restored eventually, just not in 2012. It does not mean that the stocks should be avoided, it just means that due diligence has to be an ongoing process, and (for current holders) diversification is a must.

Source: Exercise Caution With These Energy Stocks