We went back through our database to determine 2008 breakeven prices (10% rate of return) based on EnerCom's decline curve analysis of the Woodford, Fayetteville, Haynesville and Marcellus Shales. All data points reference the second slide below.
We found the Woodford, Fayetteville, Haynesville and Marcellus Shales had respective breakeven points of $6.45 per Mcf, $5.39 per Mcf, $3.62 per Mcf and $3.42 per Mcf based on the data collected in 2008. During 2008, Henry Hub natural gas prices were trading up near $9.00 per Mcf and companies were realizing prices near $8.00 per Mcf: enter the birth of the resource play and companies driving down costs to make the largest rates of return possible.
What we see as we move closer to the first shoulder months 2012 is Henry Hub and realized natural gas prices falling as inventories are building.
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Never let it be said that the ingenuity of the oil worker cannot improve a play's economics.
The advent and application of new seismic, drilling and completion technologies gives the operator in these gas-rich resource plays an opportunity to generate acceptable rates of return on invested capital.
Case in point is how E&P companies operating in the Woodford, Fayetteville, Haynesville and Marcellus regions have shrunk the disparity between the 2008 numbers above and today's breakeven points of $3.93 per Mcf, $4.19 per Mcf, $3.51 per Mcf, and $2.88 per Mcf, respectively.
Even though the Henry Hub spot price has dropped below even the Marcellus breakeven price of $2.88 per Mcf, companies' hedges are protecting CAPEX programs as companies are realizing better-than-cash prices from their daily production. In any commodity business, the low-cost operator tends to lead the way. Let's examine the Marcellus for example. Low-cost operators such as Range Resources (NYSE:RRC), Cabot Oil & Gas (NYSE:COG) and EQT Corp. (NYSE:EQT) are working to make and keep the Marcellus an economic play. Bear in mind that there has been a shift change in the market place as E&P operators have moved as a thundering herd from dry gas to crude oil and liquids-rich production. Given the current commodity price environment, it is natural for the natural gas producers to make changes to continue to provide a return on investment to its shareholders. Range, Cabot and EQT are no different, except that these companies chose to focus on cost control rather than changing their asset base to incorporate more oil. As of December 31, 2011, natural gas as a percentage of total proved reserves for Range, Cabot and EQT are 79%, 96% and 100%, respectively.
In the current resource play parlance, the next well is usually the company's best well. Looking forward using the NYMEX strip price, and as natural gas hedges continue to roll off, we take interest in asking the question "at what point do some of the largest natural gas operators in the Marcellus (lowest breakeven point in 2011) generate a 10% rate of return." At year-end 2011, we note that Range Resources, Cabot Oil & Gas, and EQT have 3-Year Finding and Development Costs of $0.84 per Mcf, $1.30 per Mcf and $1.13 per Mcf, respectively.
Are low F&D costs important? Yes. Are they the only thing to measure the economic vitality of a company? Not necessarily. F&D costs are part of EnerCom's proprietary Five Factor Model (5FM). We also like to look at what a company is able to do with the drilling investment (F&D costs) in relationship to Capital Efficiency (another part of the 5FM) and Asset Intensity.
Capital Efficiency is the measurement of cash flow generated for every dollar of investment and is calculated as (trailing twelve month EBITDA / trailing twelve month production) / 3-Year F&D cost per Mcfe. For the period ended December 31, 2012, RRC, COG and EQT's Capital Efficiency ratios were: 417%, 267% and 453%, respectively. Said another way, each company generates $4.17, $2.67 and $4.53, respectively, for every $1.00 of investment. Bear in mind that this ratio measures the entire company's cash generation capability not just a single basin.
Asset Intensity is an indicator of how much of a company's annual cash flows that are needed to be reinvested to keep production flat. It is also an indicator of a company's future growth potential. The metric is calculated as trailing twelve month production multiplied by 3-Year F&D cost all divided by trailing twelve month cash flow from operations. For Range (25%), Cabot (48%), and EQT (24%) each company needs to invest less than 50% of its annual cash flow to keep production flat. We note that these are not the only companies with favorable asset intensity metrics but we use these examples to make a point that natural gas prices can be dealt with in certain portions of the commodity cycle provided a company has the assets, cost structure, people, technologies, balance sheet and bull-headedness to make it work. As Ben Franklin was quoted to say: "Energy and persistence conquer all things."