We have talked quite extensively about the growing concerns within the energy markets having to do with various cuts in dry gas drilling. The list of companies opting to cut back on production continues to grow as they position themselves to address the current dreadful realities on the industry. Where at one point there was some optimism that the issue had reached its peak, investors have become disappointed to learn that more names were recently added among the list of those cutting back.
I do however need to make a correction - in a recent article, I included Continental Resources (CLR) as having faced similar concerns when it announced that it would discontinue drilling in the Arkoma area of the Woodford Shale. Although the news is factual, it did not need to be mentioned among the names such as Chesapeake Energy (CHK) who (by and large) had led the charge to where the sector is today - the company has a complete set of issues with which it needs to deal.
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 altogether until normalcy is restored and thus higher prices over the long term.
Other companies facing similar challenges include 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 (OTC: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.
- Ultra Petroleum (UPL) - the company is planning to spend $925 million in capital in 2012, down from the $1.5 billion spent in 2011. The company spending only $625 million in 2012, down 50% from the $1.3 billion of capital spent last year. It said that the drastic reduction in dry gas spending was due to "limited economic returns in the current natural gas pricing environment."
- Talisman Energy (TLM) - plans to reduce drilling in the Marcellus Shale in 2012, cutting its operated rig count from the current level of 10 to as low as three rigs. The Montney Shale will also see cuts, with Talisman Energy reducing its operated rig count here from 11 to four rigs in 2012.
- Encana (ECA) - has set a $2.9 billion capital budget for 2012, approximately 37% less than the amount spent in 2011. The capital plan is designed to minimize investment in dry natural gas areas of its portfolio of assets. The company expects that this reduced investment will cut natural gas production by 250 million cubic feet per day during the year.
- Energen Corp (EGN) - is cutting $45 million from the company's planned investment in the San Juan Basin in 2012. The company plans to finish its highest return wells here by the middle of 2012 and then cease all drilling in this basin. Energen Corp said that the reduction was due to the current outlook for low natural gas prices in 2012.
Several more producers of natural gas have announced reductions in dry gas drilling or production, as the exploration and production industry continues to deal with the weak environment expected for natural gas during the year. But the question is, has this concern reached its peak, or should investors anticipate more reduction during this all-important earnings season?
I remain hesitant and will avoid jumping into or adding to current positions in any of the above firms until all of the uncertainty regarding these measures are addressed. 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.